Warren Buffett Tax Plan Stifles Economic Growth

Editor’s Note: This is the final article of a three-part series on U.S. tax reform. To read Part 1 on corporate tax reform, click here. To read Part 2 on income tax reform, click here.

A critical component to any economic recovery is incentivizing capital investments and entrepreneurial activity in the private sector.

Both parties have recognized this in the past and crafted legislation to foster such an environment. Even today, President Obama will soon sign the recently passed JOBS Act – a bipartisan bill that would make it easier for small companies to go public by providing them a temporary reprieve from Securities and Exchange Commission regulations, removing SEC restrictions preventing small businesses from using advertisements to solicit investors, and removing SEC restrictions on “crowdfunding” so entrepreneurs can raise equity capital from a large pool of small investors.

But the Obama administration is seeking to hike the capital gains tax rate to its highest level since 1978, all in the name of “fairness.” Such a move will not only be unfair to the business owners and startups taking risks to create jobs, but also counterproductive to raising revenues and will only stifle investment and entrepreneurial activity.

The U.S. economy is still hobbling out of recession, middle class family incomes are falling and 12.8 million Americans are unemployed, yet Obama declared that his top priority is not to reform the tax code to promote growth and job creation. His overriding goal is redistributing income so that everyone “pays their fair share.”

Obama’s argument, personified in Warren Buffett’s returns vs. his secretary’s, is that taxes on the wealthy are lower than on the middle class. In fact, the Congressional Budget Office notes that the effective income tax rate of the richest 1% is 29.5% when including all federal taxes, or about twice the 15.1% paid by middle class families.

This is because the wealthy make most of their income from investments. Such income is taxed once at the corporate rate of 35% and again when it is passed through to the individual as a capital gain or dividend at 15%, for a highest marginal tax rate of about 44.75%.

This double taxation is one reason the U.S. has long had a differential tax rate for capital gains. Another reason is because while taxpayers must pay taxes on their gains, they aren’t allowed to deduct capital losses except against gains in the current year. Capital gains also aren’t indexed for inflation, so a lower rate is intended to offset the effect of inflated gains.

One implication of passing “the Buffett rule” is that all millionaire investment income would be taxed at the shareholder level at a minimum rate of 30%, up from 15% today. The tax rate on investment income from corporations would rise to 54.5% from 44.75%, a punitive tax on startup or expanding businesses.

The new 30% capital gains rate would be the third highest in the world, behind only Denmark and Chile, on top of the 39.2% corporate tax rate (when including state and local taxes), now the highest in the world. This will only push hundreds of billions of investment dollars overseas to global competitors. Lower capital investment in the U.S. means less wage growth, and so the people hurt most by this tax hike would not be employers, but wage earners.

Obama has conceded that the U.S. needs to lower its corporate tax rate to stay competitive globally. Yet he misses the crucial point that business owners assess the combined corporate and capital gains tax on business profits. Lowering the corporate tax rate makes the U.S. more competitive, but the tax change is self-defeating if it is combined with an even larger rise in investment income taxes on capital gains and dividends.

Obama would be going against 35 years of bipartisan tax policy that began with the passage of the Steiger Amendment by a Democratic Congress that cut the capital-gains rate from 35% to 28% in 1978. Democratic President Bill Clinton cut the rate even further to 20% after signing the Taxpayer Relief Act of 1997 as part of the balanced budget deal with the Newt Gingrich-led Republican Congress. Capital gains revenues soared afterwards, from $62 billion in 1996 to $109 billion in 1999, helping to balance the federal budget for the first time in 30 years.

During a Democratic primary debate hosted by ABC News four years ago, Charlie Gibson asked then Senator Obama why he would support raising the capital gains tax when, as he correctly pointed out, capital gains revenues only went up every time the tax rate was cut, and went down every time the tax rate went up. Obama replied, “I would look at raising the capital gains tax for purposes of fairness.”

So the government loses out on revenues, job seekers lose out on employment opportunities, entrepreneurs lose out on startup businesses, and America loses out on investment and growth.

In other words, everybody loses. Fair enough?