Saturday, July 5, 2008

Does Warren Buffett's Secretary Have a Higher Effective Tax Rate than Him?

On her Atlantic blog ("Tax talk"), Megan McCardle writes,

And [University of Chicago Economics Professor and erstwhile Obama economic adviser Austan] Goolsbee justly points out that under the current system, Warren Buffet's secretary has a higher average tax rate than he does.


To be precise, Megan writes "average" tax rate, but since the effective tax rate represents the percentage of one's income that one actually pays in taxes, I assume she meant effective tax rate1. Does Buffett's secretary (I've also heard the claim made about his housekeeper) have a higher effective tax rate than him? I'm skeptical about this.

According to these data from the non-partisan Congressional Budget Office, effective federal tax rates in America (taking into account payroll taxes as well) are highly progressive. In 2005, the lowest quintile of earners had an average effective federal tax rate of 4.3%, and the highest quintile had an average effective federal tax rate of 25.5% (the top 1% paid 31.2%). It's possible that the ultra-wealthy such as Buffett have lower effective tax rates than the top 1%, because nearly all of the income of the ultra-wealthy comes from capital gains, but I doubt the ultra-wealthy have lower effective tax rates than housekeepers and secretaries. I'd be more inclined to believe that Buffett's physician has a higher effective tax rate than him than that his housekeeper does. Perhaps Buffett will make public his and his secretary's and housekeeper's tax returns so others can verify this.

In the meantime, the issue of Buffett's taxes versus his secretary's taxes raises a couple of meta-questions:

- Does it make sense to make tax policy based on a small number of outliers such as America's multi-billionaires?

- Would proposed changes in tax policy materially affect these billionaires?

The answer to both questions appears to be "no". Multi-billionaires have far more control over how and when they get paid -- and how and when they get taxed -- than any other tax payers. I doubt Buffett's taxes will be materially affected by any tax code changes made in Washington next year.

The real impact of any changes in tax policies will fall mostly on the "working rich": the surgeon, high-end salesman, or other worker making $250k-$500k+. There will be little if any impact on the Buffetts of this country. Buffett, I would think, knows this, but he is politically savvy enough to position this as an issue of the super-wealthy such as himself paying their 'fair share'. Whether Buffett really thinks he doesn't pay enough in taxes is another question. Two data points suggest otherwise.

The first is Buffett's occasional boasting in his annual letters to Berkshire Hathaway shareholders about how much Berkshire (of which Buffett remains the largest individual shareholder) pays in federal taxes. This, for example, is from his 2006 Letter:

Berkshire will pay about $4.4 billion in federal income tax on its 2006 earnings. In its last fiscal year the U.S. Government spent $2.6 trillion, or about $7 billion per day. Thus, for more than half of one day, Berkshire picked up the tab for all federal expenditures, ranging from Social Security and Medicare payments to the cost of our armed services. Had there been only 600 taxpayers like Berkshire, no one else in America would have needed to pay any federal income or payroll taxes.


The second data point that suggests Buffett isn't really worried that he pays too little in taxes is the method in which he makes his generous donations to the Gates Foundation. Currently, Buffett donates shares of Berkshire Hathaway to the foundation. If Buffett were truly concerned that he didn't pay enough in taxes, he could easily remedy this by selling his Berkshire Hathaway shares first, paying the capital gains taxes on the sales, and then donating the net cash proceeds to the Gates Foundation. Presumably, Buffett donates the shares instead because he feels he pays enough in taxes already, or because he feels that the Gates Foundation will spend his money more wisely than the federal government will. Whatever the reason, avoiding the capital gains tax by donating the shares is inconsistent with Buffett's lamentations about not paying enough in taxes.


1Update: The phrase "average tax rate" is a synonym for the phrase "effective tax rate". Thanks to commenter Jason for indirectly pointing that out.

7 comments:

Jason said...

Megan McCardle DID mean average tax rate! I don't even know who she is, what she was talking about, or how the heck I came across your blog but this is embarrassing. There are fundamental and calculative differences between one's effective and average tax rate. I'm only 22, please don't let people like me school you on your own website.

DaveinHackensack said...

Jason,

"Average tax rate" means the same thing as "effective tax rate"; they both refer to the actual taxes one pays divided by one's pretax income. See, for example, this definition of Average Tax Rate and this definition of Effective Tax Rate. In your comment you seem to be confusing "effective tax rate" with "marginal tax rate". Thanks for your comment though. I'll update the post to note that "average tax rate" is another way of saying "effective tax rate".

kevin said...

Buffett includes FICA and SECA in his calculation. My federal income tax rate was about 6.5% last year, but when you add in FICA and SECA it jumps to about 20.7%.

DaveinHackensack said...

"Buffett includes FICA and SECA in his calculation."

The CBO data I quoted in the post take into account FICA taxes. I'm not sure why Buffett's secretary would have to pay SECA though, which is generally for self-employed business owners.

kevin said...

You are correct, it's technically not SECA because the company pays it on your behalf. Nonetheless, he includes it his calculation. I just said SECA because it is the half you would half to pick up if you were self employed.

So I pay 7.65%, my employer pays the other 7.65%, for the total of 15.3%. You then have to adjust you income up 7.65% when you go to calculate your tax rate. So say I make 50K and pay an income tax rate of 10%. Then the total according to Buffett (since I am below the SS wage base) is (10%+15.3%)/1.0765 = 23.5%.

If you make more than the SS wage base, you have to change the calculation to take into account that the OASDI is capped.

So between most of his income being taxed at the capital gains rate and the capping of the OASDI on the portion that is taxed as regular income, you can see how his statement could be true using his formula. So then the question becomes wether or not his formula is appropriate. Hope this helped.

DaveinHackensack said...

Kevin,

As I mentioned in the post, as well as in my previous comment, the CBO data takes into account payroll taxes. To clarify and expand on that, the CBO includes both the employer and employee portion of the payroll taxes in its calculation. I am aware, as is the CBO, that OASDI is capped at the Social Security wage base (and that the Medicare portion of the payroll tax is not). From the CBO site:

"CBO’s analysis of effective tax rates assumes that households bear the burden of the taxes that they pay directly, such as individual income taxes (including taxes on interest, dividends and capital gains) and employees’ share of payroll taxes. The analysis assumes—as do most economists—that employers’ share of payroll taxes is passed on to employees in the form of lower wages than would otherwise be paid. Therefore, the amount of those taxes is included in employees’ income, and the taxes are counted as part of employees’ tax burden."

Now, taking into account both the employer and employee portion of the payroll taxes, the CBO still found that, in 2005, the fourth quintile of earners (who average $85k in pre-tax earnings) had an effective tax rate (taking into account all federal taxes, including income taxes and the employer and employee portion of the payroll tax) of 17.4%. So if Buffett's secretary makes $85k, it seems possible, though highly unlikely, that she has a higher effective federal tax rate than Buffett.

If Buffett's secretary is instead in the middle quintile of earners (average income of $58,500) which had an average effective federal tax rate of 14.2% in 2005, it would seem even less likely that she has a higher effective federal tax rate than Buffett, considering that the capital gains tax rate itself is higher than that (15%).

As I wrote in my initial post,

"It's possible that the ultra-wealthy such as Buffett have lower effective tax rates than the top 1%, because nearly all of the income of the ultra-wealthy comes from capital gains, but I doubt the ultra-wealthy have lower effective tax rates than housekeepers and secretaries. I'd be more inclined to believe that Buffett's physician has a higher effective tax rate than him than that his housekeeper does. Perhaps Buffett will make public his and his secretary's and housekeeper's tax returns so others can verify this."

Jeff said...

http://www.washingtonpost.com/wp-dyn/content/article/2007/06/27/AR2007062700097.html

According to the washington post, which is quoting Warren Buffett himself,
"NEW YORK, June 26 -- Warren E. Buffett was his usual folksy self Tuesday night at a fundraiser for Sen. Hillary Rodham Clinton (D-N.Y.) as he slammed a system that allows the very rich to pay taxes at a lower rate than the middle class.

Buffett cited himself, the third-richest person in the world, as an example. Last year, Buffett said, he was taxed at 17.7 percent on his taxable income of more than $46 million. His receptionist was taxed at about 30 percent. "