It's Easy for You to Say

It's Easy for You to Say
By Ross Kaminsky on 8.16.11 @ 6:09AM

In a Monday op-ed in the New York Times, billionaire Warren Buffett​ called on Congress to "stop coddling the super-rich [and] … raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains." That's easy for Buffett to say, now that he has about $50 billion to his name. But beyond the gall of a billionaire wanting to make it harder for everyone else to get rich, Buffett's arguments range from misleading to ridiculous.

First, the idea that the "rich" have been "spared" by changes in the tax code is preposterous. The Bush tax cuts made the American income tax system its most progressive -- which is to say most penalizing of success -- ever. The share of federal income taxes paid by the top 1% of earners rose from about 34% in years 2000-2002 up to 40 percent in 2007, dropping slightly to a still nose-bleedingly high 38% due to the economic turmoil and recession in 2008.

While the bottom 50% of earners pay less than 3% of all income taxes while making about 13% of national income, the evil top one percent who pay almost 40% of all taxes earn about 20% of national income. On a percentage of national income basis, the "rich" pay almost twice as much in taxes as they earn. What argument, other than one which Karl Marx​ or Paul Krugman (pardon my redundancy) might make, can possibly justify claiming that the rich aren't paying "their fair share"?

Furthermore, as Hauser's Law shows, at least with our nation's current tax system which excludes a national sales tax, the federal government's ability to collect more than about 20% of national income, regardless of changes in the tax rate, is extremely limited. In other words, data does not support the theory that raising tax rates will raise federal tax income.

And that's particularly true for capital gains taxes, the "low" rate for which seems to be the particular burr under Buffett's tired old saddle.

Democrats often claim the Clinton years as proof that higher taxes don't damage economic growth. They hope and believe, not without some justification, that Americans will forget that Clinton passed two very different pieces of tax legislation: the 1993 income tax rate hikes and the 1997 capital gains tax cuts.

While each bill contained other provisions, the key aspects of the 1993 bill were:

• Increasing the top marginal income tax rate from 31% to 36%, with a 10% surcharge for a total of 39.6% for those earning over $125,000 as an individual or $250,000 as a married couple filing jointly.

• Raising the portion of income subject to Social Security taxes and removed the cap on income subject to Medicare taxes.

As J.D. Foster of the Heritage Foundation notes, "According to the original Treasury Department estimates, the Clinton tax hike was to raise federal revenues by 0.36 percent of gross domestic product (GDP) in its first year and by 0.83 percent of GDP in its fourth year."

An early look at the results of the 1993 law in a study published by Martin Feldstein and Daniel Feenberg said that "high-income taxpayers would have reported 7.8 percent more taxable income in 1993 than they did if their tax rates had not increased… [T]his decline in taxable income caused the Treasury to lose more than half of the extra revenue that would have been collected if taxpayers had not changed their behavior."

Furthermore, according to a 1996 report of the Joint Economic Committee:

According to IRS data, the income generated by the top one percent of income earners actually declined in 1993. This decline is especially significant since the retroactivity of the Clinton tax increase in that year limited the ability of taxpayers to deploy tax avoidance strategies, temporarily resulting in an increase in their tax burden. Moreover, according to the FY 1997 Clinton budget submission, individual income tax revenues as a share of GDP will be lower during the first four years of the Clinton tax increase, which include the effects of the 1990 tax increase, than under the last four years of the Reagan tax changes (FY 1986-89).

But perhaps the knife in the heart of the tax-raisers' argument is Feldstein's:

[The] deadweight loss associated with the 1993 tax rate increases is nearly twice as large as the net revenue raised by those increases. This means that for every dollar of additional revenue collected by the government as a result of the higher tax rates, taxpayers experience a decline in their well-being equivalent to $3 as a result of the induced changes in work, in the form of compensation, and in tax deductible expenditures.

In case Democrat Buffett wouldn't take Republican Feldstein's word for it, perhaps The Oracle of Omaha should listen to Christina Romer, Barack Obama​'s former chairman of the Council of Economic Advisers. She wrote, in a paper co-authored with her husband, that "exogenous tax increases have a large, rapid, and highly statistically significant negative effect on output." And further, "an exogenous tax increase of one percent of GDP lowers real GDP by roughly three percent."

And this is Buffett's prescription for a healthy economy?

(Note for econ geeks: The Romers also specifically say that tax hikes designed to reduce a deficit are exogenous but add that tax increases implemented for that reason may not have quite as negative an impact as other exogenous tax hikes if they have "expansionary effects through expectations and long-term interest rates, or through confidence." However, since few investors actually believe that raising tax rates will cause our deficit to go lower, as compared to the impacts of spending reductions, my belief is that tax increases to address the deficit fall fully into the Romers' exogenous category without requiring further clarification. After all, as Milton Friedman​ told us, "Politicians will always spend every penny of tax raised and whatever else they can get away with.")

Now let's look at the 1997 Clinton tax bill, the key provision of which was to lower the top capital gains rate from 28 percent to 20 percent. The bill also raised the estate tax exemption and established Roth and education IRAs, along with other relatively less important provisions.

Buffett asserts that he "has yet to see anyone shy away from a sensible investment because of the tax rate on the potential gain." This sounds remarkably like the late New Yorker magazine film critic Pauline Kael​ whose most famous utterance is often paraphrased as "I don't know how Richard Nixon​ could have won. I don't know anybody who voted for him."

Warren, your anecdotes are not data. So, instead, let's look at some data:

According to Heritage's Foster:

In 1995, the first year for which these data are available, just over $8 billion in venture capital was invested. Venture capital is especially critical to a vibrant economy because high-risk/high-return investment permits promising new businesses to blossom, rapidly spreading new technologies and new ideas into the marketplace and across the economy. Such investments, when successful, generate returns to investors that are subject primarily to the tax on capital gains. By 1998, the first full year in which the lower capital gains rates were in effect, venture capital activity reached almost $28 billion, more than a three-fold increase over 1995 levels, and by 1999, it had doubled yet again.

To be sure, the rise of the Internet had a substantial impact on the growth of venture capital at that time, but the development of the Internet to what we know today was certainly enabled by the willingness of investors to take more risk due to a lower penalty for success, i.e. a lower capital gains tax rate.

It wasn't just investments which were unleashed; the tax cut caused a tsunami of revenue for the federal government along with increasing economic growth.

Again, J.D. Foster: "According to Treasury's original estimates, the 1997 tax cut was relatively modest, amounting to just 0.11 percent of GDP in its first year and 0.22 percent of GDP by its fourth year. In 1997, the fourth-year effect would be roughly equivalent to a reduction in the overall tax burden of about $30 billion."

But, as Peter Ferrara pointed out in a 2010 article (which contains many other examples of capital gains tax cuts yielding increased tax revenue), "in 1997, Congress cut the capital gains tax rate from 28% back down to 20%. Despite this almost 30% cut in the rate, capital gains revenues rose from $62 billion in 1996 to $109 billion in 1999. Revenues over the period 1997 to 2000 increased by 84% over the projections before the tax cut."

Gross Domestic Product growth during the Clinton years was a full 1% per year higher during the four years after the capital gains tax cut than the four years before it. Real wages increased dramatically, as did the value of the stock market. Moreover, the early part of the Clinton years represented a recovery from recession, during which growth should have been faster than it was. And the later part of the Clinton years would typically have been a period of slightly slowing growth following that recovery; instead growth increased following the capital gains tax cut. In other words, the evidence is strong that the 1993 tax hike hurt the economy and federal tax receipts and the 1997 tax cut helped them. And the evidence is conclusive that the 1993 tax hike raised much less money than its supporters predicted whereas the 1997 tax cut brought in a deluge of money after its detractors and the government's static modelers predicted it would reduce federal revenue.

In short, Buffett's prescription is economic snake oil at best, poison at worst. Again, recommending higher taxes is easy for him to say, as he earns more in a month than many Americans will earn in a lifetime.

It's also worth noting that Buffett, who says his $7 million tax bill in 2010 was unfairly low in percentage terms when compared to others in his office, forgets that his long-term investments were (mostly) made with income on which tax was paid when it was earned. This is of course no different than the rest of us who are fortunate enough to be able to make long-term investments. These investments then allow others to create jobs and grow the economy. It's remarkable how the left talks about capital gains taxes as if the activities which create capital gains are non-productive at best and a form of exploitative class warfare at worst when they are in fact the highest octane fuel for our economic engine.

Analysis of the Bush tax cuts offers similar conclusions, namely that they did not reduce revenues in any substantial way, and that they increased economic growth. Perhaps the most straight-forward discussion of the Bush tax cuts and the myth that they were the primary cause today's deficits comes from a Tax Foundation note which shows that even using static modeling, the Bush tax cuts are only responsible for 16% of the swing from surplus to deficit which occurred between 2001 and 2011. Forty-four percent was caused by increased spending and another 28% by "technical corrections," which means that prior guesses about economic growth were too high. Again, even that 16% number is too high because it ignores economic growth caused by the cuts. And, "the Bush-era tax cuts have been declining as a contributing factor to the swing to deficits.… [I]n 2011, the Bush-era tax cuts account for only 6 percent of the current swing to deficits."

But data and common sense be damned. This is, despite Buffett's posturing, not about economics. It's about ideology. After all, President Obama​, who frequently seeks Buffett's economic advice, famously said that even if raising capital gains taxes would decrease federal revenue, he would still "look at raising the capital gains tax for purposes of fairness."

Buffett attributes low recent job growth to low tax rates following the Bush tax cuts, but nobody with a shred of data or common sense could believe such an argument. Poor job creation in recent years is due to many factors, most of them caused by government, such as bubble-producing multi-year periods during which the Fed held interest rates too low, out-of-control government spending, and the massive economic turmoil and recession caused by the collapse in the mortgage market (a collapse that was far more a failure of government than of markets, but that's another story).

The supercilious Buffett, feeling good about giving away his own fortune, is suggesting that government prevent the rest of us from ever earning one.

There's one more point to make here: As Milton Friedman told us, the proper measure of the burden of government is spending, not taxes and certainly not the deficit. Even if raising tax rates did raise revenue, which it doesn't, supporting tax hikes is just another way of supporting an ever-growing government. No, Mr. Buffett, the American people are sick of big-spending government and its enablers among the supercilious left-wing "millionaires and billionaires" who are oh-so-generous with other people's money.

Warren, please go back to what you're supposed to be good at. Perhaps if you spend more time working and less time encouraging the government to loot the rest of us, you can get your stock price back to outperforming the S&P 500, something it hasn't done since you started palling around with Barack Obama. Coincidence? I think not.