Searching for equality in taxation

Recent graduates, excited by the prospect of finally making money after four years of shelling it out, might have been unpleasantly surprised to notice the effect of income taxes on their first paychecks. It likely wouldn't make them feel any better to know that they might have paid a greater percentage of income in taxes than Warren Buffett, the world's third-wealthiest person. The mega-investor, who has publicized his belief that he is taxed too little, announced in June that in 2006 he was taxed at only 17.7 percent, adding for reference that his receptionist was taxed at about 30 percent.

Such gaps in tax rates are instances of the reversal of the progressive tax system, which is designed so that those with higher incomes pay a higher fraction in taxes. The reason why Buffett paid a much lower percentage is that most of his $46 million taxable income was in the form of capital gains, meaning profits incurred from the sale of stocks, bonds or other assets. Under the current system, longterm capital gains are taxed at only 15 percent, with the result that even though Buffett's salary is taxed at the maximum rate of 35 percent, the ultimate tax rate paid on his total income is only about half that.

Buffett is correct to believe that he isn't taxed enough. It is inherently unfair for a group of wealthy individuals, in this case those for whom capital gains amount to a large portion of income, to be taxed at a lower rate than those who aren't as well off. Individuals who earn less money spend larger portions of their incomes on necessities like food and shelter, and have less money left over to invest or spend on luxuries. Taxing the wealthy a lower percentage amounts to valuing the freedom of the wealthy to do what they want with their surplus income above the freedom of those less well off to enjoy what, if any, money they have left over after necessities are covered.

Of course, economic policies are ultimately judged not by how fair they seem, but rather by how effective they are at fostering growth. Any first-year economics student can recite the argument that keeping taxes low leads to investment and spending and is thus beneficial to the country's economy. But if an unfair tax policy isn't positively impacting the economy, it makes little sense to preserve that policy if options exist that are fairer while still economically viable.

Enter Rep. Charlie Rangel (D-N.Y.), chairman of the House Ways and Means Committee. Last month, Rangel introduced comprehensive tax legislation that, among other things, would roll back the Bush tax cuts that gave rise to unfairness by decreasing the burden on the nation's wealthiest. Rangel is well aware that under the current administration such a bill would never be signed into law, but he is content for the time being to let his proposal function as a thorn in policymakers' sides, forcing them to question the status quo.

Rangel's policy would increase the tax burden on the nation's wealthiest not only by raising their tax rate, but also by working to eliminate the culture of loophole-finding that the current tax system has created. Hedge fund managers, for example, are currently able to defer tax payment for years by letting their money multiply in offshore accounts. According to John Bogle '59, the founder of the investment management company Vanguard Group, "We pile advantage on advantage for these managers and there doesn't seem to be any economically logical basis for it." Eliminating economically neutral loopholes and consequentially bringing the tax rate paid by a wealthy individual closer to the 35 percent income tax rate is exactly the sort of fairness-inducing measure discussed above.

Warren Buffett can rest assured that his tax rate will increase if a Democrat is elected president next year. The capital gains tax will at least return to the 20 percent level it was at before the Bush tax cuts when the cuts expire, and any new Democratic tax policy would raise the income tax rate paid by the very rich and at least partially eliminate the loopholes that many of them currently use to pay less. There will of course be extensive debate about the effects of any proposed tax policy on economic growth, but any Democratic tax policy will at least not foster inequality in the way that the current Republican system has, which is a moral advantage if not an economic one. Michael Medeiros is a sophomore from Bethesda, Md. He can be reached at mmedeiro@princeton.edu.