Discovering Buffett’s Edge – How Progressive is the U.S. Federal Income Tax?

An Examination of the Recent History of the Effective Tax Rates of the 400 Highest Income Filers

Part II of a multipart series

Read Part I

Warren Buffett has made a fortune through the shrewd allocation of capital. So far, no one has taken Warren’s million dollar challenge to his fellow dwellers in the penthouse of American wealth. Perhaps that’s because with a performance like this, it hasn’t paid to bet against Buffett. I am sure Buffett knew his proposed bet was likely to be a winning one.

I take a closer look at the data behind Warren Buffett’s challenge in the second installment of this series examining the progressiveness of the federal income tax.

Read on to learn Buffett’s edge and more…

Thanks again to the Tax Policy Center for their treasure-trove of data. The TPC conducted a study of the effective tax rates of the four hundred highest adjusted gross incomes (AGI) earners in the United States. As the tables show, from 1992 to 2005, there has been a significant decline in the effective tax rate paid by the four hundred highest adjusted gross incomes.

The chart below illustrates the distribution of effective tax rates being paid by the 400 highest AGI earners in 1995 and a decade later in 2005. You’ll notice that there has been a very noticeable move lower in the effective tax rates paid by the 400 highest AGI earners from 1995 to 2005.

Click here to open larger image in new window

You can see the effects of several major recent tax bills in 1997, 2001, and 2003 in the following slide show:

To access a full screen version in a new window go to slideshare.

[Note: In the slideshow The Y-axis title should read % of Filers, not # of Filers – I’m just too lazy to change the labels on each slide]

Two of these recent tax bills featured significant reductions in the capital gains and dividend tax rates. In 1997 the top capital gains tax rate was cut from 28% to 20%. With the passage of the Jobs and Growth Tax Relief Reconciliation Act of 2003, the capital gains and dividend rates were again cut; this time from 20% to 15%. The 2003 act also lower the top marginal income tax rate to 35% from 39.6% John McCain has proposed a further cut in the capital gains and dividend tax from 15% to 7.5% as part of his campaign’s economic stimulus plan. In addition to the shifts in 1997 and 2001, there is a visible shift in 2003 which lowered the top marginal tax rate to 35% from the 39.6% rate that was in place at the end of the Clinton administration.

It appears that the reduction in the top marginal tax rate and reduction in the capital gains and dividend tax rate are the driving forces behind the declining average effective tax rate paid by the top 400 earners lower. I suspect one particular peculiarity of the tax code may be an additional contributing factor, but that will have to wait for a future post.

What are Warren’s Chances?

Crunching the numbers, shows 341 of the 400 highest adjusted gross income earners have effective tax rates below 30%, meaning they are paying less as a share of income than Warren Buffett’s $60,000 a year secretary.

Buffett probably wouldn’t have made this bet in 1995; at that point, only 205 (51%) of the 400 highest income earners paid an effective tax rate less than the 30% paid by Buffett’s secretary.

It’s 2008 – Warren likes his chances.

I will be writing more on the ever exciting history of taxation in the United States. In the meantime, take a crack at today’s poll question:

Look for the answer in my next post.

Coming up on SpeciousRiches:

  • More on the History of Marginal Tax Rates in the U.S.
  • The Payroll Tax
  • Regressive, Progressive, and Proportional Taxes – Alternative Taxation Schemes
  • Facts and Falsehoods about Immigration
  • What is the rationale behind progressive taxation? Why don’t we all just pay the same rate?
  • What’s a Credit Default Swap and what did I ever do to them to deserve this?
  • The Gini coefficient – The Growing Issue of Income Inequality
  • A look at how the government spends our money
  • McCain and Obama on Health Care Reform

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Filed under Economics, election, Politics, Tax Policy, Taxes

6 responses to “Discovering Buffett’s Edge – How Progressive is the U.S. Federal Income Tax?

  1. Pingback: Answer to Yesterday’s Poll Question… « Specious Riches

  2. Obama’s tax plan will destroy the Social Security system.

    Obama says his income tax plan will lower taxes for 95% of Americans. There is just one problem with this, 40% of Americans already pay no income tax. Obama’s response to this is that these people pay Social Security tax. Well, that’s not income tax, but a contribution to their retirement plan. So if he wins and implements his tax plan, for the first time in the history of Social Security, 40% of the people who will get retirement benefits will have paid nothing for them. Social Security will then loose all pretext of being a retirement plan, and will become a national welfare program.

    This will cause Social Security to lose public support in a massive way. Leave Social Security contributions out of income tax plans. If you take some peoples income taxes to pay others Social Security taxes, Social Security will be destroyed forever.

  3. Charles, you need to look at the plans a little more closely. There is no cut in the payroll tax proposed.

    Since Social Security was enacted it has relied on one younger person paying another older person’s benefits. We know this is unsustainable; it’s a government sanctioned Ponzi scheme. If anything threatens Social Security it is the fact that it is on a path to insolvency and for decades there has been a conspicuous absence of political will to tackle the problem.

    Would John McCain favor raising the cap on payroll taxes to help ensure Social Security’s future solvency?

  4. RaiulBaztepo

    Very Interesting post! Thank you for such interesting resource!
    PS: Sorry for my bad english, I’v just started to learn this language 😉
    See you!
    Your, Raiul Baztepo

  5. Hello !!! 😉
    My name is Piter Kokoniz. oOnly want to tell, that your posts are really interesting
    And want to ask you: will you continue to post in this blog in future?
    Sorry for my bad english:)
    Your Piter

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