Warren Buffet, Mitt Romney, and their secretaries

Okay, so this place is obviously becoming a repository for missives I wind up writing elsewhere, but whatever; it's better than the nothing I've been posting here the last few years.

I've remarked in a couple of places in the last few days that arguments regarding the supposedly low tax burdens of the wealthy are intellectually dishonest and have gotten responses that led to longer, more detailed analyses.

Here's the first:
“That number doesn't take into account the corporate taxes that these people already paid before their capital gains ever made it into their hands.

Let's say someone makes $50,000 and pays $10,000 in taxes. His tax rate is 20%.

Let's say another guy makes $50,000 from his regular job, but also owns 10% of a business that makes a profit of $5M. That business then pays 30% of that in taxes and returns the rest to the investors; so the guy get's $350,000 (10% of 70% of $5M) in capital gains, on which he pays a 15% tax of $52,500.

These guys like Newt and Warren Buffett and Barack Obama and the people reporting on Mitt's taxes cry foul and say that the guy who made $50,000 paid 20% while the guy who made $400,000 only paid 15.5%, or $62,500 of his $400,000 income. This doesn't take into account the fact that he already paid 30% on his investment income through corporate taxes before he even got the capital gains which were then taxed another 15%. His real tax bill was $150,000 + $52,500 + $10,000 = $212,500 of the $550,000 that he really made, or 38.6 percent.

In using the term intellectually dishonest, I'm assuming that these people all get this and present it dishonestly for their own ends. I may be being a little harsh on the journalists who quite likely just don't get it and wouldn't understand if 100 people explained it to them, but Newt, Buffett and the president know exactly what they're doing; they are liars.

That said, as long as the tax system is set up the way it is, it will be impossible to keep liars from lying and misrepresenting what's going on. I would be happy either with eliminating the capital gains tax altogether or, better yet, eliminating the corporate income tax and taxing capital gains as regular income. Either one would eliminate the perceived problem, but then, I don't think that's the real goal of the people who insist on declaring that they pay lower taxes than their secretaries.”

On facebook, someone responded to my similar remarks with:
“Did Slick Willard pay those corporate income taxes or did Bain Capital pay them? Is the corporation a separate legal entity or not? Because if it is, then it SHOULD be taxed as a separate entity! If Slick Willard pays 15% on his capital gains and then uses the after-tax income to pay his housekeeper enough to put her in the 15% tax bracket, do you think she can honestly claim to be paying a 30% tax rate? If not, then why does Slick Willard get to play the martyr because he paid taxes for himself on the money Bain paid him out of its own after-tax proceeds? Other than, of course, the fact that he's a member of the aristocracy and all us dirty peasants need to shut up about the affairs of our betters.”

Here is my response. Jason is the guy on whose wall I was posting, Andy is an economist who regularly disagrees with me, and Alan is the guy to whom I was responding:
"Jason, I apologize for puking a 800 words of econ all over your wall, but it’s a rare slow day at work that didn’t require me to work while I ate my lunch; so I figured what the hell. It won’t hurt my feelings in the least if you want to delete. As a disclaimer, much of the more detailed analysis I’m about to post is simplistic, unresearched, barely thought out at all, and drawn from concepts learned long ago that I might be hazy on, in particular the part about income versus substitution effects. Someone better versed in the subject than I am - paging Andy Balthrop (Andy, feel free just to point out my most egregious errors or not to take the bait and get drawn into a facebook fight at all) – should feel free to correct me if I’m wrong, but I don’t think any of the places I might have been mistaken would be enough to substantially alter my argument. If they are, I reserve the right to backtrack, crawfish, or otherwise revise my statements in order to save face.

Alan, whether they are separate legal entities is irrelevant to the moral question of whether it's "fair" for someone to suffer a lower tax burden, as a percentage of what they've earned, and central to that moral outrage should be the question of whether that's even actually the case.

There is a depressingly large set of people who have decided to eschew any real economic theory and assume that any decrease in corporate taxation goes entirely into the pockets of the wealthy with zero benefit to anyone else, and I won’t assume you’re among them, but if they’re right, then of course there’s every reason to attribute Mitt’s corporate taxes to his having “paid his fair share” and no reason to consider these taxes when considering the burden that falls on his employees. That’s not, however, the case; so your argument bears consideration.

First, though, the housekeeper is probably not the best subject for making your case. She operates as a business herself and faces a demand curve that is determined by an income effect and a substitution effect. The substitution effect would be relevant if we were talking about adding taxes to Mitt’s salary, as it would lower the opportunity cost of his time, but the culprit here is the taxes on his company and capital gains, which doesn’t have the same impact; so the substitution effect is fairly trivial. The income effect is a bigger portion of the demand curve she faces (and thus the price she can charge), but her services would have to be among the lowest priority services millionaires were willing to pay for out of their budgets. Since most people are employing housekeepers well before they reach Mitt’s level of wealth, it’s safe to assume neither of these effects would be significantly impacted by higher tax rates on her clientele. Yacht builders, however, should probably account for corporate taxes and capital gains taxes of their customers as part of their tax burdens, though it’s mitigated by the fact that they also avoid the costs of building the yachts that aren’t purchased.

A better example for your argument would be one of Bain’s employees. Incidence of tax isn’t exactly a straightforward calculation and would require intense, industry- and firm- specific research to nail down, but employees of Bain should absolutely consider a portion of Bain’s corporate taxes in thinking about their own tax burdens, but it’s still a much smaller consideration than it is for the owners of the company. The increased cost of doing business that Bain faces as a result of its corporate taxes impacts the amount that they are able to pay their employees because it impacts the marginal value of each unit of effort that each employee puts forth. Still, this is a relatively small impact because the bulk of an employee’s pay is determined by the value he produces over that of the next best competitive alternative, which would be the next most talented employee they could hire. Because of this, the impact of the corporate taxes on the employees is much lower, as a percentage than it is on the company owners. For the record, anyone who uses Bain’s services or anyone who uses the services of those who use Bain’s services, and so on to lesser and lesser degrees, should consider Bain’s corporate taxes as part of their tax burden.

That said, Mitt is not an employee of Bain; he is an owner. If he owns 10% of Bain, he is entitled to 10% of disbursed profits in exactly the same way he would be entitled to 100% of disbursed profits of a lawn mowing company of which he owned 100%. As such, any tax that diminishes the profits of Bain diminishes his own well-being, and it’s dishonest to exclude that from a moral argument about whether he has paid his fair share. If Bain makes a $50M profit, and corporate taxes take that to $30M before Mitt gets his 10%, then that is $2M that should be included in any fair assessment of his tax burden. Without the tax, he’d have made $5M, and because of it, he only made $3M.

On a tangentially related note, it’s a bit of a leap even to consider a system where the wealthy pay a smaller share of their income in taxes unfair. To start, there are good cases to be made that the wealthy consume government services as a percentage of income at a much lower rate than others. There are also very strong cases made by philosophers and economists for centuries that a tax on consumption is both fairer and more economically sensible than a tax on income. Such a system would be undeniably regressive, since the wealthy dedicate significantly lower portions of their income to consumption than a very poor person, who spends nearly every penny he earns."