As the tax filing deadline of April 17 approaches, President Obama is again calling on Congress to implement the Buffett Rule, the principle that millionaires should not pay a smaller share of their income in taxes than what is paid by middle-class families. In short, the key element of tax fairness embodied by the Buffett Rule is that effective tax rates should rise with income. But, because high-income households often receive a large share of their income from dividends and capital gains, and because dividends and capital gains are taxed at lower rates than earned income, income tax rates actually start falling at high income levels. The Buffet Rule addresses this problem.
The Internal Revenue Service Statistics of Income data show that in 2007, average effective income tax rates began falling for returns with adjusted gross income (AGI) above $2 million. Returns with more than $10 million in AGI paid roughly the same tax rates as returns with $200,000 to $500,000 in income. The 400 highest income returns—with more than $138.8 million in AGI—paid considerably less, with an average tax rate of just 16.6 percent. Dividends and net capital gains accounted for 73.4 percent of AGI for these highest income 400 returns, explaining why their average effective tax rate is so close to the preferential 15 percent rates on unearned income.
The cleanest way to implement the principle of the Buffett Rule would be to once again tax income derived from dividends and capital gains like all other kinds of income, which would help restore fairness to the tax code and raise much-needed revenue.