A Wall Street Journal opinion piece makes a flawed attempt to rationalize Mitt Romney’s tax rate of "probably closer to the 15% rate than anything," as well as to rationalize the tax rates paid by wealthy people in general.
The first flaw in the logic of the article is the assertion that income taxes corporations pay from their own treasuries as a result of their own profits should be attributable to the corporations’ shareholders. By that logic, an investor in the top tax bracket who took long-term capital gains in the stock of a company subject to the highest corporate tax rate (35%) should have a tax of 44.75% attributed to that investor for that gain (the 35 cents on the dollar that the corporation paid “off the top” plus the 15% the shareholder paid on the “remaining 65 cents”
{15% x .65 = 9.75%; 9.75% + 35% = 44.75%}). This argument has limited merit for three reasons.
Reason One: the corporate taxes don’t come from out of the investors’ pocket.
Suppose Company A pays 35% taxes and Company B pays 10% taxes.
If Investor Z buys stock in Company A for $40 and sell it for $50, how is that different than buying Company B stock for $40 and selling it for $50? There’s no difference at all. Company A can no more come back to Investor Z and say “I want $3.50 of your $10 gain to cover our taxes” than Company B can claim $1 from Investor Z for the same reason.
Reason Two: corporate taxes don’t reduce the return on an investment, they reduce the price of the investment.
The only 2 bottom-line reasons that give a company’s stock any value at all are expectations of:
(1) the growth of the company’s net earnings.
(2) the maintenance and growth of company’s dividend payout.
Both expectations are limited by the company’s tax burden.
Thus, when you buy a company’s stock, you demand that the price reflect this limitation. When you sell, the investor you sell it to also expects corporate taxes be “baked in” to the price.
Stockholders, especially the super-rich and their money managers, (who set and move the prices of all publicly-traded stocks) are acutely aware of how taxes effect various companies and they don’t trade any stocks without paying/receiving the right net-of-tax-effect price per share.
Reason Three: The CBO website, where the WSJ writer(s) got the statistics for the piece, even admits that there attributing corporate income taxes to corporations’ owners is a debatable practice. The statistical source says on Page 4 of their report summary:
“Far less consensus exists about how to attribute corporate income taxes (and taxes on
capital income generally) [than other forms of taxes]. … Over the long term, however, some
models suggest that at least part of the burden falls on labor income.” [emphasis mine]
There are any number of ways a corporation a corporation could use its income if it weren’t taxed: pay its executives more, pay its rank-and-file more, build a rainy day fund, build a new factory, hire more people, or charge a lower price to customers. Why not attribute corporate tax effects to all these stakeholders?
The reason: it’s impossible.
At the end of the day, the CBO is tasked with attributing federal corporate income taxes to households using samples of income tax returns. From those samples, it’s pretty easy to identify people who sold stock in Company XYZ. It’s much harder to identify Company XYZ’s other stakeholders, like its customers or the workers that weren’t hired because the company had to pay taxes instead.
Even if all the stakeholders could be identified, how could you quantify the price each paid as a result of corporate taxes? A daunting task.
Thus, it is convenient for the CBO and others interested in economic statistics to attribute corporate taxes to households with capital gains. That doesn’t mean it makes a lot of economic sense, and it certainly doesn’t mean it makes moral sense.
The article asserts that the top 1% pays an average federal tax rate of about 30% (the CBO says 29.5%) inclusive of the attributed corporate income taxes. If you subtract attributed corporate income taxes, the average out-of-pocket federal tax rate by income bracket is as follows:
| 1st 20% | 2nd 20% | 3rd 20% | 4th 20% | Top 20% | Top 10% | Top 5% | Top 1% |
| 3.6% | 10.1% | 13.5% | 16.3% | 20.5% | 21.0% | 21.1% | 20.7% |
But that isn’t the whole story. The article fails to address the impact of state and local taxes on various income brackets. Fortunately, a report by the Institute on Taxation and Economic Policy does it for us. Here is the average state & local income tax burden by income bracket of non-elderly taxpayers (including elderly taxpayers causes undue distortions).
| 1st 20% | 2nd 20% | 3rd 20% | 4th 20% | 80%-95% | 95%-99% | Top 1% |
| 10.9% | 9.9% | 9.4% | 8.5% | 7.4% | 6.7% | 5.2% |
The net effect is as follows (*since ITEP didn’t give me direct numbers on Top 20%, Top 10%, or Top 5%, I had to estimate them; I estimated conservatively):
| Bracket | 1st 20% | 2nd 20% | 3rd 20% | 4th 20% | Top 20%* | Top 10%* | Top 5%* | Top 1% |
| Full Rate | 14.5% | 20.0% | 22.9% | 24.8% | 27.0% | 27.0% | 26.9% | 25.9% |
| Avg Pretax Income | 18,400 | 42,500 | 64,500 | 94,100 | 264,700 | 394,500 | 611,200 | 1,873,000 |
Clearly, the average Top 1%-er pays a lower tax rate than the average Top 5%-er, 10%-er, or
20%-er, and many in the top 40%.
I include average pretax income (in 2007 dollars per CBO) to prove a point.
A line from the WSJ article: “No matter how many times Mr. [Warren] Buffett asserts it, secretaries… do not on average pay a higher tax rate or less in taxes than do CEOs.”
Well, maybe not the garden-variety secretary, but executive assistants who work directly for Fortune 500 CEOs and top Hedge Fund Managers have lots of skills, put in longer hours than their bosses, and they get paid accordingly… usually $100k-$250k. This puts them squarely in the brackets that pay as high or higher taxes that their millionaire bosses.
C’mon WSJ, whatever your editorial board’s collective wisdom is about money, Warren Buffett knows more.
Arguing with Warren Buffett about money is sort of like arguing Stephen Hawking about science… or arguing with God about Heaven.
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