How Capitalism Will Save Us (32 page)

Taxes also let policy makers dispense political favors. How did the the sale of lumber by the timber industry come to be taxed—and stay taxed—at the capital gains rate instead of the normal tax rate? One factor: Weyerhaeuser Company, a leading forest products company, had huge properties in Washington State, represented in the 1950s and ’60s by powerful senators Henry “Scoop” Jackson and Warren Magnuson.

Equity funds have benefited from a similar tax break, thanks in part to the efforts of Senator Charles Schumer of New York, who has helped preserve the capital gains rate for the industry—at least until the financial crisis hit. These tax breaks can be defended objectively—as we’ve done on occasion. But they never would have been enacted without powerful political lobbying.

With government spending soaring as a result of the financial crisis and recession, even some conservatives are saying that taxes must go up. After all, they argue, a top tax rate raised to 40 percent of income would still be far below the 70 percent that Reagan found when he took office. That would give us about the rate we had in the prosperous 1990s. Others advocate a European-style consumption levy called the Value Added Tax (VAT). These individuals have fallen into the trap of concluding that government outlays are inevitable and that therefore, we have no choice but to raise tax levies to “help pay for it all.” They have forgotten their basic lesson—that low, reasonable rates generate a wealthier economy.

It is precisely because of coming crises in Social Security and health care that we need more incentive for innovation and growth. A moderate increase in tax rates may produce higher revenues. But it will nonetheless stifle economic expansion, resulting in a smaller economy and lower tax receipts.

No one denies that the services of government are vital and must be paid for. But the only way we will continue to afford them is through reasonable taxation that allows people control of their behavior and leaves them free to generate wealth—for themselves and others.

T
he conventional wisdom of many politicians is that the rich don’t pay their share of taxes. Investor Warren Buffett made headlines when he complained about this to an audience of wealthy executives at a Democratic fundraiser in 2007: “The 400 of us [here] pay a lower part of our income in taxes than our receptionists do, or our cleaning ladies, for that matter. If you’re in the luckiest 1 percent of humanity, you owe it to the rest of humanity to think about the other 99 percent.”
⁶

Buffett explained that he had been taxed on only 17.7 percent of the $46 million he had made the previous year. Meanwhile, his secretary had to fork over 30 percent of her sixty-thousand-dollar salary.

Buffett and others who deride “tax cuts for the rich” ignore a little-known fact: rich people already pay more in taxes. And their share of the nation’s total tax bill has
increased
since Ronald Reagan cut taxes in 1981.

Consider this: In 1980, before the Reagan tax cuts, the top 1 percent of American income earners paid 18 percent of federal income taxes. Then rates were reduced from a high of 70 percent to a low of 28 percent. What happened? The share of the national tax burden paid by the wealthy actually
went up
. They produced 23 percent of national income and paid 36 percent of federal income taxes.

They pay even more today. That top income tax rate is now 35 percent. The top 10 percent of income earners pay 71 percent of the federal income taxes.

What about those who say that the rich should pay a higher percentage of their incomes? They already do. Some 43 percent of the population, overwhelmingly people with lower incomes, pay no federal income taxes.

Warren Buffett’s complaint is disingenuous. If he paid himself a salary, he would, indeed, be paying a higher rate than his secretary. That 17.7 percent, however, is not an income-tax rate. It’s the capital gains rate he pays on
investment income
from Berkshire Hathaway, the company he manages and in which he is a major shareholder. Critics like Buffett ignore the fact that dividend income to shareholder/owners is taxed twice, first on the corporate level and then on the personal level. Not only does a shareholder pay personally; his or her company does, too.

Why are the capital gains tax rates that Buffett pays lower than the income-tax rate paid by his secretary? Because, as we discuss later in this chapter, capital gains income is different from salaried income. Salaried income means you get paid regularly, say, every week or twice a month. As long as you are not laid off and your company doesn’t go broke, you get that paycheck. By contrast, capital gains are generated only after you have placed your capital at risk and the venture has succeeded. The gain is far from guaranteed. Most new businesses fail. And as people discovered during the financial crisis, investing in stocks is no sure thing. Stocks can plummet in value and you can end up losing money. A lower capital gains rate constitutes your “reward” for taking that risk on ventures that produce jobs and other benefits for the economy.

Conversely, raising capital gains taxes penalizes this kind of risk-taking. You ultimately get less investment and entrepreneurship, a smaller, less wealthy economy with fewer jobs. How does that help the poor? According to
Wall Street Journal
economics writer and editorial board member Stephen Moore, if the tax cuts of 2003 proved anything, it’s that cutting taxes is the best way to “soak the rich”:

Despite myriad statistics from many sources, there is a refusal by many to accept the importance of capital creators to a healthy economy. They point to economic downturns, such as today’s fierce recession, as evidence that “trickle-down” has failed. They ignore the decades of prosperity that preceded the downturn—and the fact that, over the long term, the economic pie has grown steadily. Except for the 1930s, every expansion has exceeded the peak of the previous expansion. Even with fluctuations, the standard of living of the American people has moved steadily upward.

Warren Buffett may feel guilty about paying lower capital gains tax and divided rates. But that doesn’t mean government should cripple
other critical entrepreneurs and businesses whose health is vital to pulling the nation out of bad times.