Fairness, the Buffet Rule and Capital Gains Taxation

Eliot Spitzer has a post on fairness and the capital gains tax code at Slate: “So is the call for a ‘Romney rule’ mandating that capital gains be treated as ordinary income, and so be subject to the same top marginal rate of 35 percent that applies to ordinary income, rather than the current top rate of 15 percent. But we shouldn’t raise the capital gains tax just because it’s a popular idea. The rate should rise for philosophical, economic, and political reasons.”

There’s one way of approaching fairness in the tax rate that involves two dimensions, and capital gains violates both of them. That approach has a vertical and horizontal approach to fairness. There’s vertical equity – where those with more pay more – and there’s horizontal equity, where people who are the same should be taxed the same. (Whether these are necessarily two principles of equity or one is a debate for another day.) That capital gains are taxed less than income violates both.

Everyone understands that Warren Buffet paying less of a rate than his secretary, who makes much less money than he does, is unfair. That’s the vertical relationship.

But let’s also consider the horizontal one. Let’s imagine Warren Buffet’s gardener, and let’s make up that he makes $8 an hour. Warren Buffet made roughly $63 million dollars last year. Now let’s picture that the gardener, who has all kinds of cool incentives to make lots of money since he gets to see Warren Buffet’s example, also wants to make $63 million dollars in a year.

At $8/hour, it takes him 7.875 million hours of work to pull that off in a year. Technically it takes him working 900 years to make that kind of money – but he’s capable of doing it in one year because he is really tugging at those bootstraps.

Now what’s his tax rate when he makes $63 million? It isn’t 15% – it is much higher. Even though they make the same money, the person who makes it from labor pays a much higher tax rate.

There are reasons to violate horizontal equity – we give people with children a tax break over those without children, even if they make the same income, because we value that as a society and want to invest in young people, for example. But what’s the reason to give Buffet a break over his multi-millionaire gardener? That is also as unfair as the Buffet secretary example – and why it is important that income is taxed as income is taxed as income.

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