There are two distinct ways to gain wealth in today’s world. You can work hard, invest your capital, come up with new creative ideas that create wealth, or you can figure out a way to move someone else’s money from their pocket into yours. The Government is particularly adept at the latter.
The so called “Buffett Rule” has generated a plethora of ideas all with the supposed goal of making the wealthy pay their fair share in taxes. Underlying that goal is the false notion that those earning millions are paying taxes at a lower rate than the middle class.
Those earning millions of “ordinary income” pay taxes at the highest rate while the return from a taxpayer’s investments may be taxed at a much lower rate. If the income from an investment is owned for more than one year it is classified as a “long-term capital gain.” The aim of this tax policy is to encourage people to invest rather than spend.
This is why I say to “be careful what you wish for.” For example, let’s assume you are hard working taxpayer who is part of the “99%.” (The thought that those earning millions are paying tax at a lower rate is upsetting to say the least.) You have worked for 40 years, you have a home you purchased 30 years ago and you have managed to save and create an investment portfolio with a current value of $300,000. The kids are all grown, retirement is coming soon and you decide to downsize. With your pension, your investment portfolio, and the increase in the value of your home you are feeling good about the future. You speak with a tax accountant and he tells you that the gain in value of your home and investment portfolio will be taxed at 35%, not the 15% you had expected. How can this be?
The income realized by Warren Buffett, on investments held more than one year, is no different than the income every other taxpayer realizes on their investments. In its simplest form the Buffett Rule would tax both “ordinary income” and “capital gains” the same. The reason capital gains are taxed at a lower rate is to encourage people to invest rather than spend. Many developed countries have zero tax on long-term capital gains.
One change that could be made would be to redefine “long-term capital gains” as gains on investments actually held a long time, perhaps 3 or 4 years. That would draw a clear distinction between income from speculation and income from investments.
If anyone should understand the difference between capital gains and ordinary income it’s Warren Buffett, but maybe he was just having an off day!
I wonder how often Warren Buffett wishes he had never instigated this whole discussion.