'Buffett Rule' Could Create Unintended Consequences

Is the provision more of a political tactic than a deficit-cutting move?

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President Obama put some meat on the bones of the so-called "Buffett Rule" in his State of the Union speech, explaining that it would mean a tax rate of at least 30 percent for anyone making more than $1 million.

The administration has thus far been sketchy on how exactly the policy would work, and already, those questions are giving some experts pause, causing them to speculate about the provision's unintended consequences.

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On a broad level, the Buffett Rule on its own would only contribute to the complexity of the U.S. tax code, says Roberton Williams of the Tax Policy Center, a D.C.-based think tank."The problem with the Buffett Rule is essentially [it's] saying we don't like the outcome of our basic tax system ... So let's make parts of it we don't like better."

Lawmakers have long enacted fixes like this in order to level the playing field between classes, says Williams, pointing to the Alternative Minimum Tax for an example. The result is a byzantine tax code that tries to do far more than just raise revenue. A tax code overhaul, while requiring a strenuous effort on the part of lawmakers, could likely be a better use of their time than enacting another add-on.

If a larger tax reform policy were to be enacted, could the Buffett Rule then be effective? If revenue-raising is the primary goal of the Obama administration's new tax policies, it does make logical sense to aim for the rich. While the U.S. median income has fallen in recent years, the rich are making more and more money, as the CBO pointed out in an October report.

Williams says at a certain point, there are diminishing returns on levying tax increases on the wealthy. Even the rich don't have unlimited wealth, and Williams adds that, "to close the budget deficit by half, you'd have to raise top rate to about 90 percent from current 35"—a politically untenable rate, to put it mildly.

There are a plethora of other tax changes in the political pipeline that would also affect this demographic. The expiration of the Bush tax cuts on the wealthy would further complicate the picture, says David Logan of the D.C.-based Tax Foundation. Combine that with taxes on so-called "Cadillac" healthcare policies along with ones levied on some investment income that was included in the healthcare reform act, and the richest Americans will take the biggest hit.

The question is not whether the wealthiest Americans would able to pay all of these taxes. "If you hit people with enough taxes, you will get into a situation where they will change their behavior in significant ways," says Williams. For example, there is currently incentive to "manipulate your compensation, as a high-income person," in favor of more capital gains, which are taxed at a lower rate.

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Of course, it is difficult to tell at this point exactly what effects the rule might have, or even what it might entail. It could make some headway toward "fairness" in high-income tax rates, but when it comes to deficits, the gains would be modest.

Logan adds, for example, that the tax deductions the White House has said it would eliminate for millionaires in areas like housing, healthcare, retirement, and childcare are "extremely minimal" for people making over $1 million. All told, he estimates the Buffett Rule would raise about $36.7 billion in revenue in its first year. That's roughly 3.8 percent of the estimated federal deficit for 2012.

The White House, however, maintains that to focus purely on Buffett revenue is to miss the point. White House press secretary Jay Carney stressed to reporters on Wednesday that there are "millionaires and billionaires who pay taxes at a substantially lower rate" than poorer Americans. "The President simply believes that as a matter of principle, that unfairness ought to be changed."

Political considerations may be restricting the president's tax policies. "I think he's not expansive enough in terms of target population," says Williams, later adding, "He boxed himself into a corner in the 2008 elections, saying, 'I won't raise taxes on people with incomes below $250,000.'"