Warren Buffett Raises the Bar for Who Counts As Rich

The Omaha billionaire wants to raise the cutoff point for who should pay higher taxes.

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Folksy billionaire Warren Buffett is turning into one of President Barack Obama's staunchest allies.

Buffett has long supported Obama's call for higher taxes on the wealthy, and he recently refined his thinking with a specific set of proposals published in a New York Times op-ed piece. Buffett wants to restore the higher tax rates of the 1990s for high-income families, while also setting a minimum tax of 30 percent for people earning between $1 million and $10 million per year, and 35 percent for incomes over $10 million.

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The idea behind the minimum tax is to close loopholes that allow many people who get most of their income from investments to pay lower tax rates than ordinary workers whose income comes from wages. Had such a rule applied to Mitt Romney in 2011, it would have raised his tax bill from $2 million to $4.8 million, on $13.7 million worth of income.

Buffett, CEO of the conglomerate Berkshire Hathaway, used the rest of his op-ed to argue that such higher tax rates on the wealthy wouldn't deter investors from investing, or damage economic activity the way some anti-tax crusaders claim. But the part of his plan that may have the most immediate impact was something he mentioned largely as an aside: Instead of setting the cutoff point for high-income households at $250,000, which is Obama's threshold, how about raising it to $500,000 or so?

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That's an important idea that could end up being a linchpin in negotiations regarding the "fiscal cliff" deadline at the end of this year, and in a broader tax reform effort, should Congress take that up in 2013. Since the median income nationwide is about $50,000, a family earning $250,000 per year seems wealthy to most Americans. But people who live in expensive cities like New York and San Francisco argue, with some validity, that a quarter-of-a-million dollars doesn't go all that far if you need to spend at least $500,000 to purchase a home in a decent school district, and you have a couple of kids headed for college. For many families, it takes two full-time workers to pull down that kind of money, and the stress of working and raising kids at the same time hardly makes them feel affluent.

The Census Bureau measures cost-of-living differences in about 300 cities, and they range from a low that's about 17 percent below the national average (Harlingen, Texas) to a high that's about 117 percent above the average (Manhattan). So it's possible to index the cutoff points for tax rates to the city you live in. But in practice that would make an already complicated tax code devilishly confusing, while inviting vast amounts of abuse. (Imagine all the New Yorkers who would suddenly rent tiny apartments in Texas and claim residence there, purely for tax purposes.)

That's why one income level fits all when it comes to tax rates. But it's worth keeping in mind that Obama's preference for higher taxes on households earning $250,000 is only an opening bid. Tax rates on all Americans are scheduled to rise starting January 1, and reaching a deal to prevent that with Congressional Republicans—who oppose nearly all tax hikes--will surely require some tradeoffs. An obvious one on Obama's side is raising the cutoff point for tax hikes to $500,000. Buffett has now given Obama some important cover for doing just that.

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Raising the bar for who counts as wealthy might accomplish two things. About 1.8 million households claim income between $250,000 and $500,000, according to IRS data. That's only about 1.3 percent of all taxpayers, but they account for about 7.8 percent of all income and roughly 10 percent of all taxes paid. There are also about twice as many taxpayers in this group as there are above $500,000. So exempting these households from higher taxes would generate some extra support among a key group of voters who make an important contribution to the economy.

It would also create a larger buffer zone between those whose taxes are likely to rise, and those who fear that tax hikes will eventually trickle down to them. One reason some lower earners oppose tax hikes on the wealthy is they assume that any tax hikes will start with the wealthy and spread downward. If there's a bigger gap between the cutoff point for higher taxes and the middle class, more people will feel insulated from tax hikes, generating a bit more political support.

Pushing the cutoff point upward would cost the government a bit of revenue, since 1.8 million taxpayers would continue to be taxed at lower rates than Obama has proposed. But that could be offset by Buffett's minimum tax on millionaires, or a number of other measures, such as Mitt Romney's idea of setting a cap on the total amount of deductions any taxpayer can claim. In the process, we might end up with a clearer idea of who's really rich in America.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.