Why the GOP should hike taxes on the super rich by Nina Easton @FortuneMagazine December 7, 2011, 3:53 PM EDT E-mail Tweet Facebook Google Plus Linkedin Share icons In the latest stop on his fairness crusade (a.k.a. the 2012 re-elect), President Obama yesterday touched down in Kansas to compare himself to Republican trust-buster Teddy Roosevelt — the latest in a string of presidential self-comparisons that started in 2007 with Lincoln and has since run through FDR, Kennedy, and Reagan. TR, of course, was a great proponent of the “graduated income tax on big fortunes”– the seeds of the progressive structure that has been embedded in U.S. policy for nearly a century. But today Obama asserts that the rich aren’t paying their “fair share” of taxes; it’s an argument that’s front and center in his class-conscious re-election campaign. There’s only one problem: Most people that Obama deems “wealthy” — those making over $250,000 — pay the highest tax rates of anyone around. Even most “millionaires,” with all their deductions, pay the highest rates. “The tax code,” says Roberton Williams of the nonpartisan Tax Policy Center, “is actually very progressive.” TR would be happy — almost. There is one class of wealthy people who don’t pay their fair share — a relatively small class of investors that Warren Buffett has labeled the “super rich.” Their incomes have more than quadrupled in the past two decades, while their effective rates have plummeted to below what many in the middle class pay. If Republicans were smart, they would put the Democrats’ “tax fairness” canard to rest by supporting a new minimum tax that forces the super-rich into the same brackets as other millionaires. Message to Republicans: Don’t try to support a system in which Buffett’s tax rate is lower than his secretary’s. But dare the White House to acknowledge inconvenient facts. Most of the wealthy do pay their fair share. Even the top 120,000 households — the 0.1% top earners — pay 30%, twice the middle-class rate. Buffett, by the way, distanced himself from the White House’s exploitation of his name in its proposed “Buffett Rule,” telling Bloomberg Television that it wasn’t his idea to “have the rich pay more taxes. It’s to have the super-rich pay more.” At Fortune’s Most Powerful Women Summit this fall, he said that the so-called Buffett Rule rule should apply only to 50,000 households and would raise $20 billion a year. In a nut-shell, here’s why: The super-rich make most of their money from dividends and capital gains on investments, which are taxed at much lower rates. Contrast a capital gains rate of 15% with the top individual rate of 35%. Even factoring in all those deductions available to high-salaried taxpayers, that’s a big difference. Hey corporate America: Show us your tax returns The higher you move up the income chain, the more likely you are to earn your income from investments rather than salary. The average taxpayer earns three-quarters of his income from a salary; for the top 400, it’s 8%, according to IRS numbers crunched by the Tax Policy Center. Williams calculates that the 400 richest Americans, averaging $270 million a year, paid an average 18% tax rate in 2008. Even worse, these big time investors aren’t subject to payroll tax, which everyone else has to pay until their salary hits $106,800. Neither are their investment gains subject to the 1.45% Medicare tax that the rest of us pay. But for others that President Obama has labeled wealthy, it’s a different story. The system is actually quite progressive — and fair. “It’s really about investors versus workers,” Williams notes. After deductions, the average federal tax rate of all people who make more than a million dollars is 29.1% — the highest rate paid by anyone. Keep in mind, even if you’re a TV celebrity or a NBA star, if most of your income is salary you are still paying the top rate. For those making between $500,000 and $1 million, the current average rate is 24.4%; and for those that Obama includes at the low end of “rich” — making $200,000 to $500,000–it’s 22.7%. The White House tries to spin its case for higher taxes on all rich by advertising facts like this: “165,000 households making over $1 million paid less than 30% of their income in taxes.” But 30% compared to what? That’s far higher than average rates paid by much of the middle class—which is how our progressive tax code is designed. In fact, middle class households pay average rates in the teens. It’s 19.6% between $100,000 and $200,000; about 12% if you make $50,000; and 15% for incomes in the $75,000 range. People making $30,000-40,000 pay 9.9% and those in the $10,000 to $20,000 pay only 1%. Super-rich investors are the biggest income winners over the past two decades, even as their tax rates have dropped. Williams says the IRS numbers on the Forbes 400 show that their incomes have quadrupled since 1995, even as their tax rates have dropped to 18%. The average earner has seen his income rise by only 77% while tax rates have gone up. And get this: The Alternative Minimum Tax, originally conceived as a net to catch those well-off legal cheaters deploying deductions to escape fair tax rates, maintains its own capital gains rate of 15%. Instead, every year Congress is forced to “patch” this disastrous tax policy so the poor $75,000-couple with two kids doesn’t face a double bill. The taxes paid by America’s super-rich investor class are eye-catching outrage for the 99% movement. But what to do about it? You could raise the capital gains rate — which will happen anyways if the Bush tax cuts expire for the wealthy next year and it returns to 20%. The danger is that it could discourage investment. A narrowly tailored Buffett Rule — in the form of a minimum tax that acknowledges that the “millionaires-escaping-taxes” story is really an exception to the rule — makes sense. Catch the people who really don’t pay their fair share. That would be fairness, not class warfare.