Why The Super-Rich Pay Half the Taxes We Do

Facebook CEO Mark Zuckerberg arrives for a town hall meeting with President Obama. Mandel Ngan / AFP-Getty Images

It drives economist Bruce Bartlett crazy every time he hears another bazillionaire announce he's in favor of paying higher taxes. Most recently it was Mark Zuckerberg who got Bartlett's blood boiling when the Facebook founder declared himself "cool" with paying more in federal taxes, joining such tycoons as Bill Gates, Warren Buffett, Ted Turner, and even a stray hedge-fund manager or two.

Bartlett, a former member of the Reagan White House, isn't against the wealthy paying higher taxes. He's that rare conservative who thinks higher taxes need to be part of the deficit debate. His beef? It's a hollow gesture to say the federal government should raise the tax rate on the country's top wage earners when the likes of Zuckerberg have most of their wealth tied up in stock. Many of the super-rich see virtually all their income as capital gains, and capital gains are taxed at a much lower rate—15 percent—than ordinary income. When Warren Buffett talks about paying a lower tax rate than his secretary, that's because she sees most of her pay through a paycheck, while the bulk of his compensation comes in the form of capital gains and dividends. In 2006, for instance, Buffett paid 17.7 percent in taxes on the $46 million he booked that year, while his secretary lost 30 percent of her $60,000 salary to the government.

"It's easy to say 'Raise taxes' when you know you're not going to have to pay those taxes," Bartlett says. "What I don't hear is 'Let's raise the capital-gains tax.'" Instead the focus has been on the federal tax rate paid by those with an annual income of $250,000 or more—the top 3 percent of earners. Bartlett argues that while raising taxes on the country's richest individuals would go a long way in easing the debt crisis, it makes no sense to treat the professional making a few hundred thousand dollars a year the same as the Richie Rich set. Maybe it's hard to muster sympathy for an executive pulling down $1 million a year. But ours is a tax system where a person in the top tax bracket (those earning more than $374,000 in 2010) pays a tax rate of 35 percent on the upper portions of his or her income (37.9 percent if you include Medicare), whereas a hedge-fund manager or mogul earning 10 or 100 times that amount pays less than half that tax rate.

"America has two tax systems. Separate and unequal," says David Cay Johnston, a bestselling author and columnist for Tax Notes, who has spent much of the past decade exposing ways the tax system favors the wealthy.

It wasn't always this way. Until the 1990s, the capital-gains tax was 28 percent. The rate was lowered to 20 percent during Bill Clinton's tenure—and, lo and behold, says Johnston, the tax rate paid by the country's 400 wealthiest souls fell by the same 8 percentage points. When the second President Bush lowered the capital-gains tax another 5 points along with his other tax cuts, the country's richest citizens saw their tax rate fall another 5.5 percent, Johnston says.

Obama recently proposed bumping the capital-gains rate to 20 percent for those earning around $250,000 a year or more. That increase, according to estimates by his budget team, would add $12 billion to the Treasury in 2014.

But many argue that a low capital-gains tax encourages investments in business, which in turn leads to greater job growth. Then there's the perspective of conservatives such as Ryan Ellis, the director of tax policy at Americans for Tax Reform, who see the capital-gains tax as little more than a vehicle for double taxation. His argument goes that corporations have already paid a tax rate of 35 percent on their profits (at least theoretically), so why should an individual owning shares in that corporation pay additional taxes just because the stock price went up? Where Chuck Marr of the Center on Budget and Policy Priorities thinks the cap-gains rate should at least revert to 28 percent, to Ellis, the proper tax rate on a capital gain is zero.

"Any of these guys who don't feel their taxes are high enough, I want to point out that they can make a contribution to the Treasury Department right at the Treasury's website," Ellis says. "They don't have to advocate policies that would ruin the country's economy just to assuage their guilt."