One of the most common misconceptions is the belief that wealthy individuals and corporations pay less Federal income tax than ordinary individuals. This belief is widely spread by some politicians, the press, and others who believe that the tax system is stacked against ordinary individuals. Indeed, most uninformed observers assume that our federal budget deficit could be wiped out if only the rich and the corporations paid their fair share of taxes. But in fact these beliefs are largely untrue.
Now that's not to say that there are tax "breaks" that treat certain types of incomes, transactions, or expenditures in a more favorable manner. There are plenty of them. But these areas of special treatment were not created by Congress to hand out rewards to their rich campaign contributors, but rather enacted by Congress to promote some social or economic goal. Now you might agree or disagree with the purposes behind these tax breaks, but they are intended to alter public behavior, not pay off cronies, And in fact, dollar wise most of these tax breaks favor the little guy, not rich individuals and businesses.
For example, what is the biggest tax break in the Internal Revenue Code? It's the provision that lets workers exclude the value of employer provided health benefits from income tax, which saves workers (and takes away from the Treasury) $180 billion a year. In second place is the provision that allows taxpayers to delay paying tax on pension and Sec. 401(k) plan contributions until they actually withdraw the funds, which saves workers over $100 billion a year in taxes. In third place? Well, this spot goes to the provision that permits homeowners to deduct the interest expense on the first $1.1 million of mortgage debt, which saves taxpayers $100 billion a year. So the three biggest tax breaks in the Internal Revenue Code go to workers, not business or rich individuals.
But what about the Buffett rule proposed by President Obama, which would make Warren Buffett pay taxes at the same rate as his secretary? Well that makes for terrific sound bites on the news, but in fact there are very few Warren Buffetts and Mitt Romneys out there paying that low tax rate. Indeed, the revenue projections accompanying the Buffett rule proposal is estimated to only raise $3 billion a year in revenues, a pittance compared to the trillions of dollars that the U.S. is in the hole.
Now, there are tax breaks that benefit business, but as noted above there's a reason why Congress inserted them in the tax law. The biggest break is for accelerated depreciation. When a business buys plant and equipment, and other long lived assets for use in their business, U.S. tax law requires that the cost be deducted gradually over the life of the property. Now in some countries, taxpayers are permitted to write the entire cost of the property in the year of acquisition, but U.S. law generally requires a write off over a period between three and forty years, depending on the type of property involved. In recent years, the law has been changed so that the write-off period is less than what the actual useful life of the property, to encourage businesses to invest in more plant and equipment than they otherwise would. Indeed, with the economic downtown, some classes of property were permitted an immediate write off last year. The faster write off compared to the economic life of property produces a tax "break" of $70 billion a year, certainly a sizable amount, but calculated to boost the economy.
Lower rates for capital gains is a big item at $60 billion, but there are problems with raising capital gains rates. First of all, income tax rates are graduated, meaning you pay at a higher tax rate the more you earn (think of being pushed into a higher tax bracket), and capital gains recognized in a particular year often represent the accumulation of several years worth of appreciation at once. Paying tax on $500,000 income recognized in one year produces a much higher amount than the tax on $50,000 a year for 10 years. Consequently a lower capital gains rate merely smoothes out the tax rate in a fair manner. But perhaps more importantly, there have been times where capital gains were taxed at a high rate, and an unexpected, but very disturbing behavior arose. What happened is that people with appreciated assets refused to sell their assets because they didn't want to pay the tax. In essence, people tied up their money in what they already owned, causing great economic inefficiencies. People didn't sell their land to someone who would develop new houses or shopping centers, and they didn't sell their stocks and use the funds to invest in new businesses. It was against this backdrop that capital gains tax rates were lowered to coax people into selling their property and reinvesting the proceeds.
If you're looking for other large dollar tax breaks, there aren't that many more, and against most of them benefit ordinary individuals. The next largest tax breaks are $50 billion for state and local tax deductions for individuals and $40 billion for charitable contributions for individuals. There are no other business tax breaks that come anywhere close to these amounts. There is the research and development tax credit, the low income housing tax credit, clean energy tax credits, the domestic production deduction and a few other narrowly defined tax breaks, but once again they have been created by Congress to encourage taxpayers to engage in specific types of activities desired by Congress.
Of course, then there are those who think that the solution is to raise tax rates. But tax rates are high enough already. I'm certainly not one of the 1 percent, but when I recently received a small bonus, my net pay check was only 60 percent of the gross amount after deductions for federal income tax, state income tax, and payroll taxes. And the 1 percent actually pays more because of the progressive rate schedule. As far as corporate rates go, the United States has the highest corporate tax rate in the world. It is so high that a booklet giving tax and business advice to corporations headquartered in Ireland tells Irish companies selling products and services into the United States to minimize their presence in the United States as much as possible, because of the high tax rates. Indeed, even President Obama recognizes that the corporate tax rate needs to be lowered to avoid having the United States become noncompetitive in the international economy.
Senator Russell Long said it best many years ago. "Don't tax you, don't tax me, tax that man behind the tree." The man behind the tree is the guy benefiting from tax breaks and loopholes. And he's about as real as the tooth fairy and the Easter bunny.