Welcome to this blog. Well, let’s hit the ground running because there are things to be said.
Unless you have been living
in under a rock for the past 3+ years, you at some point in time have heard about Warren Buffett’s claim that he pays less in taxes than his secretary. More specifically he claimed that he paid 19% of his income in taxes while his secretary paid roughly 33%, (the exact numbers change all the time) the difference being accounted for his revenue being from “capital gains” which are taxed at 15% while his secretary is paid a wage which are taxed at a much higher rate. (Even at relatively low income levels) This has since become for liberals a symbol of an unfair and inequal society while conservatives have largely been complaining about job-destroying-class-warfare. Everyone has been playing their role to perfection with the latest stunt being Michelle Obama inviting Buffett’s secretary (Debbie the Secretary? Or are we done with “[firstname] the [job]” titles?) to listen to the State of the Union with her where the “Buffett rule” came up. (look it up, it changes every five minutes)
But what about economists? Were they doing their jobs? Well, Greg Mankiw was. In a column in the New York Times, he pointed out that Buffett’s numbers are misleading because he forgot about all those taxes he paid indirectly by being a shareholder of Berkshire Hathaway which pays significant amounts in taxes. Greg Mankiw argues quite reasonably that the profits belong to the shareholders and therefore, if you tax the profits, you tax the shareholders.
This obviously did not sit well with some people. And by some people, I mean LOTS of people. An argument I have now read over and over again is that it is unfair to assume the burden of the corporate tax falls on shareholders only. After all, it also depresses salaries, prices paid to vendors, etc… That is true. That is also besides the point.
The problem is that once again people are confusing tax incidence with tax collection. The difference is simple: If you make a gasoline company pay $1 for every gallon of gas they sell, the tax collection is a burden of $1 per gallon of gas on the gasoline company. But the tax incidence is very different since the gas company will raise their prices by some amount. So if they raise their prices by 90 cents, the tax incidence is 90 cents on consumers and 10 cents on producers. However, most people will stop at who wrote the check to the IRS. This is a basic mistake that people make all the time and teaching people about tax incidence is a job that every economist takes on when they talk about taxes.
But what’s the mistake here? Isn’t it true that the burden of the corporate tax is born by both shareholders, vendors and consumers? Well of course, but we need to choose what we’re talking about and stick to it. If we talk about the incidence of the tax, we need to remember that the income tax paid by Buffett’s secretary creates a burden for both her and her employer. It’s quite obvious that Buffett and Obama are not talking about the burden of taxation. Otherwise, Mr Buffett could not get his numbers by glancing at his tax return and his secretary’s tax return. He has to perform a complicated analysis which is unlikely to be completed in his life time. So they must be talking about tax collection at which point it doesn’t make sense to talk about the burden of the corporate tax on consumers, employees and vendors.
“But wait!” I hear you say. “Mr Buffett doesn’t actually write a check to the IRS for Berkshire Hathaway’s taxes. So obviously Greg Mankiw is looking at tax incidence (and doing a poor job at that) which means we can ignore him and return to Buffett’s numbers.” No. You can’t. Taxes are applied against people, not things. When you pay your property tax, you pay the tax. Not your house. So you have to attribute the corporate tax collection to somebody. That person should be the shareholders.
Imagine that you are self-employed. Every year, you earn $100,000, pay 35% in taxes and have $65,000 left in your pocket. Now you form a corporation. $100,000 goes into the corporation. There is a corporate tax rate of 25%, so that leaves $75,000 which you pay to yourself as a dividend which are taxed at 15% which leaves you roughly $65,000. So sure, you could say that your tax rate was 15%, but that would be nonsensical. Nothing of significance has changed. What about if you get a partner and the corporation earns $200,000 paying $65,000 to each of you? Well, what changed? Nothing.
The bottom line is that if you want to look at the effects of tax policy by looking at tax collection, Buffett pays a share of Berkshire Hathaway’s tax bill and his original numbers are wrong in the way Mankiw said. If you want to look at tax incidence, the picture is very messy and Buffett’s numbers are definitely wrong.