Warren Buffet attacked the federal tax preference for the rich over the middle-class Tuesday, arguing that it is an outrage that his receptionist pays a higher effective tax rate than he does. A major cause of the problem is the special low tax rate (15 percent) for capital gains and dividends, which mostly benefits the wealthy. Conservatives often argue that repealing this tax break or allowing it to expire (it currently is scheduled to expire at the end of 2010) would cause investment to dry up and lead to a loss of jobs. Unfortunately for proponents of the tax break, there has been no relationship between low capital gains tax rates and economic growth over the past 50 years. The lower rate can just as easily lead to greater inefficiency in the economy, since it can result in tax shelters that have no real economic rationale (as investments are made purely to transform ordinary income into capital gains).
Congress May Take a Small Step in the Right Direction
For those members of Congress who get a little weak-kneed at the thought of allowing the President's favorite tax cut to expire or be repealed, there are smaller steps that can be taken in this direction. For one thing, private equity fund managers making millions or even billions of dollars are taking advantage of the special capital gains rate even though they are not actually investing their own capital.
The House Ways and Means Committee is expected to hold hearings in July to consider a bill (H.R. 2834) that would close this loophole. Meanwhile, Senate Finance Committee chairman Max Baucus (D-MT) and ranking member Charles Grassley (R-IA) are sponsoring a narrower bill that would require publicly traded partnerships that get their income from investment services to pay the corporate income tax rate of 35 percent (which is what other publicly traded partnerships almost always must pay) instead of the capital gains rate they currently pay. The Finance Committee is expected to hold hearings later this summer and it is not yet clear if Baucus will add the provisions the House includes in its version relating to the taxing of the fund managers' compensation.