In Part 1, we looked hard at Buffett’s effective income tax rate (17.4%), and showed how he could get to that low rate by offsetting practically all of his ordinary income with $23 million in deductions.
This conclusion debunks the popular pundit point that he gets to the rate by having practically all of his income in capital gains and dividends.
In Part 2, we showed that about $20 million of the deductions are probably charitable contributions – a device that rich folks use to (1) do good things and (2) to manage down their tax liabilities.
Better to give to a cause that you believe in, right? Why give it to the government and have it waste the money?
Today, let’s look at the popular headline: “Buffett’s Tax Rate Lower than His Secretary’s”
Since we don’t know his secretary’s specifics, we looked at 3 hypotheticals: a single taxpayer (i.e. not married), all ordinary income, no dependents, standard deduction (i.e. doesn’t itemize).
The bottom line: The headline seems reasonable. In each of 3 income scenarios ($50k, $75k and $100k) the rate to taxable income is in the lower 20s – about 5 points higher than Buffett’s rate.
But, keep reading …
First, these are scenarios the get to the highest possible tax rates – a joint-married filer with dependents and itemized deductions would pay less.
Nonetheless, it’s hard to imagine an ordinary person closing the gap to Warren’s rate unless they had a big mortgage deduction and played the charity angle: giving a lot to charity to shelter income down to the 15% rate.
For example, if our 50K single taxpayer had no mortgage interest and paid about 5% in state & local taxes, he could make a charitable contribution of about $10,000 and land in the 15% tax bracket (which is capped at $34,000)
Here’s the arithmetic: $50,000 less $3,650 in exemptions, less about $2,500 in state and local taxes, less $10,000 in charitable deductions is less than$34,000 – which is the top of the 15% bracket.
The charitable deduction would be 20% of AGI … which is lower than Buffett’s apparent 30% donations’ rate ($20 million / $63 million = 31.4%) … but probably not practical at that income level.
And, using the same logic, getting our $75k and $100k ordinary income earners into the 15% bracket would require a charitable giving rate approaching 50% of AGI.
That certainly doesn’t seem practical.
What’s the point?
Buffett’s case illustrates how a completely discretionary itemized deduction – charitable contributions – can be used by folks – especially rich folks – to shelter ordinary income from taxes … and get them to a low effective tax rate.
That’s not a shot at charitable deductions – more on that in subsequent posts – just raises the point that closing the gap between Buffett and his secretary may be less a matter of raising tax rates (on capital gains) and more a matter of how deductions are allowed and applied.
More to come ..
The Homa Files 