One in four millionaires gets break on taxes

WASHINGTON — A quarter of millionaires in the United States pay a smaller share of their income in federal taxes than many middle-class families, according to a new congressional analysis that offers fresh support for President Barack Obama’s push to raise taxes on the nation’s wealthiest households.

The report, by the nonpartisan Congressional Research Service, found that when all federal taxes are taken into account, including taxes on wages, investment income and corporate profits, households earning more than $1 million face an average tax rate of about 30 percent, significantly higher than the roughly 19 percent rate paid by households earning less than $100,000.

However, the average obscures a great deal of variation within income categories, the report says, with some millionaires paying rates as high as 35 percent and others paying rates as low as 24 percent. Using 2006 IRS data, the CRS found that about 94,500 households making more than $1 million a year paid a lower rate than the most heavily taxed households earning less than $100,000 year. About 10.4 million moderate-income families paid more than 26.5 percent of their earnings in federal taxes.

The prime culprit, according to the report by Thomas Hungerford, a CRS specialist in public finance, is low tax rates on investment income, such as capital gains and dividends. Although ordinary earnings are subject to payroll taxes as well as income tax rates of as much as 35 percent, investment income, which constitutes the bulk of earnings for many very wealthy households, is taxed at no more than 15 percent.

This disparity has been brought to public attention by billionaire investor Warren Buffett, a former Washington Post board member, who complained that he pays a lower tax rate than any of the 20 employees in his office, who earn much less than he does. After Buffett wrote an op-ed in the New York Times, Obama argued that policymakers should overhaul the tax code to ensure that millionaires pay at least as large a share of their income in taxes as middle-class families do, a principle Obama dubbed “the Buffett Rule.”

The CRS report demonstrates “that the current U.S. tax system violates the Buffett rule in that a large proportion of millionaires pay a smaller percentage of their income in taxes than a significant proportion of moderate-income taxpayers,” Hungerford writes, though “not to the extent alluded to by Mr. Buffett.”

Congressional Republicans have attacked the Buffett Rule, and a separate proposal by Senate Democrats to impose a 5.6 percent surtax on income over $1 million, as “class warfare.” They argue that raising taxes on millionaires would penalize many small businesses, which are the primary engine of U.S. job growth. They also oppose raising taxes on investment income, arguing that it would discourage savings and risk-taking.

The CRS report offers a withering rebuttal to both of those claims. The report notes that just 1 percent of tax returns with business income have adjusted gross income of more than $1 million a year. And those businesses are some of the least likely to create jobs.

“Many observers claim that small businesses are the primary creators of jobs,” the report says, but “most of the research cited by these observers is from the 1980s. More recent research suggests that small businesses contribute only slightly more jobs than larger business.” And the main difference “appears to be due to hiring by new startup firms rather than to existing small businesses.”

Startup firms “generally do not generate much business income in their first years in operation; consequently, most small-business owners of startup firms are not in the top income categories and would not be affected by tax policies that observe the Buffett rule.”

As to savings, the report notes that private saving rates have fallen over the past 30 years while the capital gains tax rate has fallen from 28 percent in 1987 to 15 percent today. “This suggests that changing capital gains tax rates have had little effect on private saving.”

While some argue that lower capital gains rates boost investment in high-risk projects, the report argues that most venture capital “is supplied by pension funds, college endowments, foundations and insurance companies — sources not associated with the capital gains tax. In 2003, only about 10 percent of investors in venture capital funds were individuals and families.”