It was reported on January 30, 2012 that Senator Sheldon Whitehouse of Rhode Island is introducing a bill that would impose a minimum 30% tax on individuals earning more than $1 million per year. This type of tax policy has been dubbed the "Buffett Rule" due to the news last year that Warren Buffet had a lower tax rate than his secretary. He claims to have a tax rate of 17.4%. His claim is true only if one ignores one of the most basic economic principles of tax analysis: that the person who writes the check is not necessarily the same as the person that bears the economic burden of the tax. The article goes on to explain that this distinction is known as the difference between "legal incidence" (the entity with legal responsibility for paying taxes) and "economic incidence" (a measure of who really bears the economic burden of the tax). The discussions surrounding this new bill have focused solely on the legal incidence of the personal income tax system and have failed to think through the economic incidence of the overall tax system. Warren Buffett receives most of his income from dividends and capital gains which are taxed differently.
There are a number of problems with this new bill, the most important being that it would exacerbate the already existing tax distortion that favors debt over equity. Should we allow Congress to justify this potentially bad tax policy on the basis of naive and misleading understanding of tax incidence?
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