A Deferred Tax is a Preferred Tax: Max Sawicky and Greg Mankiw Are on the Same Page

Max Sawicky gets the capital gains tax issue exactly right:

the historic bargain had always been taxing inflationary gains but only as realized, rather than accrued. Realized means when the financial asset is sold. Holding an asset that appreciates in value without the need to pay annual income tax is itself a tax advantage. Deferral of said tax until realization is a tax break. Capital gains have enjoyed a reduced rate relative to “ordinary income” long before G. Bush arrived in Washington. The Bushies succeeded in knocking the lower rate of 28% even lower, basically to 15%. On this account, the tax code advantages capital gains relative to dividends and interest, even if all their rates are the same. For capital income in general, much is sheltered from taxation because it sits in IRAs and 401(k)s, or it figures in more sophisticated (legal) tax avoidance schemes. Meanwhile, at the corporate level interest is deductible to the firm and dividends are not, so that’s a bias in favor of interest and against dividends. Economists have written papers asking why corporations pay dividends in the first place. The Bushies reduced the rate on dividends, providing some counterweight. It’s all basically a mess. Simplicity of administration dictates taxing gains as realized without inflation adjustments under uniform rates. A reduced rate is a concession to the inflation impact, though for some time we have had little inflation.

Max then endorses a plan from Senator Wyden with this:

Tax ’em all with the same set of rates, let God sort it out.

While I’ll bet Warren Buffet might like the Wyden plan, Greg Mankiw goes after Mr. Buffet’s claims with this:

Even more striking to me is a fact that Mr Buffett did not emphasize: how low his taxable income is. His income of $46 million represents a mere 0.1 percent of his reported net worth of over $50 billion. That is not an impressive rate of return!

Why is it so low? I can think of at least four possible ways investors like Mr Buffet can keep their taxable income, as opposed to their true income, low:
1. They hold stocks that pay minimal dividends.
2. They avoid realizing capital gains.
3. They hold some of their portfolios in tax-free municipal bonds.
4. They give appreciated assets to charity, getting a deduction for the current market value without ever having to realize and pay tax on the capital gain.
Notice that raising tax rates, as Mr Buffett seems to want to do, would not much affect any of these tax avoidance strategies. Even if tax rates were raised substantially, the tax savvy Mr Buffet probably wouldn’t be paying much in taxes as a proportion of his wealth or as a proportion of his true income.

It seems Greg is getting a little personal here, but he has a point and it is the same point Max made. Tax deferral strategies can really lower one’s effective tax rate. But what is wrong with taxing all income as it accrues at the same rate? I bet Max could fire back that taxing income when it accrues adds complexity. Then again – the current system is really complex. And it does let the very rich – including Mr. Buffett – game the system. But isn’t these accounting gimmicks what Mr. Buffet was advocating that we abolish?