How to raise taxes on millionaires without really trying

Millionaires should pay more in taxes. As a group, they've weathered the stormy economy better than most of us. And given the need to find ways to reduce the federal deficit, sooner rather than later, taxing millionaires sure seems a lot better than most other options – certainly to those who are not millionaires, but even to some millionaires, too.

Billionaire Warren Buffett alerted the public that his average income tax rate is lower than his secretary's. Multimillionaire presidential candidate Mitt Romney revealed that his average tax rate is only 15 percent – the same marginal tax rate that a typical household earning $40,000 to $50,000 per year would pay (although their average tax would still be smaller than the GOP candidate's). [Editor's note: This sentence was changed to clarify the distinction between the marginal and the average tax rate for households.]  

These well-publicized examples have led many policy leaders, including President Obama, to call for changes to the federal tax system to honor the so-called Buffett rule, which in its most basic form says that millionaires and billionaires should face higher effective tax rates than middle-income households do.

One way to do this is through a "millionaire surtax."

This may be politically appealing because it explicitly targets the richest households, but it's economically unsophisticated. This amounts to raising tax rates above the $1 million gross income threshold without doing anything to reform the "Swiss cheese" of tax breaks, which allowed Mr. Buffett's and Mr. Romney's tax rates to fall so low in the first place.

Instead, the surtax would slap on through brute force an extra penalty tax rate on millionaires.

One bill from Sen. Sheldon Whitehouse (D) of Rhode Island, for example, would effectively double that 15 percent rate by adding another alternative minimum tax. (The one we already have, ironically, burdens the upper middle class more than millionaires.)

The idea appeals to politicians because it's simple: If a millionaire's ordinary income tax liability amounts to less than 30 percent of his income, the surtax would make up the difference.

It also avoids getting bogged down in drawn-out tax-reform battles in Congress.

This lack of reform to the existing tax system, however, is one of two big weaknesses in the surtax strategy.

Without eliminating some tax breaks and broadening the tax base, Congress will have to make effective tax rates much higher to gain significant revenue. This would worsen the economic distortions created when some activities are less taxed than others.

The other problem with an alternative millionaire's tax is that it probably won't raise much revenue, says the Tax Policy Center. That's because the vast majority of millionaires already pay an average tax rate above 30 percent.

The economically smarter way to raise millionaires' taxes would be to raise taxes more broadly but more evenly – such as by taxing capital gains and dividends at the same rate as labor income, or limiting itemized deductions so that the rich do not receive higher subsidies than middle-income households.

We could start by letting all of the Bush tax cuts expire, as already scheduled under current law. That would raise far more additional tax dollars from millionaires and billionaires than all the add-on proposals.

Raising taxes is hard enough, politically. Limiting tax increases to such a tiny fraction of the population under our much-too-narrow current definition of taxable income makes the effort almost fruitless.

– Diane Lim Rogers is chief economist of The Concord Coalition, a nonpartisan group advocating fiscal responsibility.