4 Things to Remember About the Buffett Tax

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President Obama allegedly sought Warren Buffett's permission to use his name for the so-called Buffett tax -- the proposed rule that would ensure those making more than $1 million a year don't end up with lower tax rates than middle-income workers. That was smart. The tax might be one of the most controversial proposals of Obama's presidency.

Some say it's a jobs killer. Others say it's class warfare. A comparison to socialism inevitably pops up. The responses are as predictable as they are impassioned.

In the spirit of adding fuel, here are four points about the Buffett tax to keep in mind.

1. Buffett has his own take on class warfare.
"Class warfare may make for really good politics, but it makes for rotten economics," said Congressmen Paul Ryan, referring to the Buffett tax. He's right. Any policy that takes aim at one class is bad economics, if only because it creates the perception that those elected to serve you are out to get you.

But Buffett, the Berkshire Hathaway (NYS: BRK.B) billionaire, has his own take on class warfare: "There's class warfare, all right, but it's my class, the rich class, that's making war, and we're winning," he's said in the past.

There are no specifics of how the Buffett tax might work, but initial descriptions outline that its goal is to ensure that the highest earners pay at least the same tax rate as middle-income workers. This isn't about taking one group of taxpayers who already pay abnormally high tax rates and pushing those rates higher. It's about flattening the tax code so that some with the highest incomes don't end up with some of the lowest tax rates, as is now the case.

2. If implemented, the number likely affected rounds to zero.
Several have countered that most people making more than $1 million a year already have much higher tax rates than middle-income workers. "The claim that CEOs are routinely paying lower tax rates than their secretaries is Omaha hokum" wrote TheWall Street Journal. They're absolutely right -- the vast majority of high-income workers have tax rates well above the average rate.

But, as the Buffett tax appears to be envisioned, those earners wouldn't be affected at all. Their tax rates would stay the same. Only those making more than $1 million with below-average tax rates likely face a change. That's a very small group. As Congressman Sandy Levin pointed out, just 20,000 people earning more than $1 million a year had tax rates below 15% in 2009.

3. It seems poorly thought out.
Changing marginal tax rates is one thing. That way, the tax on an extra dollar of income only hits that specific dollar.

But it sounds like the Buffett tax is aimed at overall tax rates. That sets up all kinds of madness. Take someone earning $999,999 a year in interest and dividends. Taxed at the normal 15%, that person would currently pay $150,000 in taxes. But if the Buffett tax sets the minimum tax rate on those making more than $1 million at, say, 20%, then earning a single extra dollar would trigger an additional $50,000 tax bill.

See the craziness? $999,999 of income faces a $150,000 tax bill, while $1 million faces $200,000 in taxes. If that's the case, people would rationally jump through hoops to lower their income.

To be fair, this is how it appears on the surface, but no one knows how the Buffett tax might work in practice. There are no details yet.

4. It stands virtually no chance of becoming law.
Nearly everyone has a passionate stance on the Buffett tax. Either it's brilliant and desperately needed, or destructive and dangerous.

Debate is great, but keep in mind that that's all this is -- debate. There's almost no chance that the proposal could become law under the current Congress. Use the Buffett tax as fodder to rant about flaws in either our tax code or elected leaders, but if you're concerned about it actually impacting the economy's bottom line, waste your precious time on something else.

Fool contributor Morgan Housel owns shares of Berkshire Hathaway. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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