IMPLEMENT THE BUFFETT RULE BY IMPOSING A NEW “FAIR SHARE TAX” Current Law

Under current law, individual taxpayers may reduce their taxable income by excluding certain types or amounts of income, claiming certain deductions in the computation of AGI, and

claiming either itemized deductions or a standard deduction. Major exclusions include the value of health insurance premiums paid by employers and interest on tax-exempt bonds. Major itemized deductions include those for State and local taxes and for home mortgage interest. Qualified dividends and long-term capital gains are taxed at a maximum rate of 23.8 percent, while ordinary income, including wages, is taxed at graduated rates that rise as high as 39.6 percent. In addition, wages and self-employment earnings are subject to payroll taxes as high as 15.3 percent (7.65 percent each for employee and employer), but average and marginal payroll tax rates are much lower for higher-income families, because the wage base for much of the payroll tax is capped at $118,500 in 2015.

Reasons for Change

Deductions can significantly reduce tax liability for high-income taxpayers. For example, under current law, almost eight percent of itemized deductions would accrue to the top 0.1 percent of families in 2015. Higher-income families also face lower payroll average tax rates than do middle income families.

In addition, many high-income taxpayers derive large benefits from the preferentially low tax rates on dividends and capital gains. For example, nearly 90 percent of families in the top 0.1 percent of the income distribution benefit from the lower tax rate on dividends and capital gains, compared to less than 10 percent of families in the bottom 60 percent of the income distribution. High-income investors, who have large amounts of dividends and capital gains, can have tax burdens that are much lower than those paid by equally well-off high-income workers. In addition, the maximum 23.8-percent tax rate on dividends and capital gains (inclusive of the 3.8 percent net investment income tax) is below the statutory tax rates on wages faced by many families with moderate incomes. Consequently, a high-income taxpayer whose income is largely derived from capital gains or dividend income may have a lower average tax rate than a taxpayer with less income whose income is largely or exclusively derived from wages.

Increasing the income tax liability of higher-income taxpayers with relatively low tax burdens would reduce the deficit, make the tax system more progressive, and distribute the cost of government more fairly among taxpayers.

In a separate proposal, the Administration proposes to increase the top long-term capital gains and qualified dividends tax rate from 20 percent to 24.2 percent. Including the 3.8 percent tax on net investment income, this would increase the top effective long-term capital gains and qualified dividends tax rate to 28 percent. Although this tax rate increase would reduce the effect of the Buffett Rule, the Rule would still be needed to address tax inequities.

159 Proposal

The proposal would impose a new minimum tax, called the Fair Share Tax (FST), on high- income taxpayers. The tentative FST would equal 30 percent of AGI less a credit for charitable contributions. The charitable credit would equal 28 percent of itemized charitable contributions allowed after the overall limitation on itemized deductions (so called Pease limitation). The final FST would be the excess, if any, of the tentative FST over the sum of the taxpayer’s (1) regular income tax (after certain credits) including the 3.8-percent net investment income tax, (2) the alternative minimum tax, and (3) the employee portion of payroll taxes. The set of certain credits subtracted from regular income tax would exclude the foreign tax credit, the credit for tax withheld on wages, and the credit for certain uses of gasoline and special fuels.

The amount of FST payable (i.e., the excess of tentative FST over regular tax) would be phased in linearly starting at $1 million of AGI ($500,000 in the case of a married individual filing a separate return). The FST would be fully phased in at $2 million of AGI ($1 million in the case of a married individual filing a separate return). For example, if a single taxpayer had AGI of $1.25 million, tentative FST of $375,000 and regular tax of $250,000, his payable FST would be (($1.25 million - $1 million) / ($2 million - $1 million)) × ($375,000-$250,000) = $31,250. The AGI thresholds would be indexed for inflation beginning after 2016.

160 IMPOSE A FINANCIAL FEE

Current Law

There is no sector-specific Federal tax applied to financial firms (although these firms are subject to the general corporate income tax and potentially a wide range of excise taxes). Financial sector firms are subject to a range of fees, depending on the lines of business in which they participate. For example, banks are assessed fees by the Federal Deposit Insurance Corporation to cover the costs of insuring deposits made at these institutions.

Reasons for Change

Excessive risk undertaken by major financial firms was a significant cause of the recent financial crisis and an ongoing potential risk to macroeconomic stability. The financial fee is designed to reduce the incentive for large financial institutions to leverage, reducing the cost of externalities arising from financial firm default as a result of high leverage. The structure of this fee would be broadly consistent with the principles agreed to by the G-20 leaders.

Proposal

The Administration proposes to assess a financial fee on certain liabilities of large firms in the financial sector. Specific components of the proposal are described below.

The fee would apply to banks, both U.S. and foreign, and would also apply to bank holding companies, and “nonbanks,” such as insurance companies, savings and loan holding companies, exchanges, asset managers, broker-dealers, specialty finance corporations, and financial captives. Firms with worldwide consolidated assets of less than $50 billion would not be subject to the fee for the period when their assets are below this threshold. U.S. subsidiaries and branches of foreign entities that fall into these business categories and that have assets in excess of $50 billion also would be covered.

The fee would apply to the covered liabilities of a financial entity. Covered liabilities are assets less equity for banks and nonbanks based on audited financial statements with a deduction for separate accounts (primarily for insurance companies).

The rate of the fee applied to covered liabilities would be seven basis points. The fee would be deductible in computing corporate income tax.

A financial entity subject to the fee would report it on its annual Federal income tax return. Estimated payments of the fee would be made on the same schedule as estimated income tax payments.

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