A couple of days ago, I wrote that if we go over the fiscal cliff, the real losers would be the American people. A couple of days later, we’ve averted the fiscal cliff, but, unfortunately, the government took a pound of flesh. Things aren’t as bad as they would have been if automatic tax increases had kicked in, but the deal that averted the fiscal cliff is bad enough to weigh heavily on the pocketbook of Warren Buffett’s secretary.
The average American’s taxes increased directly, because the deal did nothing to avert the 2% increase in the payroll tax. But this isn’t the only thing that will negatively affect middle and working class incomes. The tax increases on income-earners who make over $400,000 has been called a victory for the Democrats. This might be true, but it is not a victory for anyone else.
Few people realize that based on current income tax brackets, Warren Buffett, the world’s third richest man, probably will pay around $25,000/year in income taxes. In other words, the reason Warren Buffett pays less income tax than his secretary is because his income (which does not include capital gains) is significantly lower. The majority of Buffett’s wealth did not come from compensation for the work that he did running the business day-to-day, but rather because he owns a large stake in a major corporation.
This is true of most CEOs, though Buffett is perhaps a more extreme example. Many CEO’s earn huge cash bonuses which significantly increase their income at year’s end, but Lloyd Blankfein, the CEO of Goldman Sachs, is guaranteed only a fifth of the annual salary of Bob Kerrey, a university president at New York City’s New School for Social Research.
While Warren Buffett’s income taxes won’t be going up as a result of the fiscal cliff bargain, his capital gains taxes will, but they will be taxed at a significantly lower rate than, say, the heart surgeon or university professor who makes a salary just over $400,000.
But what is most unfortunate about this legislation is not that it will adversely affect the upper-upper middle class; it is that it will adversely affect the unemployed. Yes, the president did manage to get an unemployment benefits extension out of the deal, but hardly anyone on unemployment benefits wants to stay on unemployment benefits. Most are probably out looking for some job — any job — right now.
In spite of dropping in recent months, America’s unemployment rate is still nearly 8%. This budget deal may help those unemployed receive money for a little while longer, but it probably won’t help them find work.
The reason is fairly straightforward: More money in the private economy means more jobs. This is often dismissed by people to the left-of-center as “trickle-down economics.” Matt Damon famously said that he “didn’t start a small business with his tax break.” Hard as it is for people like him to accept, though, in purely economic terms, his money is probably worth much more than he is. Given his somewhat paranoid filmography, it is possible that Damon squirrels his payroll under his mattress or keeps it in a safe-deposit box to which he has lost the key, but chances are that his money is sitting in a bank or fund of some sort serving as capital investment in some enterprise.
Most investors (of all income levels) probably don’t know what their money looks like in the world. The middle class and the poor, on the other hand, know what this money looks like, but they don’t know where it comes from. To give some idea of what money looks like when it's being invested and saved, it looks like the house you grew up in, the small business loan you received that allowed you to hire your first employees, or the four-passenger car your spouse paid for on credit when you had the first child.
Will this tax increase mean fewer houses, fewer small businesses and fewer four door auto purchases? Most definitely. The economics of the issue are not complex. It is a matter of supply and demand: As the government decreases the supply of money, the cost of borrowing money will increase. This isn’t to say that the economy will falter or unemployment will rise, but neither will grow at the rate of their full potential.
We have had tax increases before that did not have drastically adverse effects, but one thing is for certain: If private investors continue to provide finance to people who want to own a home, start a business or make a better life for their family, this week’s budget deal has demonstrated that the government is not on their side.