Buffett Rule: Not so simple

Warren Buffett's call for higher taxes on the super rich inspired President Obama to propose a "rule" for taxing millionaires more.

NEW YORK (CNNMoney) -- Taxing the rich more. It's a central theme in the debt-reduction proposals put forth by President Obama on Monday. It's a familiar theme for Obama, but this time he added a twist by proposing the "Buffett Rule" for millionaires.

The Buffett Rule, named after billionaire Warren Buffett, is intended to ensure that those making more than $1 million pay a higher percentage of their income in federal income and payroll taxes than those who make less.

Buffett, who has urged Congress to tax the uber-rich more, has often noted that he pays a lower percentage than his secretary.

"[Last year] what I paid was only 17.4% of my taxable income -- and that's actually a lower percentage than what was paid by any of the other 20 people in our office," Buffett wrote in a New York Times op-ed.

Why? Two reasons: First, he makes a lot of money from investments, which are taxed at a lower rate than wages. Second, the Social Security tax applies only to the first $106,800 in wages. That means Buffett's secretary likely owes that payroll tax on most if not all of her income, while Buffett ends up owing it on a very small piece of his income.

"Middle-class families shouldn't pay higher taxes than millionaires and billionaires. That's pretty straightforward," Obama said.

As a talking point it certainly is. But as a matter of tax policy, it's not as straightforward as it sounds.

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In terms of averages, the current tax system already satisfies the Buffett Rule. Americans on average pay 16% of their total income in federal income and payroll taxes, while millionaires pay an average of 20.1%, according to the Tax Policy Center.

But averages mask the Buffett phenomenon. (See why some millionaires end up owing no tax at all)

For most people, wages make up a majority of their income, so when they get a raise their average tax rate may go up, said Diane Lim Rogers, chief economist at the Concord Coaltion, a deficit watchdog group.

But millionaires typically have several sources of income -- some taxed at lower rates than others, if at all. So it's entirely possible that their effective tax rate can fall as their income goes up if they start to get less money from wages and more from, say, tax-preferred or tax-free investments.

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Correcting for that seems to be an aim of the Buffett Rule. But doing so involves complex policy decisions -- so many in fact it probably is best done in the context of comprehensive tax reform, said Roberton Williams, senior fellow at the Tax Policy Center.

Indeed, the administration said it wanted the Buffett Rule to be a guiding principle for tax reform. But that was it on details.

"We're not going to give the Congress a detailed proposal for how to meet that specific principle now because there's lots of different ways to do that," Treasury Secretary Tim Geithner said Monday.

A tax overhaul would fundamentally reassess all the tax breaks in the code, including the favorable treatment on investments and the income subject to the payroll tax, both of which lighten the tax burden on Buffett and his cohorts.

"The appropriate thing to do is to reform the code and make it the way you want," Williams said. He noted that reform done right would preclude the need to have things like a Buffett Rule.

Tax reform, of course, seems to be a ways off for this Congress.

In the meantime, the president offered $1.5 trillion in revenue proposals under the current tax system to help with deficit reduction. But it's not immediately clear if his own proposals would move the tax code significantly closer to meeting his own Buffett Rule.