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Labor & Economy

Why the Rich Can Brush Off Tax Hikes




Syd Hoff, 1935

How much do the newly enacted tax hikes on the wealthiest Americans actually affect them? Hardly at all.

Almost all of the debate that convulsed Capitol Hill in December concerned the reinstatement of the highest marginal tax rate on earned income — that is, on wages and salaries. But as Fitzgerald said, the rich are different from you and me, and one of the primary ways they’re different is that they don’t get their income from wages and salaries.

In 2006, the bottom four-fifths of U.S. tax filers got 82 percent of their income from wages and salaries, a Congressional Research Office study found. The richest 1 percent, however, got just 26 percent of their income that way; for the richest one-tenth of 1 percent, the figure is just 18.6 percent.

The study also looked at dividends and capital gains. The bottom four-fifths got just 0.7 percent of their income from those sources. (Those who believe we’ve become an “ownership society,” please take note.) The wealthiest 1 percent, however, realized 38.2 percent of their income from investments, and the wealthiest one-tenth of 1 percent realized more than half: 51.9 percent.

The tax deal Congress passed last week raised the top rate on wages and salaries from 35 percent to 39.6 percent. The rate on income from capital gains and dividends, however, was raised to only 20 percent from 15 percent. There has been no rending of garments nor gnashing of teeth from our super-rich compatriots; they got one sweet deal.

The intellectual foundations of this deal are even more dubious than the deal itself. Taxing investment income at a lower rate than labor income presumably fosters more investment in the U.S. economy. But say you buy a share of General Electric. The money you pay for your stock will be invested both at home and abroad, because GE, like virtually every major U.S. corporation, is a global company that retains a U.S. headquarters. Now suppose you’re an assembly worker at a GE aircraft engine parts plant in Dayton, Ohio. All your work takes place in the United States, and most of your spending is local, even though many of the products you buy are made abroad. Yet our GE employee may be taxed at a higher rate than our GE investor. We reward the investor for, in effect, sending money abroad, while the worker who produces wealth entirely within our borders gets no such reward. Globalization has completely changed the investment patterns of American corporations, but our tax breaks for investments chug placidly along as though U.S. companies still confined their work inside our borders.

Moreover, taxing wages and salaries at a higher rate than investment income means that the tax code is taking a bigger bite out of a steadily shrinking share of Americans’ income. Pay from work just ain’t what it used to be. As the St. Louis Federal Reserve has documented, income from wages and salaries as of July 2012 constitutes the smallest share of gross domestic product since World War II. The earned-income share of GDP peaked in 1969 at 53.5 percent. In 2012, it was 43.5 percent.

Where did those 10 percentage points of GDP — currently, about $1.5 trillion every year — go instead of to U.S. workers? It went, in significant part, to corporate profits, whose share of the economy has risen as the share going to wages has diminished. In the third quarter of 2012 — the most recent period for which there are data — after-tax corporate profits constituted the largest share of U.S. GDP since World War II: 11.1 percent.

This shift from wages to profits is called redistribution. It is the central fact of American economic life. And it is the primary reason that economic inequality in the United States has skyrocketed.

Yet wages, which are descending, are taxed at a higher rate than income derived from corporate profits — capital gains and dividends. Far from mitigating the consequences of this shift, the U.S. tax code reinforces the redistribution from wages to profits. Broadly speaking, it rewards the winners of this epochal shift and penalizes the losers, who are the vast majority of Americans.

The lower tax rates for capital gains and dividends, then, effectively reward offshoring more than work done within the United States, increase economic inequality and deprive the federal government of revenue it will need to support an aging population and meet its other obligations. None of this upsets Republicans, but it would be nice if Democrats realized that these tax breaks undermine everything they stand for.

(This post first appeared in the Washington Post and is republished here with permission.)

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