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Taxes favor capital over wages


Historical and International context of taxes.

The top federal income tax rate started at 6% when the 16th amendment was ratified to permit income taxes.  By 1918, to finance WWI, the top marginal rate was 77% (note the marginal rate means the tax on amounts above some threshold – amounts below that threshold are taxed less, or not at all).  The marginal rate reduced to 24% by 1929.  In 1932 it was increased to 63% during the Great Depression, and increased to 94% in 1945 to finance WWII.  It stayed near 90% until 1964 when it was lowered to 70%, then 50% in 1982, 28% in 1988, raised to 39% by 2000 and lowered to 35% in 2003 ( Wikipedia). 

The overall tax burden in the US is lower than all OECD countries (Organisation for Economic Co-operation and Development – the industrialized countries), except Japan, Korea and Mexico (Forbes).  (Because many countries use value-added and other taxes not used in the US, a comparison of just income taxes is not meaningful)

Increasing disparity between rich and poor. 

The income of the 1% richest taxpayers doubled from 1977 to 1999.  The top 10% went up 88.6%.  The bottom 90% stagnated, slipping slightly (all inflation adjusted) (Perfectly Legal).

Capital gains (income of rich) taxed less than wages. 

The capital gains tax (capital gains are 2/3 of the income of the 400 richest people) fell from 28% in 1987 to 20% in 1998 to 15% in 2003.  Some hedge fund managers are paid based on stock performance so the only taxes they pay are capital gains - their salaries are capital gains. The 2003 dividend tax reduction primarily affects the wealthy, since the middle class usually own stock in 401K plans that aren't taxed (Perfectly Legal).

Many commentators argue that low capital gains rates are needed to spur investments, but they are short on proof.  For example, the conservative Heritage Foundation points to capital gains tax collections doubling after the cuts as proof that it spurs investment.  However, this just shows that people sold, it doesn’t show what they did with the money.  This is un-investing to presumably re-invest.  No proof is offered that this helps the economy.

Common sense, and reasoned studies say this is wrong.  The Congressional Budget Office says “But in general, the more a business tax cut is focused on income from new capital as opposed to income from old capital, the more effective it will probably be in stimulating new investment.” In other words, capital gains tax cuts only spur investments if applied to sales of capital purchased after the cuts go into effect.  The CBO goes on to say “In general, little immediate fiscal stimulus would be provided by cutting capital gains tax rates or expanding capital loss provisions.” (See also Joel Friedman).

Capital gains are usually generated by transactions that have nothing to do with building factories and pumping money into business.  Rather, it usually just passes from one shareholder to another.  The selling shareholders get the cash, not the company (except for IPOs and similar stock sales – a small percentage of what is invested daily.

Many states, such as California, tax wage income and capital gains at the same rate - and we haven't exactly seen venture capitalists fleeing California.

It makes common sense that raising capital gains rates would not strangle investments.  People need to put their money somewhere, and are unlikely to move to another country to avoid a higher rate, as long as the rate isn’t hugely out of line with the rest of the world.  Corporate investments may be another matter, as corporations can re-incorporate elsewhere.
Increasing tax share on middle class wages.

As described above, although wage income tax rates are higher for the rich, capital income is taxed at capital gains rates, which make up much of the income of the rich, are only 15%.  In addition, social security taxes, which only apply to the first $87,000 of wages in 2003, increased 82% faster than incomes (most social security revenue is diverted to the general budget, so this is another income tax).  Thus, social security taxes are a larger percentage of the income of the middle class than the rich.  The social security tax was increased in the 80’s for admirable reasons – to keep the social security trust fund solvent.  The high tax rates were also reduced for noble reasons.  But when a deficit resulted, money was taken from Social Security, with the result being a tax shift from the rich to the poor.

Those objecting to the poorest paying little or no income tax need to remember that they pay sales tax, and through rent, pay property tax, with the amounts paid being a higher portion of their income.  Looking at all income (not just reported income), in 2001 all taxes (not just income taxes) were 18% of income for the poorest fifth of Americans, and 19% for the richest fifth (Perfectly Legal, page 308). [although this number isn’t broken down in Perfectly Legal, the poorest fifth pay a higher percentage on sales taxes and social security.  The highest fifth pay less on the portion of their income due to capital gains.  Presumably, capital gains rates don’t account for all of the reduction to 19% from the 35% (plus state) income tax rate, and there are a lot of deductions or tax avoidance.  If any reader knows the answer, we’d appreciate an email] 
The tax rate on the rich is high enough, but we need to make them actually pay it. 

First, is morally acceptable to tax the rich at a higher rate.  They got rich because of government investments in infrastructure, education of workers and a complex regulatory system that favors those with money.

Tax schemes cut taxes for those who can afford lawyers and accountants.  Heiress Leona Helmsley famously said taxes are for "the little people."  Because of cutbacks and restrictions on the IRS (sold as protecting the average person) it is estimated that $350 billion in tax revenue is now lost.  Because it is easier, the poor are three times more likely to be audited than the rich.
Corporations have also benefited from reduced rates, tax shelters, and tricks such as reincorporating in tax havens or moving intellectual property to shells overseas.  While they report low income under the tax rules, they report high profits to shareholders (under general accounting rules).  In 2002, 10% of federal revenues came from corporations, down from 33% in the Eisenhower years

Wealth v. wages. 

Taxes have shifted from wealth to wages.  The rich make money on investments, not on wages.  To spur the economy, we cut the capital gains tax - which makes stock prices go up.  But doesn’t common sense tell us the economy boosted more by cutting wage taxes?  Give the average worker an extra $500, and they’ll spend it – on a TV, a down payment on a new car, etc., creating more demand for those products.  Give $500,000 to Bill Gates, and it will simply add to his investments and not be spent or noticed.

If we want to stimulate the economy, give money to the spenders (to provide demand), not to the suppliers (supply side).  More supply makes no difference if people don’t have the money to spend on goods.  Henry Ford recognized this.  To ensure people could buy his cars, he increased the wages he paid his workers to almost double the prevailing wages.

California Taxes  [to come]


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