Janet Bauer | Oregon Center for Public Policy
In the pantheon of American values, few are more venerated than work. The esteem accorded to a strong work ethic dates from the days of the Puritans and was evident in President Obama’s recent address to the nation’s schoolchildren.
But if we rightly value work, why does our tax code give it second-class status? Why does the code give preference to unearned income over earned income?
Today, those who earn a paycheck can see their income taxed up to 35 percent, while those who collect investment income – capital gains and dividends – are taxed at a rate of only 15 percent.
On top of that, investment income is exempt from payroll taxes of about 15 percent to fund Medicare and Social Security. Half of payroll taxes are technically paid by employers, but economists agree that even that half is ultimately paid by employees in the form of reduced wages. By contrast, not a penny of investment income supports the program that provides health care and retirement security to nearly every elderly American.
Not surprisingly, the preferential treatment of investment income is a boon for the wealthy, who still have plenty of money to invest after they have purchased all the goods and services they consume. The result is billionaires paying a lower effective tax rate than their secretaries, as Warren Buffet discovered a couple of years ago.
There was a time when the income tax, at least, treated earned income and unearned income the same. President Ronald Reagan, an icon of the conservative movement, signed a law that ended the preferential tax rate for capital gains and dividends, treating them just as any other income (though investment income was still exempt from payroll taxes). Subsequent administrations, however, pushed through loopholes favoring investment income, culminating in the tax breaks of the George W. Bush presidency that capped income tax rates for capital gains and dividends at 15 percent.
But today we have an opportunity to begin to restore the value of work relative to investment earnings, as Congress searches for revenue to pay for health care reform. Several senators have discussed extending to investment income the 1.45 percent Medicare tax that individuals pay directly on their wages. The main proposal under consideration would exempt the first $10,000 of investment income for individuals and the first $20,000 for married couples.
Such legislation would raise tens of billions of dollars to help pay for health reform, while leaving most families largely unaffected. According to the nonpartisan Citizens for Tax Justice, 87 percent of the revenue raised by the legislation from Oregon taxpayers would come from the wealthiest 5 percent of households. About 65 percent would come from the richest 1 percent of taxpayers, who have an average income of $1 million. The lowest-earning 60 percent of Oregon families would see an average tax increase of just $1.
Those numbers show that even as investment products have become more widespread, the monies invested by ordinary Americans are just a grain in the sandbox that remains the playground of the wealthy. The wealthy, not ordinary Americans, are the primary beneficiaries of the preferential tax treatment of investment income today.
Beyond extending the Medicare payroll tax to investment income, the ultimate goal must be to honor American workers by ending the preferential treatment of unearned income throughout the tax code. That includes changing provisions that treat capital gains and dividends differently from earned income.
Restoring the value of work in this way would raise revenue for health care reform and other priority investments that our nation needs. And valuing work is as American as mom and apple pie.