Why the “very rich” have lower tax rates than the rest of us

August 16, 2012 | Alex Stone

Recently, the IRS reported the average tax rate of the top 400 highest earning Americans. With average earnings of $200 million per filer, you might think this group paid a tax rate close to the maximum, but you’d be wrong. In 2009, this elite group enjoyed an average tax rate of just 19.9% – closer to someone earning about $75,000 per year.

The numbers are staggering. Last year billionaire investor Warren Buffet enjoyed a tax rate of just 17.4% while his secretary paid 35.8%.  Republican Presidential candidate Mitt Romney paid just 13.9% in taxes on his $21.7 million in income.

America’s tax system is progressive – meaning higher tax rates are paid by those who can afford it – so how are millionaires paying the same tax rate as those in the middle class? In an effort to explain this seemingly unfair tax advantage, the nonpartisan Tax Policy Center took a look at the income and taxes of the very rich. Here’s what they found:

  • In 2009, the wealthiest Americans got 47% of their income from capital gains.
  • The average millionaire (not in the top 400) claimed just 17% of their income from capital gains.
  • Most middle class Americans claim a much smaller proportion (if any) from capital gains.

Capital gains, which is income derived from the sale of stock, property, or other capital assets is only taxed at a rate of 15%. Meanwhile salary and wage income – the primary source of income for most middle class Americans – doesn’t enjoy the same tax advantage as capital gains. So a single filer earning $50,000 in 2009 actually paid a higher tax rate than someone who took home $100 million from capital gains.

tax policy center, top 400

In 2009, for the average filer in the top 400, $100 million of their earnings came from capital gains.

It hasn’t always been this way. From 1992-2002, the average tax rate of the top 400 filers was higher – about 25%. Then in 2003, the George W. Bush Administration reduced the capital gains tax rate to 15%. The average tax rates of the top 400 plummeted, and have stayed below 20% ever since.

Capital gains rates are set by the federal government – and it’s difficult to predict their trajectory in the future. But many states also levy their own capital gains tax – Washington is one of just 8 states that does not. Last year, a proposal for a capital gains tax from the Washington State Budget and Policy Center was introduced by the state legislature, but failed to advance.

It’s something that deserves a second look. A state capital gains tax would provide much-needed funding for K-12 education, public health, higher education, and infrastructure improvements. It would also ensure more equity in our backward state tax structure, and ensure high-quality services that are crucial to attracting and keeping good jobs.

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Posted in EOI, Tax and Budget

Comments

  1. Winslow P. Kelpfroth says:

    I listened to a seminar on this recently which highlighted the economic phenomenon of ETI, or elasticity of taxable income. In one speaker’s analysis, the effective tax rate, that is, the rate actually paid by the wealthy on income, capital gain and dividend has been relatively constant for the 100 years the federal income tax has been in force. There are several ways to achieve this and in the capital gains case, the payment of capital gain taxes by the wealthy is voluntary, as the tax cannot be collected until the asset is sold. Warren Buffet pays a low effective rate on his wealth because of his investment strategy: he buys when he sees a good deal but he doesn’t sell much in any year so there are few capital gains to be taxed. He also lives pretty frugally, so his capital gains in any year are offset by his personal exemptions.
    It might seem attractive and necessary for the state to impose a capital gains tax but don’t count on it as a stable revenue source.

    • Alex Stone says:

      Winslow,

      Capital gains are only realized on sales in which a profit is realized – so of course payment of capital gains taxes are only made when the asset is sold (provided it’s sold at a profit). Of course, an investor can also carry forward capital losses to offset taxes they pay on their gains.

      It’s not that Warren Buffet and other investor live frugally – it’s that their income is taxed at a lower rate than most everyone else. Capital gains income is taxed at a flat 15% rate. Wage/salary income from work is taxed progressively – with the 15% rate applying to income between $8,500 and $34,500. Every single filer earning more than $34,500 pays a higher tax rate on that income than someone earning $100 million from capital gains. Individuals also pay payroll taxes to Social Security, Medicare and Medicaid on their income. Capital gains income is exempt from payroll taxes.

  2. Sarajane46th says:

    As a candidate for the 46 District open House seat, I support a 5% state capital gains tax with a $10,000 exemption, as in the bill sponsored by Rep. Laurie Jenkins last session. This is the best and most fair way to raise a large share of the $1 billion ordered by the judge as the down payment for “amply funding” Basic Education in 2013-2014.

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