Do the Rich pay an Unfair and Increasing Tax Burden

            It has become increasingly fashionable to argue that since the very wealthy pay an increasing percentage of the total tax burden, the system is becoming more “progressive” and unfair to those who pay so much in tax.  Consider some recent arguments.

In a March 8, 1999 editorial titled “The Rich Deserve a Tax Break, Too”, Business Week argued, “So people making $100,000 or more will shoulder 62% of the income tax burden in 1999”.  They then argue, “People in the $20,000-$30,000 income bracket will pay 2.4% of all income taxes.  Those making $30,000 to $40,000 will pay 4.3% and those in the $40,000 to $50,000 will pay 5.9%.”  And finally, “If conservatives want a 10% across-the-board income tax cut, they should simply say the rich deserve one because they pay most of the income taxes.”

In a January 22, 2002 editorial, the Wall Street Journal argued, “Start with the richest of the rich, the top 1% of all earners.  In 1999 they earned 19.5% of all adjusted gross income reported to the IRS.  Yet they paid 36.2% of all federal income taxes that year.  About 20 years ago they paid only 19% of all federal income taxes.  By 1991…that share had climbed to 24.8%, and by 1999 it was above 36%.  The story is the same for the merely filthy rich, the top 5% of filers, who paid 43.4% of all taxes in 1991, but by 1999 paid 55.5%.”  They then argue, “There’s a word for this kind of tax system.  It’s called progressive, not to mention confiscatory….And it is getting more confiscatory all the time.  From 1989 to 1999, the share of total taxes paid by the entire top 50% was largely unchanged.  But the share paid by the top 10% of filers jumped by 19%, the share paid by the top 5% leapt by 26%, and the share paid by the top 1% soared by more than 43%.”

And finally, in a July 26, 2011 USA Today article titled, “Punishing the rich:  Impractical, unethical” Michael Medved says, “Conservatives also cite the latest IRS figures showing top earners already paying more than their fair share:  The top 5% earn 35% of adjusted gross income but pay 59% of all income taxes.  What’s more, the share of the overall burden shouldered by this group has risen sharply, not declined, since controversial Bush tax cuts of 2001-03.”  He then adds, “It makes no sense to penalize successful people with higher tax rates.  Their effort and imagination add jobs and growth while subtracting nothing from society at large.”

There is a difference between arguments that the rich pay an increasing share of total taxes paid, and that such an increase in share is also an increase in the progressivity of the tax, or that it imposes an unfair burden. While we can conclude that the richest Americans paid more income tax and also paid a larger percentage share of taxes after the Reagan marginal rate cuts beginning in 1981, we cannot conclude that the system was therefore made more progressive.  The mythical increasing tax burden of the wealthy is now the primary argument for reducing their taxes by a larger percentage than that of the poor or middle-classes. 

Ronald Reagan was correct when he argued that his 1980s cuts would lead to the rich paying a larger share of income taxes, but he was incorrect in arguing that this would also increase the progressivity of the tax system.  The same argument was used by George W. Bush in 2001 when he proposed a $1.6 billion cut that bestowed a large share of the total benefits on the wealthiest Americans.  Increasing taxes paid have resulted entirely from income growth and not from rate increases, or an increase in relative tax burdens.

A tax is progressive if the percentage of income paid in tax increases as income increases, i.e., the rich pay a higher percentage of their income in tax than do the poor.  Taxes paid are the product of the tax rate times the tax base, so the percentage burden is a function of both the rate and the base.  If taxes paid increase faster than income, the percentage paid will also increase.  But if the rate falls, the only way for the burden to increase is for the base to decrease even faster.  In a period like the 80s when rates were falling and the base rising, the percentage burden may increase or decrease.  But if the base (income) for the rich is rising faster than that of the poor, their burden will fall faster and the tax will become less, not more, progressive. If their tax rate is also falling faster than that for the poor, tax progressivity will decline even faster.

Republicans want more than is possible to deliver.  They want rate cuts that favor the rich, base decreases that also favor the rich, and still argue that progressivity in the tax system is increasing.  They do so by distorting the definition of progressivity.  The fact that the rich pay a larger percentage of total income taxes collected is far different than arguing they pay an increasing percentage of their incomes in tax.  Consider the following example:

Assume we have three taxpayers: "A" has an income of $10,000 and a marginal tax rate of 10%; "B" has an income of $30,000 and a marginal tax rate of 25%; "C" has income of $100,000 and a tax rate of 50%.  If all marginal rates are cut by 50%, they become 5%, 12.5%, and 25%, and everyone enjoys an "equal" tax cut since their marginal taxes are cut in half.  But put another way, "A" enjoys an increase in take–home pay of 5.5%, "B" 16.7%, and "C" 50%. 

Using a percentage distribution system, "A" continues to pay 1.7% of the total tax burden, "B" pays 12.8%, and "C" pays 85.5%.  That is, the percentage shares are the same before and after the tax cut as long as the percentage cut in rates is uniform.  The same is true if all three taxpayers experience an equal percentage increase in their incomes.  If all incomes rise by 20%, the percentage distribution of the tax burden will remain constant.  The only way for the percentage share of the richest taxpayer to rise is for his income to increase at a faster percentage (or to have a smaller percentage tax decrease).

Consider another example which shows that even a proportional system (where every taxpayer pays the same percentage of income as tax) results in the rich paying most of the taxes collected.  Assume we have 10 taxpayers with income and taxes as follows:

Taxpayers        Income             Tax Rate          Total Tax Paid            % of Tax Paid 

      1                $10,000                       20%                 $2,000                     2.2%
      2                $20,000                       20%                 $8,000                      8.9
      4                $40.000                       20%                 $32,000                  35.6
      2                $70,000                       20%                 $28,000                  31.1
      1                $100,000                     20%                 $20,000                  22.2   
     10               $450,000                     20%                 $90,000                  100.0%

Under a proportional system where every taxpayer pays a flat 20% of income, those with the highest incomes obviously pay the highest percentage of the total taxes collected.  Now assume that these taxpayers experience income increases as follows:

Taxpayers        Income             Tax Rate          Total Tax Paid            % of Tax Paid

      1                $10,500           20%                 $2,100                         1.4%
      2                $22,000           20%                 $8,800                         6,1
      4                $44,000           20%                 $35,200                       24.2
      2                $98,000           20%                 $39,200                       27.0
      1                $300,000         20%                 $60,000                       41.3
      10              $726,500         20%                 $145,300                     100.0%

In this table the poorest taxpayers experienced an increase in income of 5%, those in the middle two levels received a 10% increase, those in the fourth level received 40%, and the richest had an increase in income of 200%.  Even with a proportional tax system, the burden of the rich, as measured in percent of the total taxes paid increases substantially, while the relative burden in all other brackets declines. But the system has not become more progressive, since all continue to pay the same 20% of income as tax.  To argue that the increasing burden makes a case for a tax cut for the richest taxpayer would be to argue for a regressive tax system, where the rich would pay a lower percentage than the poor.  The increasing burden is totally a result of incomes increasing at different percentages.

The existence of a progressive rate system, which increases the marginal tax rate as incomes increase, will cause the percentage paid by the wealthy to increase even faster, but it does not indicate the progressivity of the system is also increasing.  In fact, given the growth in incomes in the highest tax brackets, tax progressivity is likely to fall.  The only way to keep the percentage of total taxes paid by the rich from increasing as their incomes grow faster than average is to move in the direction of a regressive system.

But are the assumptions concerning income growth given in the above table representative of actual income increases over the past twenty years.  The table below begins to examine this issue.  Over the past thirty years the percentage of total incomes going to the top 20 percent of the population has increased from 41.5% to 53%, an increase of 27%, while the percent of income received by the poorest 20 percent fell from 5.1% to 4%, a drop of 21%.  Relative percentages of income received fell in all quintiles except the highest, indicating a long-term trend giving the highest group a substantial increase in incomes relative to the rest of society.

PERCENT OF INCOME RECEIVED

BY INCOME CLASS

INCOME                                                                                                        
QUINTILE                  1980                1988                1999               2007
LOWEST                    5.1                   4.6                   3.6                   4
SECOND                    11.8                 10.7                 8.9                   9
THIRD                        17.5                 16.7                 14.9                 14
FOURTH                     24.2                 24.0                 23.2                 20
HIGHEST                   41.5                 44.0                 49.4                 53

Source:  U.S. Census Bureau & Congressional Budget Office

            According to the Congressional Budget Office the average income of the poorest one-fifth of the population grew by 18% from 1979 to 2007, while the incomes of the richest 1% rose by 275%.  The richest one percent now earns 24 percent of all income, up from 11 percent in 1980, and now controls 37% of all the wealth in the U.S. Since 1980 virtually all the nation’s growth in income has gone to the wealthiest one percent of the population.  In 1980 the average CEO salary was 42 times an ordinary worker's, but by 2005 it was 531 times as much.

In addition, about 48% of all stocks are owned by the wealthiest 1% of Americans, while the bottom 80% owns only 4%.  That is, the richest 1 million people own 10 times as much stock as the bottom 200 million.  And while these ownership percentages are about the same as they were 20 years ago, the market value of stocks is now over five times as great as in 1990.

Republicans would have us believe that the rich are being treated unfairly when they pay an increasing share of total taxes.  But if that increasing share is the result of the rich receiving an increasing share of a growing pie, why is it unfair?  The fact is that the rich now pay the lowest overall tax burdens they have paid in the past 60 years.  The top marginal tax rates have decreased from 91 percent in the early 1960s, to 70 percent under the Kennedy tax cut of 1964, to 50 percent under Reagan, and to 35 percent under Bush.  The increase in taxes paid has resulted entirely from rapidly rising incomes, not increasing tax burdens.

Republicans also believe that since the rich do most of the saving and investing, and are therefore the “job creators” they need to be rewarded with lower tax rates.  But the evidence of the past thirty years is that the rich use their new income to increase their economic power and political influence.  It is clear that rising percentage shares of taxes paid do not show increasing progressivity or increasing tax burdens, but only a redistribution of income upward, with the rich claiming a larger and larger share of the total income available.   

Taxation of Dividends

(Some of the information on taxation of dividends has been moved from last week’s post to this week.)

            The taxation of capital gains and dividends has been closely linked by Republican Presidential candidates during the 2012 Presidential primary campaign.  While the argument presented earlier about the impact of eliminating taxes on capital gains also apply to eliminating taxes on dividends, there are some additional issues with dividends that need to be explored.  Table 1 summarizes the income received from dividends for those taxpayers earning over $200,000 a year in 2008.  Dividends accounted for only 2.65 percent of total income, but ovedr half of all dividends were reported by those earning over $200,000, and 42 percent of all dividends were earned by those taxpayers who reported over $500,000 in total income, the wealthiest 3 percent of the population.  Further, over one-third of all dividends were earned by those making $1 million or more.

Table 1

Income Earned From Dividends--2008

Dividends accounted for 2.65 % of all income earned

Bracket                                    Percent of Taxpayers               Percent of Total Dividends

$200,000 or less                     89 %                                        43 %

$200,000 or more                    11 %                                        57 %

$500,000 or more                    2.5 %                                       42 %

$1.0 million or more               .95 %                                       37 %

$2.0 million or more               .40 %                                       27 %

Source:  Statistics of Income, 2008, IRS

Until the Bush tax cuts in 2001 and 2003, dividends tended to be taxed as ordinary income, so the maximum tax was the same as the maximum tax on wages and salaries.  Taxes on dividends were reduced as ordinary tax rates were reduced in 1964, 1981, 1986, and 2001, but were increased in 1993.  The Bush tax cuts of 2001 and 2003 reduced the maximum dividend tax rate to only 15 percent.  But, as argued earlier, the reduction had only a limited impact on the growth in employment and output.  Employment and output seem to respond more to general tax cuts or tax increases rather than being attributable to specific tax changes on individual income components.

There are two primary arguments being used by advocates of eliminating dividend taxation.  The first is that dividends are taxed twice under U.S. tax law—once under the corporate profits tax, and a second time when profits are distributed as dividends and are then subject to personal income taxes.  The second argument is that U.S. income taxes penalize U.S. multinational corporations who earn a substantial portion of their total profits from overseas operations.  In order for U.S. corporations to remain competitive internationally, U.S. taxes must become more competitive with those nations that tax corporate profits and dividend distributions at rates as low as 10 to 15 percent. 

The double taxation of dividends argument has been made for decades and has some credibility in taxation literature.  Corporate stockholders are said to pay taxes on profits under both the corporate and the personal tax systems.  If the personal tax on dividends was eliminated the tax system would be more equitable and simpler.  There are at least two arguments against this position.  First, the impact of the corporate profits tax may or may not actually fall on stockholders.  Some studies show that the tax is shifted backward to employees in the form of lower wages or forward onto customers in the form of higher prices.  If either argument is even partially correct, the burden of corporate taxes is not borne entirely by stockholders, but by other parties.

The second argument against the double taxation of dividends is “so what”.  Wages and salaries are subject to multiple levels of taxation, not just “double” taxation.  Workers pay Social Security taxes on all wages and salaries up to $110,100 in 2012, and then also pay personal income taxes on total wages and salaries as well.  They then pay sales taxes on expenditures and property taxes on real estate, both of which must be paid out of wages and salaries earned.  The double taxation argument is a problem only for those taxpayers who earn dividend income, which, again, is only a small fraction of total income earned.  If politicians really want to eliminate double taxation on income they should propose to deduct Social Security taxes from total income before calculating income taxes on those same wages and salaries, and to make sales taxes also deductible again.

The second argument of equity between U.S. and foreign tax systems is more real and more difficult to deal with.  This argument deals as much with corporate profits taxation as it does with personal taxes on dividends.  The current maximum tax on corporate profits is 35 percent, but virtually no multinational corporation actually pays a 35 percent tax.  In fact, every year news media reports dozens of major corporations who paid zero corporate taxes in the prior year.  The corporate tax is riddled with loopholes, deductions, and exclusions that allow corporations to legally reduce or eliminate their actual tax burden.  Income tax paid on foreign operations to foreign governments is deductible for U.S. tax purposes.  Further, if income is earned on foreign operations and not repatriated, it is not subject to U.S. taxes.

From 2004 to 2006 Congress approved a temporary measure to allow U.S. corporations to repatriate foreign income to the U.S. and pay only 5.25 percent tax.  The reason used was to allow corporation to bring back billions of dollars in foreign profits that could then be used to create U.S. jobs and stimulate the economy.  While hundreds of billions were repatriated by the largest U.S. corporations, billions were used to repurchase their own stock and to pay millions in bonuses to corporate executives.  Since corporations were not required to report what they actually used the funds for there is no reliable evidence that the program was successful or not. However, a Senate study published in 2011 argued that the largest 15 firms that brought funds home accounted for over half of all the funds repatriated.  The study found that those 15 firms actually employed 21,000 fewer people in 2007 than in 2004.  Pfizer, which repatriated the most ($35 billion), reduced employment by over 11,700 workers.  A similar proposal was circulated in 2011 for another temporary tax reduction to 5.25 percent in an effort to stimulate the economy and create more jobs.

It is clear, however, that U.S. multinational firms do have an incentive to leave profits outside the U.S. if repatriation would subject those profits to taxes of up to 35 percent.  What is not clear is whether they would use any potential repatriated funds to increase employment and capital investment within the U.S.  Additional after-tax profits could also be used to repurchase corporate stock, pay bonuses, or to pay increased dividends to stockholders, which would only have an indirect impact on employment and total spending.  But whatever direct or indirect benefits may result, it is clear that the U.S. would be better off if those profits could be brought back into the country.  But an incentive needs to be provided for using the funds to increase employment rather than paying dividends or bonuses.

I propose a sliding scale tying corporate profits taxes and dividend taxes to corporate total worldwide employment.  Table 2 summarizes this proposal.  A reduction in corporate tax rates and corresponding dividend rates would be tied to the ratio of total U.S. employment to total worldwide employment.  In addition, current loopholes and exclusions would be eliminated. 

Table 2

Proposed U.S. Corporate/Dividend Taxes and Employment

U.S Employment as a %                      Maximum U.S.             Maximum U.S.

Of Worldwide Employment                Corporate Tax Rate                 Tax on Dividends

Less than 50 %                                    35 %                                        35 %

50 -60 %                                             30 %                                        30 %

60 – 70 %                                            25 %                                        25 %

70 – 80 %                                            20 %                                        20 %

More than 80%                                    15 %                                        15%

Such a system should encourage corporations to repatriate profits as well as provide incentives to repatriate jobs outsourced during the past decade. A decrease in corporate tax rates or personal tax rates on dividends not tied to the level of new employment will likely lead to actions by corporate officers that maximize their own and their stockholders interests rather than the interests of the entire country.  Tying the corporate and dividend tax rates to the levels of U.S. employment would encourage corporations to repatriate foreign income while shifting overall employment back to the U.S.

Stockholders would also have an incentive to demand that corporate officers increase domestic employment rather than repurchase stock or pay executive bonuses so their overall taxes on dividends paid would be as low as possible.  Even if officers used the funds to pay higher dividends without increasing domestic employment, taxes on those dividends would remain high. Since the current rate on dividends is only 15 percent, such a new system would result in additional taxes only for those companies that continue to shift employment from the U.S. to foreign operations.  It would also allow corporations with substantial U.S. employment to remain competitive with foreign corporations in low tax nations.

            An example can illustrate this process.  In 2010 General Electric was widely reported to have earned over $14 billion in profits but paid zero U.S. corporate income taxes.  In fact, they received a refund of over $1 billion.  Would elimination of the tax on dividends or a reduction in the current corporate tax rate be expected to result in the creation of thousands of new U.S. jobs as argued by Republican candidates?   

According to the 2010 GE Annual Report, in 2001 GE employed 158,000 workers in the U.S. and an additional 152,000 worldwide, a total of 310,000 employees.  U.S. employment reached a high in 2004 when GE employed 165,000 in the U.S. and 142,000 outside the U.S.  Total employment reached a high in 2007 when they employed 155,000 in the U.S. and 172,000 outside the U.S, a total of 327,000.  By 2010 total U.S. employment had fallen to 133,000 and employment outside the U.S. had fallen to 154,000

            GE’s total U.S. employment as a percentage of worldwide employment was highest in 2001 at 51 percent, before the Bush reductions in dividend taxes.  It declined throughout the decade, reaching a low of 46 percent in 2010.  Total U.S. employment decreased by 32,000 workers between 2004 and 2010, but it had decreased by 10,000 before the 2007-2009 recession.  Meanwhile corporate profits ranged from $13 billion to $17 billion a year during the same period.  Under the proposed system GE would pay a maximum corporate rate of 25 to 30 percent until they increased U.S. employment as a percentage of total worldwide employment.  Since they currently pay zero corporate taxes, any system that eliminates current loopholes would result in increased taxes for GE.

            It seems clear that job creation and increased production and output depend on numerous factors, of which tax rates appear to be only a minor cause.  There is little or no evidence to suggest that the most successful anti-recession economic policy is likely to be a reduction in corporate tax rates and/or an elimination of personal taxes on capital gains and dividends.

The Impact of Eliminating Capital Gains Taxes

            During the 2012 Presidential Republican primary campaign all of the potential nominees made proposals for reforming the federal income tax system to make it simpler and fairer while stimulating the economy and creating millions of new jobs.  But the concept of what constitutes simple or fair or how much stimulus would actually occur depends on what reforms are proposed.  U.S. Rep. Michele Bachman of Minnesota, U.S. Rep. Ron Paul of Texas, former pizza executive Herman Cain, former House Speaker Newt Gingrich, Texas Governor Rick Perry, former Massachusetts Governor Mitt Romney, and former Utah Governor Jon Huntsman all made reform proposals to reduce or eliminate taxes on dividends and capital gains and reduce marginal income tax rates for both individual and corporate taxes.
            Herman Cain’s proposal was to eliminate the entire income tax system and replace it with a system he called “9-9-9” for a 9 percent personal income flat tax on wages and salaries, with dividends and capital gains excluded from tax, a 9 percent national sales tax, and a 9 percent corporate income tax.  Rick Perry proposed an alternative flat tax of 20 percent on wages and salaries with virtually no deductions or exemptions, but with both dividends and capital gains again excluded from tax. Mitt Romney proposed a reduction in tax rates and elimination of capital gains taxes for taxpayers earning less than $250,000 a year.  Bachman, Paul, Gingrich, and Huntsman all proposed eliminating income taxes on dividends and capital gains as a primary way to stimulate the economy and create new jobs.
            The economic question that must be answered is, “Would elimination (or reduction) of taxes on dividends and capital gains result in a tax system that was ‘fairer’, or ‘simpler’, and lead to increased economic output and employment?”  An alternative question might be, “Who would benefit most from elimination of the income tax on dividends and capital gains?”  The answers depend on who earns income from dividends and capital gains, and, hence, whose taxes would be reduced or increased by such a move to a “simpler and fairer” tax system.
            Analysis of the Statistics of Income for 2008, published by the Internal Revenue Service provide most of these answers.  Table 1 summarizes the income statistics for the wealthiest Americans for 2008.  Table 2 summarizes the major sources of income for these groups of taxpayers, including wages and salaries, dividends, and capital gains.  Those who earn incomes of $200,000 or less receive 80 percent of all wages and salaries, while those earning $200,000 or more receive 84 percent of all capital gains, 57 percent of all dividends, but only 20 percent of wages and salaries.  Those who earned $1.0 million or more accounted for only 5.5 percent of wages and salaries, but 66 percent of all capital gains and 37 percent of dividends.  In addition, 72 percent of all income earned comes from wages and salaries, but only 6 percent comes from capital gains and only 2.65 percent comes from dividends.
                                                                           Table 1

Income Brackets and Adjusted Gross Income for 2008

Income Bracket                      Percent of Taxpayers              Percent of AGI

$1.8 million or more              Top .1 %                                 9.70 %

$1.0 million or more              Top 2.5 %                               13.00 %

$380,000 or more                   Top 1.0 %                               20.00 %

$200,000 or more                   Top 3.0 %                               29.80 %

Source:  Statistics of Income, 2008, IRS

                                                                           Table 2
                                                             Sources of Income for 2008

Wages and Salaries account for 72 % of all income earned
Bracket                                   Percent of Taxpayers              Percent of Total W/S
$200,000 or less                     97 %                                        80 %   
$200,000 or more                   3 %                                          20 %
$500,000 or more                   .60 %                                       9.0 %
$1.0 million or more              .20 %                                       5.5 %
$2.0 million or more              .08 %                                       3.5 %  

Capital Gains accounted for 6.0 % of all income earned
Bracket                                   Percent of Taxpayers              Percent of Total Capital Gains
$200,000 or less                     85 %                                        16 %
$200,000 or more                   15 %                                        84 %
$500,000 or more                   4.3 %                                       74 %
$1 million or more                 1.8 %                                       66 %
$2.0 million or more              .80 %                                       57 %

Dividends accounted for 2.65 % of all income earned
Bracket                                   Percent of Taxpayers              Percent of Total Dividends
$200,000 or less                     89 %                                        43 %
$200,000 or more                   11 %                                        57 %
$500,000 or more                   2.5 %                                       42 %
$1.0 million or more              .95 %                                       37 %
$2.0 million or more              .40 %                                       27 %

Source:  Statistics of Income 2008, IRS

            It is clear that elimination of income taxes on capital gains and dividends would benefit those who earn $200,000 a year or more, and especially those who earn $1.0 million or more.  A “flat” tax of 9 percent or 20 percent that excludes dividends and capital gains from the tax base would shift the entire tax burden from the wealthy to the middle class and poor.  Those who now pay little or no income tax would have a very large tax increase, while those who earn $200,000 or more would receive a very large tax decrease.  Such a flat tax proposed by Republican candidates would essentially be a flat tax only on wages and salaries, earned primarily by the poor and middle class, while the wealthiest 1 percent who earned most of their income from dividends and capital gains would then pay zero income tax on up to 85 percent of their income.
            The argument that such a modified tax system would be “fairer” is true only if you are a taxpayer in the top two current tax brackets.  For the 99 percent of taxpayers who earn their income primarily from wages and salaries this “fairer” system would amount to a major tax increase.  Since the very wealthiest taxpayers who live on investment income returns usually have little or no income from salaries, they would pay zero income taxes.  And corporate executives who now earn multi-million dollar salaries would have a huge incentive to reduce their wages to zero and take their compensation in the form of dividends and stock options that produce future capital gains. 
           Even small business owners would have an incentive to shift their income from salaries to distributions of profits and pay no taxes.  Under such a system many factory workers, professionals, and retirees would pay more income taxes in both absolute and percentage terms than Bill Gates and Warren Buffett combined.  And that system is proposed as one that will produce “fairness” in the tax system.
          The proposals are also argued to produce an expanding economy and new jobs for those currently unemployed.  But examine the history of previous reductions in tax rates on capital gains and dividends.  Table 3 summarizes the recent history of tax rates on capital gains and dividends.

Table 3

                                                          Taxation of Capital Gains and Dividends

Tax Years                   Maximum Tax            Maximum Tax            Maximum Tax
                                    on Capital Gains         on Dividends              on Wages/Salaries
Before 1964                25 %                            91 %                            91 %
1964-1981                   28 %                            70 %                            70 %
1981-1986                   20 %                            50 %                            50 %
1986-1993                   28 %                            33 %                            33 %
1993-2001                   20 %                            39.6 %                         39.6 %
2001-Present               15 %                            15 %                            35 %
Source:  Statistics of Income, Various Years, IRS

 Until the Bush tax cuts in 2001 and 2003, dividends tended to be taxed as ordinary income, so the maximum tax was the same as the maximum tax on wages and salaries.  But capital gains taxation has almost always been subject to preferential tax rates.  Capital gains taxes were increased in 1964 and in 1986, and were reduced in 1981, 1993, and 2001.  Taxes on dividends were reduced as ordinary tax rates were reduced in 1964, 1981, 1986, and 2001, but were increased in 1993.  The question of whether or not tax rates on capital gains and dividends stimulate or restrict investment and create employment are impossible to isolate because each rate change was also accompanied by numerous other changes in the tax base.  In addition, employment and production may increase in some industries but fall in others.

         The tax changes in 1964, 1981, and 2001 were revenue reductions, while the changes in 1986 were argued to be revenue neutral, and the changes in 1993 were tax increases.  The two supply-side tax cuts were in 1981, which reduced tax rates on capital gains from 28 to 20 percent, and 2001, which reduced capital gains rates from 20 to 15 percent.  Maximum rates on dividends were reduced from 70 to 50 percent in 1981 and from 39.6 to 15 percent in 2001.  What were the immediate impacts on output and employment for the five years following each tax cut?
            Table 4 summarizes the growth in employment and GDP during the five year period following the major tax changes since 1981.  Total civilian employment increased from 100.4 million workers in 1981 to 109.6 million in 1986, a total of 9.2 million workers, or an increase of 10.9 percent.  Employment after the 2001 tax cut increased from 136.9 million in 2001 to 144.4 million in 2006, a total of 7.5 million, or 5.0 percent.    But total employment also increased from 109.6 million

                                                                        Table 4
                          Employment and GDP Gains During 5 years Following Major Tax Changes

Year of                        Employment              %                     GDP                            %
Tax Change                  Growth                      Change            Growth                     Change
1981                            9.2 million                  10.9                 1334.4 billion             42.7
1986                            8.1 million                  7.0                   1533.1 billion             34.4
1993                            11.2 million                9.0                   2089.6 billion             31.4
2001                            7.5 million                  5.0                   3298.1 billion             32.7
Source:  Economic Report of the President 2010, White House

in 1986 to 117.7 million in 1991 (a 7.0 percent change) after the “revenue neutral” tax reform of 1986, and from 120.3 million in 1993 to 131.5 million in 1998 (a 9.0 percent change) after the Clinton tax increase.  But the 1993 Clinton tax increase did lower rates on both capital gains and dividends. 

           But as a reference, the change in overall employment in the five years prior to the 1981 tax cut was from 88.8 million in 1976 to 100.4 million in 1981, a total of 11.6 million workers, or 13 percent, which was greater than in any of the tax change periods.  Clearly, tax cuts do not produce superior increases in employment, and economic factors other than tax rates must also be examined to determine causes of total employment.

The logic of arguing for elimination of capital gains taxes as a means of job creation is also suspect.  As argued earlier, the definition of capital gains includes gains on the sale of virtually any asset, including stocks, real estate, vacant land, and dairy cattle.  By what logic does an “investment” in vacant land lead to creation of new jobs?  And then why should such an investment be deemed so socially desirable that is should not be taxed?  But the same could also be said for investment in virtually every other existing asset.  The sale of corporate stock yields nothing to the issuing corporation after the initial offering of stock.  If I buy $1 million of corporate stock and later sell it for $2 million, the only one who benefits is the previous owner, not the corporation.  It is simply a change in asset ownership that allows the seller to then purchase some other existing asset.  The same is true for existing real estate such as office buildings or apartment complexes.  The transfer of ownership does nothing to produce new jobs, but only increases the wealth of the investor.

        The purchase and later sale of assets is not a job creating activity that should be deemed by society as so desirable that it should be rewarded with a zero tax rate.  Why should investment income be more socially desirable than wages and salaries (the returns to labor)?  But that is the consistent argument that has been made for over thirty years by Republicans who believe that the only productive members of society are the wealthy, who primarily move financial assets from one place or owner to another.  Those who labor for wages and salaries are treated as parasites who attempt to steal the rewards from the hard work of investors.  Logic and equity would treat all income as equal that should be taxed under the same system and equal tax rates.         
        Total Gross Domestic Product increased by 42.7 percent and 32.7 percent following the two supply-side tax cuts in 1981 and 2001, but also increased by 34.4 percent after 1986 and by 31.4 percent after 1993.  But between 1976 and the 1981 tax cut GDP increased by 71.4 percent, larger than any of the tax change 5-year periods.  Again, the impact of tax cuts on producing superior increases in GDP is questionable and other economic factors must also be determining factors.

         
         Republican proposals to eliminate income taxes on capital gains and dividends and to reduce overall rates in an effort to produce a tax system that is simpler and fairer and also produces superior growth in employment and output are not supported by the history of tax changes or by what might be reasonably forecast for the future.  The real purpose of such proposals is clearly to give large tax benefits to the very wealthiest Americans and to increase the relative tax burdens on the poor and middle class.