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 2Sources 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 DividendsTax 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.
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