Merely Rich and Superrich: The Tax Gap Is Narrowing
Floyd Norris
APRIL 17, 2014
nytimes.com 
Will this be the year that the superrich finally pay higher taxes than the very rich?
This is not, I admit, something that many people are worried about.
But it is an interesting fact that our current tax system assures that — year after year — the superrich, those who report adjusted gross incomes of more than $10 million, have tax rates that are significantly lower than those of the very rich, those earning more than $500,000 but less than $10 million.
Figures just released by the Internal Revenue Service show that in 2011 the difference in rates between the groups rose to 4.1 percentage points, the largest since the I.R.S. began calculating the data in 2000. The superrich paid 20.4 percent of their income in federal income taxes in 2011, while the very rich paid 24.5 percent.
On average, each of the 11,445 taxpayers who reported more than $10 million in income would have paid an extra million dollars in taxes if they had faced the same tax rates as the very rich.
Why are the superrich treated so well? It is largely because investment income — what we used to call unearned income — has long enjoyed preferential tax treatment. President Ronald Reagan briefly eliminated that preference in the Tax Reform Act of 1986, but it was restored within a few years and, until now, had tended to grow whenever the tax law was changed.
The bulk of that income goes to very-high-income taxpayers, in part because they have the largest investments and in part because the tax advantage does not apply to retirement accounts, which is where most ordinary Americans have their investments.
But starting in 2013, the wealthy face significant tax increases. And the increases are greater for investment income. It seems likely that the gap in tax rates between the superrich and the very rich may be narrowed.
For earned income, like salaries and bonuses, married couples who make more than $450,000 now face a top marginal tax rate of 39.6 percent, up from 35 percent. That was part of the deal President Obama and Congress reached at the beginning of 2013. That deal allowed the supposedly temporary tax cuts passed during the George W. Bush administration to become permanent for the bulk of taxpayers. It also provided for some tax deductions to be reduced for those with very high incomes.
That no doubt hurt the rich, but it is the increases in taxes on investment income that have caused the most surprise, and distress, for some wealthy people as they filed their tax returns this month.
Under the Affordable Care Act passed in 2010, the Medicare payroll tax increased by 0.9 percentage point in 2013, but only for couples earning more than $250,000 and unmarried taxpayers earning more than $200,000. And unlike the old Medicare tax, the increase applies to investment income, not just to wages.
More important was an additional 3.8 percent Medicare tax on “net investment income” for those couples earning more than $250,000. That includes long-term capital gains and qualified dividends on stock, income that until now was taxed at a maximum rate of just 15 percent. But it also includes other income that had been taxed at the same rate as earned income, including rent, royalties, interest and short-term capital gains.
That tax affects a tiny minority of taxpayers; in 2011, 98 percent of tax returns reported adjusted gross income of less than $250,000. But the tax may help to explain the intensity of the anger felt by some people campaigning to repeal President Obama’s Affordable Care Act, which subsidizes health insurance premiums for people who could not previously afford to buy insurance.Reports of people who faced drastically higher premiums or lost health insurance altogether because of the health law have not stood up to close inspection. But there is no doubt that some very wealthy people are paying higher taxes because of it.
The 2013 tax law made the health law tax bill even higher. The long-term capital gains rate was raised to 20 percent for couples who earn more than $450,000. Add in the Medicare tax, and the capital gains rate is 23.8 percent for the rich.
For the first time in memory, the wealthy are confronting a tax rate on some investment income — like interest and short-term capital gains — that is higher than the ordinary income rate. Including the Medicare surcharge, the top rate on such income is now 43.4 percent.
For those who believe low capital gains rates are necessary to encourage investment and economic growth, high taxation of investment income is an outrage. If the recent stock market weakness persists, you can be sure that the additional taxes will be blamed.
As it happens, evidence supporting the theory that low capital gains rates are crucial for growth is not easy to come by. The decade of the 1990s was among the best in American history, whether measured by economic growth or stock market profits. For most of that decade, long-term capital gains rates were 28 percent.
In 2003, in one of the great steps to help wealthy investors, the Bush administration and Congress lowered the tax on dividends to match the capital gains rate, 15 percent. The effective rate paid by the superrich dropped to the low 20s from the mid-20s.
In 2007, the year before the Great Recession, the effective tax rate for the superrich fell to 19.7 percent. That was also the year that 18,394 tax returns reporting that much income were filed, a record that has not been equaled since. The average income reported on those returns that year exceeded $30 million, another first. In 2011, the average was about $28 million.
I.R.S. figures show that in most years since dividend tax rates were reduced, the superrich have reported that about half of their income came from tax-advantaged investments. For the very rich the proportion in 2011 was less than 17 percent. That is no doubt a chief reason for the substantial difference in tax rates for the two groups.
Of course, ordinary Americans also are eligible for preferential tax rates on dividends and capital gains, and for most of us they remain at 15 percent. The catch is that few of us have a lot of investments in taxable accounts and therefore derive little benefit from those breaks. In 2011, the average taxpayer earning less than $500,000 received just 2 percent of his or her income from dividends and long-term capital gains. Most of that money went to people earning more than $100,000.
Most ordinary Americans, if they have investments that produce dividends and capital gains, have them in tax-deferred retirement accounts, either individual retirement accounts or 401(k) plans. When they draw out the income from those accounts, they will pay ordinary income tax rates, regardless of whether the profits came from dividends and capital gains.
If Congress ever gets serious about increasing tax revenue enough to pay for the spending bills it passes, the big tax advantage given to unearned income may have to be reduced, if not eliminated. Eliminating it would mean that the private equity executives who manage to pay very low tax rates — because they classify their salaries as capital gains — would be taxed like the rest of us. The “carried interest” issue would vanish.
This year, that tax advantage has been reduced, even if only for some of the highest-paid Americans. It is a start toward a tax policy that no longer discriminates against people who have to work for a living because they do not have dividend checks to support them.
Floyd Norris comments on finance and the economy at nytimes.com/economix.
A version of this article appears in print on April 18, 2014, on page B1 of the New York edition with the headline: New Tax Takes Aim at Ranks of Superrich. Order Reprints| Today's Paper| Subscribe |
