Capital Gains and Crappy Tax Policy

Recently, the Congressional Research Service published a study on changes in income distribution from 1996 to 2006, which shows, first of all, that's its good to be rich.

From Changes in the Distribution of Income Among Tax Filers Between 1996 and 2006:  The Role of Labor Income, Capital Income, and Tax Policy by Thomas L. Hungerford

While the bottom twenty percent actually made less money in 2006 than ten years earlier, the wealthiest top 0.1% saw their pre-tax income nearly double. During that time, the average inflation-adjusted after-tax income went up 25%, but the only people who did that well were in the top 20%. The other 80% of America under-performed.


Why is that?

From Changes in the Distribution of Income Among Tax Filers Between 1996 and 2006:  The Role of Labor Income, Capital Income, and Tax Policy by Thomas L. Hungerford

One big reason is capital gains (and dividends). The share of income derived from these sources actually went down for the bottom 80%, amounting to little more than an rounding error, while capital gains and dividends ended up contributing more than half of all income to the top 0.1%.


In fact, the "changes in capital gains and dividends was the largest contributor to the increase in the overall [measure of inequality, or] Gini coefficient."

From Wikipedia:  While developed European nations and Canada tend to have Gini indices between 0.24 and 0.36, the United States' and Mexico's Gini indices are both above 0.40, indicating that the United States (according to the US Census Bureau) and Mexico have greater inequality.

Tax policy played a roll as well. From the CRS study:

The major tax change between 1996 and 2006 was enactment of the 2001 and 2003 Bush tax cuts, which reduced taxes especially for higher-income tax filers. These tax cuts involved reduced tax rates, the introduction of the 10% tax bracket (which reduced taxes for all taxpayers), reduced the tax rates on long-term capital gains and qualified dividends, and other changes. 

In 1996, long-term capital gains were taxed at 28% (15% for lower-income taxpayers) and all dividends were taxed as ordinary income. By 2006, long-term capital gains and qualified dividends were taxed at 15% (5% for lower-income taxpayers).

So we basically cut a tax rate in half for the people who needed it the least. The bottom 80%, remember, only derived 0.7% of their income from capital gains and dividends, while the top 0.1% got a majority of their money from unearned income. 


As the CRS notes:

Tax policy changes that affect progressivity will affect after-tax income inequality. Duh.

What all this means is that the effective tax rate for the top 0.1% plummeted; they paid out nearly 33% of their income in taxes in 1996, but only 25% in 2006. This is what the Bush tax cuts did.

From Changes in the Distribution of Income Among Tax Filers Between 1996 and 2006:  The Role of Labor Income, Capital Income, and Tax Policy by Thomas L. Hungerford

Fortunately, though, the Bush tax cuts ushered in an era of unknown economic growth.

From here.

Or not.


But the Bush tax cuts are the largest contributor to the the increase in the national deficit.

From the New York Times.

So, in summary, if you want to reduce the deficit, improve income equality and maybe remove the jackboot of capitalism from the trachea of the bottom 20% of Americans, all without affecting the economic performance of the country, start taxing capital gains as ordinary income now.


Bonus: Taxing capital gains also fixes Social Security!