Last week, The New Republic’s Jon Chait took issue with my assertion that, when super-rich people like Mark Zuckerberg say their taxes should be increased, they are effectively calling for increasing the taxes of people who make a lot less money than they do.
I would like to preface my response with two preliminary notes. First, there is something unseemly about the idea that super-millionaires should be setting tax policy for the rest of us. Their incomes, standards of living, and purchasing power are hardly comparable to those of most Americans, or even those making $500,000 or $1 million a year.
This debate all started when I read this piece in Newsweek:
It drives economist Bruce Bartlett crazy every time he hears another bazillionaire announce he’s in favor of paying higher taxes. Most recently it was Mark Zuckerberg who got Bartlett’s blood boiling when the Facebook founder declared himself “cool” with paying more in federal taxes, joining such tycoons as Bill Gates, Warren Buffett, Ted Turner, and even a stray hedge-fund manager or two.
Bartlett, a former member of the Reagan White House, isn’t against the wealthy paying higher taxes. He’s that rare conservative who thinks higher taxes need to be part of the deficit debate. His beef? It’s a hollow gesture to say the federal government should raise the tax rate on the country’s top wage earners when the likes of Zuckerberg have most of their wealth tied up in stock.
On its face, raising the top income-tax rate seems like an effective way to make our (already progressive) federal tax system even more tilted against success. But the federal tax system is more complex than that:
• As income increases, the proportion coming from wages/salary decreases (red). Wealthy Americans draw much of their income from dividends, interest payments, and capital gains (blue). People with capital income have much greater control over the timing, level, and composition of their income.
• Overall, the federal income tax already targets the rich: For instance, the top 10 percent of tax filers — those earning about $114,000 or more — pay 70 percent of all federal income taxes. However, the burden is not shared equally among relatively high earners, but rather falls disproportionately on those wealthy enough to face the highest income-tax rates but not wealthy enough to draw the largest proportion of their income from non-wage sources. According to IRS data, filers with incomes between $100,000 and $500,000 pay the biggest share of their income in taxes. (Note, though, that this data does not measure the impact of double taxation.)
One explanation is that the highest marginal tax rate (now 35 percent) applies to income above $373,650. There is a big difference between making $373K and making millions of dollars. Also, because so many super-rich millionaires take their income in the form of capital gains and dividends, which are theoretically taxed at 15 percent, the tax code may actually be regressive at the very top (again, ignoring the impact of double taxation — more on this later).
Is that a problem? Probably not, especially considering that the wealthiest taxpayers still end up paying more in taxes, in absolute amounts, than anyone else. Also, there is no moral or (valid) economic argument for trying to squeeze as much in taxes from super-millionaires as we possibly can..
Chait points out that Zuckerberg would like to see all of his taxes go up, not just his income taxes. For instance, if the Bush tax cuts expire, income-tax rates go up, but so does the tax rate on capital gains (from 15 percent to 20 percent). Chait is correct.
But even if tax rates on capital gains do go up, my point still stands, because it is unlikely that the people at the very top will be the ones affected most. #more#First, while on paper the capital-gains tax would go up from 15 percent to 20 percent, that doesn’t mean that people will pay 20 percent on their capital gains. In the current system, for those at the very top of the income spectrum, realized capital gains can probably be offset with an equal amount of losses, offsetting the need to pay tax on the gains. This means that someone with a sufficiently large and diverse portfolio may never need to pay the capital-gains tax, so long as they can balance selling assets with gains and losses. More importantly, when it comes to capital-gains taxes, timing is everything. Consider this interesting paragraph from CBO:
Because taxes are paid on realized rather than accrued capital gains, taxpayers have a great deal of control over when they pay their capital gains taxes. By choosing to hold on to an asset, a taxpayer defers the tax. The incentive to do that — even when it might otherwise be financially desirable to sell an asset — is known as the lock-in effect. As a consequence of that incentive, the level of the tax rate can substantially influence when asset holders realize their gains, as can be seen particularly clearly when tax rates change. For instance, the Tax Reform Act of 1986 boosted capital gains tax rates effective at the beginning of 1987. Anticipating that increase, investors realized a huge amount of gains in 1986. Then, in 1987, realizations fell by almost as much, returning to a level comparable to that before the tax increase.
This is why a change in the capital gains rate from 15 percent to 20 percent probably wouldn’t make a difference in the overall tax burden of those at the very top of the income distribution.
But there’s a more important issue of good tax policy that should be part of this discussion. The reason for the current preferential treatment of capital and dividends is to offset the “double taxation” (it’s really triple taxation) of corporate profits. Leaving aside the fact that this probably means that the rate should be zero rather than 15 percent, this double taxation of corporate profit and its consequent disincentive to invest means that increasing the capital-gains tax isn’t a good idea in the first place, no matter what goal we are trying to achieve.
More importantly, as we know, the statutory incidence of a tax is very different from its economic incidence. Take the corporate income tax: As I have mentioned in the past, several much-discussed studies have found that it is likely that most of the burden of the tax is borne, not by capital, not by shareholders, but by domestic labor, in the form of lower wages. Here is CBO’s William Randolph (2006):
Burdens are measured in a numerical example by substituting factor shares and output shares that are reasonable for the U.S. economy. Given those values, domestic labor bears slightly more than 70 percent of the burden of the corporate income tax. The domestic owners of capital bear slightly more than 30 percent of the burden. Domestic landowners receive a small benefit. At the same time, the foreign owners of capital bear slightly more than 70 percent of the burden, but their burden is exactly offset by the benefits received by foreign workers and landowners.
I assume the same thing can probably be said about capital gains taxes. Basically, the person paying the tax isn’t always the person shouldering its burden. As such, it is very risky to be calling for an increase in taxes on rich taxpayers because it is likely to be paid for by — if not entirely by — less-wealthy taxpayers, too.
For me, this discussion underlies how meaningless and artificial the distinctions are between capital income, corporate income, and personal income. Instead of calling for an increase in their tax rates — whatever the tax — people like Buffet and Zuckerberg should call for the end of this fake classification of income. For instance, we could eliminate the corporate income tax, the capital-gains and dividend taxes, and other wealth taxes and simply roll all income into one category taxed at a low rate (the idea being that if there is going to be double taxation of income, it should be done at a lower rate). Alternatively, instead of trying to raise the tax rates of people whose income is derived from wages and salary, we should instead lower the tax rate applied to wages and salary so that it is equal to the 15 percent capital-gains tax enjoyed by those who make most of their income in the form of capital and dividends. (Moving a consumption-based tax system would of course be my preference, but that’s not the topic here.)
Until we do, if Warren Buffet and Mark Zuckerberg want to pay more taxes, they should just send a check to the federal government.