TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Tuesday, September 12, 2017

Why American Workers Pay Twice As Much In Taxes As Wealthy Investors

Bloomberg Politics, Why American Workers Pay Twice as Much in Taxes as Wealthy Investors:

Let’s say you and I are neighbors. You’re an emergency room doctor, and I don’t work, thanks to a pile of money my grandparents left me.

You spend your days and nights stitching up gunshot wounds and helping children survive asthma attacks. I’ve gotten really good at World of Warcraft, winning EBay auctions, and frying shishito peppers to just the right crispiness.

Let’s also say we both report $300,000 in income to the Internal Revenue Service this year. Who pays more in taxes?

You do, by a lot. You owe the IRS about $38,500 more, assuming each of us pays the maximum with no special deductions. I also have more flexibility to lower my burden with tax planning strategies and other tricks, and I get to skip about $24,000 in payroll taxes that you and your employer must fork over each year.

This isn’t some quirk of the U.S. tax code. Politicians have intentionally set tax rates on wages much higher than those on long-term investment returns. The U.S. has a progressive tax system in the sense that well-paid workers sacrifice much more than poor workers on their “ordinary income.” But Americans with so-called unearned income—qualified dividends and long-term capital gains—get a break. A billionaire investor can pay about the same marginal rate as a $40,000-a-year worker, a fact Warren Buffett has famously lamented. ...

Trump, Ryan, and other Republicans in Congress are wrangling over a variety of competing goals for reform. The most aspirational is a tectonic simplification of the tax code that really would allow everyone to file using a postcard. But more realistic legislative targets are lowering tax rates on individuals and corporations as well as eliminating the estate tax and alternative minimum tax. They may also try again to kill the Affordable Care Act taxes—including those on all that investment income raked in by the wealthy.

By taxing investors less, some economists argue, you give taxpayers more of an incentive to save. The more savings in the economy, the more capital that companies and entrepreneurs can invest in ways that expand the economy and make workers more productive. Everyone, including workers, wins, according to this theory.

But there are potential negative consequences to such a policy. By lowering taxes on investors, you shift more of the tax burden to well-paid workers. This may give highly skilled and creative people a disincentive to work hard or improve their skills so they can earn more money, while also giving children of wealthy parents another reason not to work at all. ...

In practice, the person who successfully accumulates assets is often not the person who spends them. Affluent retirees are increasingly reluctant to even touch their nest eggs. A huge and disproportionate share of the nation’s largest fortunes is in the hands of people in their 80s and 90s. And the estate tax, already very easy for the wealthy to avoid, is targeted for elimination by the Trump administration.

As a result, an unprecedented amount of wealth may soon be inherited. The generation on the receiving end of this familial largesse will get a tax break every time they cash in on the fruits of others’ labor.

Yes, many of these lucky heirs and heiresses go to work anyway, or contribute in other ways. Still, it’s hard to argue that productive members of society—people like our ER doctor—should pay twice as much in taxes as people who sit around playing video games. But that’s the choice that underlies America’s tax code—and one that will figure in the debate over how, or whether, to rewrite it.

(Hat Tip: Bill Turnier.)

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DA.........the distinction between ordinary income, capital gains and dividends should be eliminated. As long as it exists the working stiff will always pay more in taxes. Make it simple and get rid of the distinction and tax everyone with the same rate or set of rates.

Posted by: sid | Sep 12, 2017 5:40:48 PM

Duh. The wealthy have something the near-rich professional class doesn't -- assets. If you have assets you can control your income. If you don't have assets, you have to work harder to try and accumulate some assets. Unfortunately, the way the game is played, you're not gonna win. The near rich professional class can afford to drive Lexus cars, but they can't save any money.

The real lesson the "tax the rich" people never understand is having assets means you have choices. Unlike the near-rich professional class who have no other option than to get beaten like a rented mule, the wealthy can vote with their feet and assets. Squeeze them at one end, and they move to the other.

That said, I agree with Sid: all income - capital or wages - should be taxed the same. However, unlike Sid perhaps, I believe capital losses should be fully deductible.

Posted by: Dale Spradling | Sep 13, 2017 6:37:00 AM

An honest author wouldn't have included payroll taxes and excluded the social security benefits, and would have included the reduction in wealth from corporate level income tax associated with the taxable dividends, but we aren't really about honesty anymore, are we?

Posted by: Steve | Sep 13, 2017 6:55:17 AM

Except that the median American "worker" doesn't make nearly $300,000 per year. He/she makes around $55,000 nationally. The effective tax rate for the median American worker is also nowhere near 34%, and the $ he/she pays is nowhere near $34,000 per year.

A better example would've been to compare the median worker to the median investor. Problem there: Even investors tend to have wage jobs, unless they're retired.

Still, interesting. And largely meaningless.

Posted by: MM | Sep 13, 2017 7:38:47 AM

A well-worn piece of propaganda, with all the standard misleading elements. Counts the employer's contribution as paid by the employee? Check. Ignore value of benefits received from employee and employer payroll contributuons? Check. Ignore inflation effects in capital gains rates? Check. It's surprising Bloomberg would print it; it seems more in the line of Salon.

Posted by: Not this again | Sep 13, 2017 11:52:47 AM

SOLUTION: "Workers" pay the same tax rates as "Investors". That's fair: same income and same taxes. No need to punish Workers.

Posted by: stephen karpa | Sep 13, 2017 1:49:17 PM