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.