Income Inequality Driven By Slashes to Capital Gains Tax Rate

The Congressional Research Service declined a vacation in favor of whipping up a report on the major causes of inequality, which Jared Bernstein summarizes here. The report does find that income inequality is in part a function of the Bush tax cuts, and I’m unsure how it accounts for the higher salaries granted to executives with a lower tax burden as part of that whole equation. However, it turns out that the more important cause happens to be dividends and capital gains:

The largest single contributor to the growth of inequality, 1996-2006, was dividends and capital gains. Adding in business income, like profits from a hedge fund, comes to 0.061, more than explaining the 0.057 point increase in the Gini index.

It may surprise you that income from earnings reduced inequality’s growth over these years. It’s not because the distribution of earnings became more equal—to the contrary. It’s because earnings are a) less skewed than cap gains, dividends, and business income, and b) comprised a significantly smaller share of income in 2006 than in 1996.

In other words, a more equal type of income (earnings) was a smaller share of total income at the end of the period, and visa versa: a more skewed income source comprised a larger share.

Over the past several decades, the capital gains rate has taken a beating. Every Republican Presidential candidate except for Romney and Santorum has vowed to eliminate the capital gains tax. It gets demonized as “double taxation,” and wild claims are made about a lowered or cashiered capital gains tax leading to increased investment and higher growth. The truth is that our unequal society is made far more unequal when the rich can shift themselves almost entirely into a 15% tax rate through capital gains. Among the top 1%, 38% of income now comes from dividends and capital gains, triple the percentage rate of all tax filers. According to Bernstein’s precis of the report, “if capital and business income shares hadn’t grown—i.e., if one assigns the growth in their shares to the wage share—inequality would have grown slightly more than half as fast as it did.”

It’s important to nail this down, because it hasn’t really been part of the conversation in the progressive community. The reduction in the capital gains tax from 20% to 15% exactly was part of the 2003 Bush tax cuts, and has been extended twice since then, most recently with the rest of the Bush tax cuts in 2010 (starting in 2008, the long-term capital gains rate for individuals in the lowest two income brackets actually reduced to 0, but if you’re in those brackets, you are highly unlikely to benefit from a lot of capital gains). This is not only a giveaway mainly to the rich, it distorts income inequality, and as a result the political economy of the country.

Reagan increased the capital gains tax from 20% to 28% in the 1986 tax reform, reversing a cut from 1981. But there’s almost nobody clamoring for this today. Occupy Wall Street has raised the issue of income inequality, but not really this specific cause. In fact, they have started to veer into other avenues like protesting the NDAA. That’s perfectly noble, but if we’re going to change the conversation nationally around the dangers of income inequality, we should at least pinpoint the cause.

Comments are closed.