ANALYSIS: BUDGET

Income-Tax-Rate Hikes Aren’t the Only Way to Hit the Rich

The debate over revenue has centered on George W. Bush’s tax cuts. But for the wealthy, investment taxes matter more.

A Pacific herring is shown in this undated photo provided by the Washington state Department of Fish and Wildlife. Environmental groups filed a petition Wednesday, Jan. 21, 2004, seeking federal endangered-species protection for Cherry Point herring, a type of Pacific herring, a foundation of the food chain that includes chinook salmon and killer whales. The petition was mailed to the National Marine Fisheries Service and Secretary Donald Evans of the Commerce Department, the agency's parent. State research has determined that this herring population, near Bellingham in Whatcom County, is genetically distinct, the groups said. 
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Nancy Cook
Nov. 29, 2012, 11:30 a.m.

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Dav­id A. Lev­ine knows firsthand how the tax code can shape be­ha­vi­or. Be­gin­ning in the late ‘80s, the Wall Street eco­nom­ist’s take-home pay rose dra­mat­ic­ally while his salary grew and his in­di­vidu­al in­come-tax rate fell. He made out so well that he could leave his job in 1990, at the age of 44. Now he lives com­fort­ably in New York City off in­vest­ment in­come, which is taxed at just 15 per­cent; in the past five years, his total tax rate has nev­er ex­ceeded 7 per­cent of his ad­jus­ted gross in­come. He finds this fact as out­rageous as Pres­id­ent Obama does. “It’s pathet­ic,” Lev­ine says. “I have way more than I need.”

Poli­cy­makers have spent two years de­bat­ing how to re­duce the de­fi­cit, with much of the at­ten­tion dur­ing the cam­paign centered on who should pay what. Top earners, Obama says, should pay their “fair share,” but con­gres­sion­al Re­pub­lic­ans op­pose in­come-tax hikes. The stale­mate might push us off the fisc­al cliff. Un­for­tu­nately, it also misses an im­port­ant point. Wealthy people have many sources of in­come bey­ond their salar­ies — from in­her­it­ances to in­vest­ments. Tax­ing those funds at high­er rates could fur­nish equally pro­gress­ive and nearly-as-luc­rat­ive rev­en­ue streams.

Demo­crats fo­cus on in­di­vidu­al in­come-tax rates be­cause those raise the most money for the fed­er­al gov­ern­ment. If the top two mar­gin­al rates re­turn to pre-Bush levels, the Treas­ury De­part­ment es­tim­ates the change would raise $835 bil­lion over 10 years (more than half of the ex­pec­ted $1.56 tril­lion in rev­en­ue over that time). The top rate, which was 91 per­cent in the late 1950s, ac­cord­ing to the Con­gres­sion­al Budget Of­fice, is now 35 per­cent and will de­fault to 39.6 per­cent at the end of the year. The gradu­ated in­come-tax brack­ets help keep the code pro­gress­ive, says Rober­ton Wil­li­ams of the Tax Policy Cen­ter, and they are easi­er to tweak than oth­er pro­posed ideas in­volving de­duc­tion caps. For Re­pub­lic­ans, rais­ing mar­gin­al rates also would most clearly vi­ol­ate Grover Nor­quist’s fam­ous pledge.

But, as Lev­ine points out, tinker­ing with in­come-tax rates is not the only way to make rich people pay their share. For one thing, wealthy people already pay far less in total in­come tax than they did in years past. In 2010, ac­cord­ing to the most re­cent data from the In­tern­al Rev­en­ue Ser­vice, the av­er­age tax rate for ad­jus­ted gross in­come above $500,000 fell by as much as 1.7 per­cent­age points from the year be­fore. The IRS at­trib­utes this drop to the way people made money. In 2009, those mak­ing between $500,000 and $10 mil­lion re­por­ted 19 per­cent of their in­come as cap­it­al gains and di­vidend in­come; in 2010, that share shot up to 25 per­cent. For those mak­ing more than $10 mil­lion, the rate climbed from 36 per­cent to 49 per­cent.

Those in­vest­ment taxes are slated to rise at the end of 2012, both from the ex­pir­a­tion of the Bush-era cuts and be­cause of the new in­vest­ment taxes in the health care law. When they do, they could cause a wind­fall for Wash­ing­ton: Just restor­ing the Clin­ton-era rates would bring in roughly $242 bil­lion over a dec­ade, ac­cord­ing to the Treas­ury De­part­ment. Lim­it­ing the de­duc­tion cap to house­holds above the $250,000 in­come threshold could bring in an­oth­er $573 bil­lion over that peri­od. Re­im­pos­ing the es­tate tax at 2009 levels would bring in $119 bil­lion. To­geth­er, those add up to $934 bil­lion — far more than halfway to­ward Obama’s $1.6 tril­lion rev­en­ue tar­get.

The rich might not be en­tirely op­posed to pay­ing more taxes. Lev­ine joins a grow­ing chor­us that in­cludes Gold­man Sachs CEO Lloyd Blank­fein (“Tax in­creases, es­pe­cially for the wealth­i­est, are ap­pro­pri­ate” when coupled with spend­ing cuts, he wrote in The Wall Street Journ­al); the busi­ness lead­ers be­hind Fix the Debt, an ad­vocacy group that wants a de­fi­cit deal; and Re­spons­ible Wealth, a long-stand­ing 500-per­son Bo­ston group that sup­ports tax hikes on salar­ies and in­vest­ments and wants to close the so-called car­ried-in­terest pro­vi­sion, which al­lows as­set man­agers to use the low cap­it­al-gains rate. As one tax lob­by­ist put it, rich people (out­side the Belt­way) care more about the num­ber at the bot­tom of their tax re­turn than the polit­ic­al mach­in­a­tions over their brack­et’s rate. Most rich people, after all, nev­er pay the full amount that their tax rate sug­gests.

The chal­lenge for the gov­ern­ment when it comes to wealthy tax­pay­ers is, of course, to ac­quire rev­en­ue without dis­cour­aging them from in­vest­ing in the eco­nomy. Just as low tax rates pushed Lev­ine in­to semire­tire­ment, high ones af­fect be­ha­vi­or, too, eco­nom­ists say. (In a re­cent New York Times op-ed, War­ren Buf­fet dis­agreed, ar­guing that savvy in­vestors nev­er turn their backs on good busi­ness op­por­tun­it­ies.) So, where is the sweet spot, the most-ef­fect­ive ways to tax the rich? It’s prob­ably a com­bin­a­tion of slightly high­er tax rates on house­hold in­come, in­vest­ment in­come, and in­her­it­ances. It’s a more nu­anced equa­tion than the cur­rent polit­ic­al ob­ses­sion with the top two brack­ets of the Bush-era tax cuts al­lows.

This art­icle ap­peared in print as “Red Her­ring.”

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