Politicians have set tax rates on wages at rates that are much higher than those imposed on long-term investment returns. Well-paid workers, including physicians and farmers, face a progressive tax system in the sense that they pay more than poorer workers on what its deemed “ordinary income.” However, taxpayers who have unearned income, such as long-term capital gains and qualified dividends, are favored by the current income system. 

Congress legislated comprehensive tax reform in 1986, seeking to eliminate this gap between rates imposed on investors and workers. But when Democrats controlled Congress and the White House in the early 1990s, tax rates on wealthy wage earners rose higher than on investments. In the 1990s and into the early 2000s, when Congress was controlled by Republicans, the gap widened further when rates on wealthy investors declined.

Tax return on a postcard

Currently, the Republican-controlled appears ready to engage in some sort of tax reform. For example, House Speaker Paul Ryan (R-WI) told the National Association of Manufacturers in June: “We will consolidate the existing seven brackets into three, double the standard deduction, and simplify things to the point that you can do your taxes on a form the size of a postcard. This, instead of the 1040 form. Wouldn’t that be nice? This is within our reach.” He repeated the image in a CNN interview in August, saying that GOP’s goal is to “simplify the [tax] code so much that you can fill out your taxes on a postcard.” That proposed postcard is circulating on social media. 

The proposed tax form is quite simple. The first line on the card asks tax filers to record their wages for the previous year. The second line requests just half of the filers’ investment income. Thus, investment is rewarded but wages are fettered with taxes.

The goal for Republicans is clear. Ryan said earlier this year. “We want a tax code built for growth. We want a tax code that raises wages, keeps American companies in America, gives us faster economic growth.”

Trickle down

The explanation that is aired for why investment should be taxed at a lower rate is that it gives taxpayers incentive to save money, thus increasing the amount of capital available to companies and enterprising individuals to invest and contribute to economic growth. According to this theory, it is a win-win for everybody.

However, not all taxpayers are winners. Lowered taxes on investors means a shifting of the tax burden to well-compensated workers and professionals. Those in the higher brackets may thus have lessened incentives to work hard, earn more, and improve skills and thus earn more money. These workers would include highly skilled physicians and surgeons, who have to pay considerable amounts of money every year not only to stay current in their professions but also to improve and excel. 

Is there an ideal tax rate to impose on investors? A study conducted by the Federal Reserve in 1999 used complicated algebra to reach the ideal optimal tax rate on investment income: “zero.” However, another study published in 2009 by the American Economic Review found the best rate to be 36 percent. 

There is evidence that investors are more sensitive to taxation that workers are. Workers, on the other hand, tend to go to work every day no matter what. Men, for example, are not particularly responsive to the tax rate, while women are only “responsive at the margins,” according to economist Joel Slemrod. Investors are more sensitive in the short term. If taxes on investors decline next year, investors may wait until then to sell stocks and businesses they own. Evidence for that is that US Treasury income declined this year even though the economy is strong. 

The Greatest Generation

Those in favor of taxing investment point to the famous post-World War 2 economic boom when top rates on dividends were between 70 and 90 percent. They also contend that rapid growth also followed tax hikes on investors in the late 1980s and early 1990s. And after George W. Bush cut the top rate on dividends by half, they argue, they were followed by the Great Recession and the erasing of any conceivable benefits of his policy. And more than a decade later, the Great Recession swamped any conceivable benefits from then-President George W. Bush’s tax cuts, which dropped the top rate on dividends by half.

Democrats want to see higher taxes imposed on investment income. The so-called Buffett Rule would have imposed a minimum rate of 30 percent on all taxpayers with income of $1 million or more, no matter where the money came from. While the Buffett Rule did not pass, Congress increased the rate on capital gains and dividends from 15 percent to 20 percent. Then came the Affordable Care Act (Obamacare) and the imposition of the net investment income tax (NIIT): a 3.8 percent levy on wealthy investors. 

According to Republican Rep. Kevin Brady of Texas, the House Ways and Means Committee Chairman, the NIIT is “incredibly anti-growth,” but noted that getting the Senate to approve its repeal would be “a challenge.” The Tax Foundation estimates the repeal of NIIT would boost the U.S. economy by 0.7 percent over the next 10 years.

Part of what legislators must consider is demography. The World War 2 generation is dying out, and the income earned in the post-World War 2 era is about to change hands. Thus, an unprecedented amount of investment income is about to be inherited. The generation about to benefit from the savings of its parents will benefit from the current tax code, while younger workers will pay a disproportionate rate. Supply-siders contend that investments should not be taxed at all, arguing that it is “double taxation” because it is a levy on money coming from assets that were taxed when they were first earned. The supply-siders argue that taxing workers more than investors is fair because workers and investors are merely people at different stages of life: the young can save even while they are being charged high tax rates on wages. The elderly are taxed less on investments so as to enjoy their saved earnings from their younger years. 

The passing of the torch

However, there has been a huge jump in inherited wealth. And those who accumulate wealth are often not the same people who spend the wealth. Reluctant to part with their money, a huge share of the Americans with large fortunes are aged in their 80s and 90s. And because the Trump administration is seeking to eliminate the estate tax, they will accumulate still more wealth that they will pass on to a new generation of lightly-taxed investors.  

Lowering investment tax rates or eliminating NIIT altogether are billed as the means towards the end of stimulating the national economy by inducing the wealthy to both save and invest more. This is the argument hazarded by supply-side economists, who point to the results of the Reagan years. But economists Emmanuel Saez and Gabriel Zucman note that the top 1 percent of wealthy Americans are already saving and investing more: Saez and Zucman calculate that the 1 percent have been consistently saving 30 percent of their income since the 1970s, according to Bloomberg News. Debt is increasing, as is wage stagnation.

The rest of the country is saving less, making retailers and manufacturers complain that consumer spending is insufficient. Trillions of dollars, however, are sitting in investment accounts; banks have plenty of deposits, stock prices are high, and corporations have plenty of cash on hand (some of which is contributed to nonprofits that have progressive political goals). Warren Buffett, for example, is worth just a little south of $100 billion, and George Soros is worth about $24 billion. 

Currently, the median American worker (ages 55 to 64), however, has just $15,000 saved in retirement accounts, according to the left-of-center New School for Social Research. The vast majority of wealth held by the middle classes are in the form of retirement accounts and residences. Accessing a retirement account almost never means the levying of a capital gains tax, and a home sale is taxed only if the gain is more than $250,000 for a single person and $500,000 for a couple. Also, the tax rate for those with less than $38,000 in investment income is zero. 

“Taxing investors less is really not what the U.S. needs now,” Saez told Bloomberg. He suggested that policymakers should instead seek to rebuild middle-class wealth to save for their retirement years and pay off their mortgages.

The choice facing President Trump and Republicans in Congress is whether to continue with the disparity of tax rates imposed on workers and investors, or to seek a new model.

 



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Spero News editor Martin Barillas is a former US diplomat, who also worked as a democracy advocate and election observer in Latin America. His first novel 'Shaken Earth', is available at Amazon.

The views and opinions expressed herein are those of the author only, not of Spero News.

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