Tag: top 1%

The Politics and Economics of the Capital Gain Tax

The Treasury Department is said to be studying the idea of providing some sort of inflation-protection (indexing) for the taxation of capital gains.  Rep. Devin Nunes (R-CA) has introduced a bill  (H.R. 6444) to do just that.   Predictably, Washington Post writer Matt O’Brien instantly dismissed the idea as “Trump’s new plan to cut taxes for the rich.” 

O’Brien relies on a two-page memo from John Ricco which yanks mysterious estimates out of a black box – the closed-economy Penn-Wharton Budget Model.   The “microsimulation model” predicts that the Top 1 Percent’s share of federal income taxes paid could fall from 28.6% to 28.4% as result of taxing only real capital gains.  “That’s real money,” exclaims O’Brien.

No model can estimate how much revenue might be lost by indexing (if any) because that depends on such unknowable things as future asset values, future tax laws and future inflation.   Yet Mr. Rico magically “projects” future realizations to “estimate that such a policy would reduce individual tax revenues by $102 billion during the next decade [sic] from 2018-2027.”   Does that imaginary $102 billion still look like “real money” when spread over Rico’s extended 20-year “decade?”   It would be a microscopic fraction of CBO’s projected individual income taxes of $21.1 trillion over that period. 

One problem with the notion that indexing capital gains could only benefit the top 5 percent (over $225,251 in 2016) is that it wrongly assumes the capital gains tax only applies to stock market gains. Another Washington Post article said, “Researchers have estimated that the top 5 percent of households in terms of income hold about two-thirds of all stock and mutual fund investments, putting wealthier Americans in the position of benefiting much more than others from any changes to capital gains rules.”  But the capital gains most likely to be seriously exaggerated by decades of inflation are not gains from selling financial assets, but from selling real assets.  After many years of even moderate inflation, an unindexed tax may be imposed on purely illusory “gains” from the sale of real property that actually involve a loss of real purchasing power.  A 2016 report from the Congressional Budget Office and Joint Committee on Taxation, “The Distribution of Asset Holdings and Capital Gains” reports that Americans held $7.5 trillion in stocks and mutual funds in 2010, but $12.2 trillion in private businesses and $8.5 trillion in nonresidential real estate.  

A related problem with conventional distribution tables is that they add realized capital gains to income in the year in which a farm, building or business is sold, which makes it true by definition that unusually large one-time gains are received by those with “high incomes” (including those gains).

Competing Analyses of the Republican Tax Reform Framework

The media’s favorite analysis of the Big Six tax reform framework comes from the Urban-Brookings Tax Policy Center (TPC), which purports to estimate that the plan would increase individual income taxes by $471 billion over a decade (by slashing exemptions and deductions), while cutting business taxes by $2.6 trillion.  Predictably, this generated a tidal wave of outraged editorials and TV ads claiming the plan would do nothing for economic growth and benefit only “big corporations and the top 1%” (which is redundant, because individual taxes aren’t cut and the TPC wrongly attributes nearly all corporate tax cuts to the top 1%).

The Wall Street Journal has offered a powerful corrective to the TPC’s concealed analysis in “Where Critics of Tax Reform Go Wrong”, by Larry Kotlikoff of Boston University. It draws on his working paper with Seth Benzell of MIT and Guillermo Lagarda of the Inter-American Development Bank, which found “The [corporate] tax reform produces enough additional revenues to permit a reduction in personal income tax rates.”

The Tax Policy Center opines there will be “little macroeconomic feedback effect on revenues,” Kotlikoff explains, because they rely on an antique closed-economy model in which (1) investment can only be financed from some domestic “pool” of savings, and (2) higher taxes are equivalent to more savings because they supposedly reduce government deficits without reducing private savings. If government borrows more, this supposedly raises interest rates and “crowds out” private investment.

In reality, U.S. interest rates do not rise and fall with budget deficits, partly because arbitrage ensures the global bond yields move in tandem. Japan ran large chronic budget deficits for decades with super-low interest rates.  

TPC “Experts” Don’t Know Who Gets What Share of Trump Tax Cuts

According to Wall Street Journal writer Laura Saunders, future Treasury Secretary Mnuchin must be wrong because Tax Policy Center experts say so. Actually, Mr. Mnuchin may be partly right, but the experts are almost entirely wrong.

“Steven Mnuchin, the likely next Treasury secretary, this week said rich U.S. taxpayers won’t get “an absolute tax cut” under President-elect Donald Trump,” writes Ms. Saunders; “But that is not what Mr. Trump says in his taxation plan. In fact, under his approach the wealthy would receive an average tax cut of about $215,000 per household, experts say.” 

“What Mr. Trump says” is not at all the same as what some “experts say.” Expert or not, Tax Policy Center (TPC) estimates of who pays what under different tax rates are distressingly capricious.

Mr. Mnuchin appeared to be talking only about individual income taxes. That is why he suggested that lower marginal tax rates for high earners “will be offset by less deductions.” So long as we focus only on non-business taxes (including high salaries and dividends), Mr. Mnuchin was probably right. Indeed, according to Ms. Saunders’ experts, the lost revenue from lower tax rates over 10 years totals $1.49 trillion plus $145 billion from eliminating the 3.8% Obamacare surtax.  Yet those individual tax cuts are more than offset by $2.6 trillion in added revenue from Trump’s cap on itemized deductions and the loss of personal exemptions. More than doubling the standard deduction loses considerable revenue, but not from high-income taxpayers.

Ms. Saunders mentions only the loss of itemized deductions—not exemptions—and concludes “these limits don’t fully offset the effects of income- and estate-tax cuts for high earners proposed by Mr. Trump, according to experts.” 

Repealing the estate tax loses very little revenue, but it is arbitrary for the TPC to assign that lost revenue to people with high incomes because the estate tax is borne by heirs and charities—not dead people.

With estate tax repeal included, only 22% of the Trump tax cut goes to households (including investors) according to the TPC, with 44% of Trump tax cuts going to corporate earnings (and the rest to unincorporated business). 

More Evidence That Lower Marginal Tax Rates Speed Up Economic Growth

An important and timely paper from Columbia University economist Karl Mertens finds that amount of income reported on tax returns is highly sensitive to marginal tax rates, and that the effect is mainly from changes in real activity not tax avoidance.

Mertens estimates “elasticities of taxable income of around 1.2 based on time series from 1946 to 2012. Elasticities are larger in the top 1% of the income distribution but are also positive and statistically significant for other income groups… . Marginal rate cuts lead to increases in real GDP and declines in unemployment.”  Other recent research also shows that “higher marginal tax rates reduce income mobility” while eliminating higher tax brackets improves upward mobility.

Both Democratic candidates for the presidency, Sanders and Clinton, want to greatly increase marginal tax rates on high incomes and on realized capital gains. By contrast, all Republican candidates propose to reduce marginal tax rates.

Mertens’ research unambiguously predicets that economic growth would slow or stop under the Democrats’ proposed tax increases, but accelerate under Republicans’ tax reforms.

High Turnover Among America’s Rich

Your odds of “making it to the top” might be better than you think, although it’s tough to stay on top once you get there.

According to research from Cornell University, over 50 percent of Americans find themselves among the top 10 percent of income-earners for at least one year during their working lives. Over 11 percent of Americans will be counted among the top 1 percent of income-earners (i.e., people making at minimum $332,000 per annum) for at least one year.

How is this possible? Simple: the rate of turnover in these groups is extremely high.

Just how high? Some 94 percent of Americans who reach “top 1 percent” income status will enjoy it for only a single year. Approximately 99 percent will lose their “top 1 percent” status within a decade.

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Can Inequality Get Worse If Poverty Gets Better?

Jim Tankersley of the Washington Post believes he has discovered “The Big Issue With Hillary Clinton Running Against Inequality”:

“Inequality got worse under Bill Clinton, not better. That’s true if you look at the share of American incomes going to the 1 percent, per economists Emmanuel Saez and Thomas Piketty. It’s also true when you look at the share of American wealth going to the super-super-rich, the top 0.1%, per research by Saez and Gabriel Zucman.”

What this actually reveals is the absurdity of (1) defining inequality solely by top 1% shares of pretax income less government benefits, and (2) judging any strong economic expansion as a failure because top 1% income shares always rise during strong economic expansions.

The graph uses the Congressional Budget Office estimates of top 1% shares, because (unlike Piketty and Saez) they include government benefits as income and subtract federal taxes.  What it shows is that both affluence and poverty are normally highly cyclical. When the top 1 percent’s share of after-tax income jumped from 11.2% in 1996 to 15.2% in 2000, the poverty rate simultaneously dropped from 11% to 8.7%.  Meanwhile, median income, after taxes and benefits, rose from $50,900 in 1993 to $61,400 by 2001, measured in 2011 dollars. 

 

Conversely, when the top 1% share fell from 16.7% in 2007 to about 12% in 2013 (my estimate), the poverty rate rose from 9.8% to 15%.  If we adopt the egalitarians’ top 1% mantra, must we conclude that inequality “got better” lately as poverty got worse?Top 1% and Poverty

The income peak of 2000 is a tough act to beat, and few of us are ahead of it today – least of all the top 1%. The brief surge in top incomes of 2006-2007, like the related speculative surge in housing prices, proved unhealthy and unsustainable. But weak economic performance and high poverty in the past four years is no reason to dismiss the 3.7% average economic growth of 1983-2000 simply because such prolonged prosperity made more people rich.

Tankersley also asks us to “look at the share of American wealth going to the super-super-rich, the top 0.1%, per research by Saez and Gabriel Zucman.”  As I’ve explained in The Wall Street Journal, however, the Saez-Zucman estimates misinterpret shrinking shares of capital gains and investment income still reported on individual tax returns, or shifted from the corporate tax to a pass-through firm, rather than (like most middle-class savings) sheltered in IRA, 529 and 401(k) plans.

It is easy to envision Republican partisans welcoming and adopting the Tankersley theme that Hillary Clinton should now be ashamed of the strong economy of 1996-2000 because “inequality got worse” as many new firms were created and stock prices soared. Yet whenever stocks crashed and the top 1% share fell (making inequality “better”?) the poverty rate rose and median incomes were flat or down.

Some Republican candidates have already alluded to the same pretax, pre-transfer “top 1%” figures to claim inequality worsened under Obama – meaning since 2009.  According to Piketty and Saez, real average incomes of the top 1% were indeed higher in 2013 ($1,119,315) than in the crash of 2009 ($975,884).  Before crashing below $1 million in 2009, though, top 1% incomes had been much higher in 2007 (the equivalent of $1,533, 064 in 2013 dollars) and in 2000 ($1,369,780). The rising tide has not lifted many small boats or big yachts since 2009, because the tide hasn’t risen much; higher tax rates in 2013 certainly didn’t help.

The trouble with Republicans using highly cyclical top 1% statistics as a political weapon against Democrats is that doing so requires capitulating to the divisive and dishonest leftist fallacy that poor people and middle-income people do best when the top 1% is doing badly.

The truth is that the poverty rate fell sharply and middle-incomes rose briskly in President Clinton’s second term, and the top 1% gladly reported more taxable income and paid more taxes as the tax on capital gains was cut from 28% to 20%.  There is a lesson to be learned here, but it is not to denigrate the so-called rising inequality of the late 1990s.

Bottom 90% Pretax Pretransfer Income is no Proxy for Median After-Tax Income

bottom 90 percent vs CBO median

This graph illustrates a few points made in my recent Wall Street Journal article.  First of all, the Piketty & Saez mean average of bottom 90% incomes per tax unit is not a credible proxy for median household income, particularly since the big reductions in middle-class taxes from 1981 to 2003.

Second, the red bars claiming bottom 90% incomes in the past six years have been no higher than they were in 1980 (Sen. Warren) or even 1968 (see the graph) is literally unbelievable.  If that were true then all other income statistics – including GDP – would have to be completely false.