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Low Capital Gains Tax Rates Fueling Record Income Inequality

February 21, 2013

Last month, an analysis by Berkeley Professor Emmanuel Saez revealed that the top 1 percent of American earners captured all the income gains during the first two years of the current economic recovery while the other 99 percent lost ground. Now, a new analysis by Congressional Research Service analyst Thomas Hungerford is just the latest to show that historically low capital gains tax rates are "by far the largest contributor" to America's historically high income inequality.

As ThinkProgress explained Hungerford's findings, the upward spiral of income inequality (as measured by the Gini coefficient) between 1991 and 2006 is mostly due to federal tax policy that slashed rates on capital gains and dividend income, income which flows almost exclusively to the rich:

By far, the largest contributor to this increase was changes in income from capital gains and dividends. Changes in wages had an equalizing effect over this period as did changes in taxes. Most of the equalizing effect of taxes took place after the 1993 tax hike; most of the equalizing effect, however, was reversed after the 2001 and 2003 Bush-era tax cuts. [...]
The large increase in the contribution of capital gains and dividends to the Gini coefficient, however, is due to the large increase in the share of after-tax income from capital gains and dividends, and to the increase in the correlation of this income source with after-tax income.

Hungerford's table below provides a window into the rapid upward income redistribution underway over the last two decades. Between 1991 and 2006, the share of Americans' total income coming from wages and salaries dropped from 92 to 77 percent. During the same period, capital gains income almost tripled, catapulting from 5.4 to 15.6 percent. Unsurprisingly, "capital gains and dividends share appears to be pro-cyclical, increasing during the expansions and falling during recessions." (That is reflected in Saez' findings, which showed that the dramatic increase in stock prices from 2009 to 2011 drove much the winner-take-all payday to the top sliver of U.S. households.)

As the Washington Post reported in 2011, the dynamic at play here is hardly a mystery. As part of its series on the widening chasm between the super-rich and everyone else titled "Breaking Away," the Post similarly concluded that "capital gains tax rates benefiting wealthy feed [the] growing gap between rich and poor." As the Post explained, for the very richest Americans the successive capital gains tax cuts from Presidents Clinton (from 28 to 20 percent) and Bush (from 20 to 15 percent) have been "better than any Christmas gift":

While it's true that many middle-class Americans own stocks or bonds, they tend to stash them in tax-sheltered retirement accounts, where the capital gains rate does not apply. By contrast, the richest Americans reap huge benefits. Over the past 20 years, more than 80 percent of the capital gains income realized in the United States has gone to 5 percent of the people; about half of all the capital gains have gone to the wealthiest 0.1 percent.

The handy chart at the top tells the tale.
This is not the first time the Congressional Research Service has reported these results. In December 2011, Hungerford authored a CRS analysis which similarly found:

Capital gains and dividends were a larger share of total income in 2006 than in 1996 (especially for high-income taxpayers) and were more unequally distributed in 2006 than in 1996. Changes in capital gains and dividends were the largest contributor to the increase in the overall income inequality. Taxes were less progressive in 2006 than in 1996, and consequently, tax policy also contributed to the increase in income inequality between 1996 and 2006.

During those years, the effective total tax rate on the top 1 percent dropped from 30.3 to 24.2 percent. For the top 0.1 percent, the payout was even bigger, as their real rates plummeted from 32.7 to 24.8 percent.
Reviewing another study by Saez and co-author Thomas Pinketty of the Paris School of Economics, Ezra Klein explained the central role in low capital gains taxes in "how the ultra-rich are pulling away from the 'merely' rich." As Klein noted, "If you don't look at capital gains, the top 0.01 percent only captures 3.15 percent of income in the United States," adding "that's about a third smaller a share as when capital gains are included." All told, the top 10 percent account for almost half of total income in the United States, up from just over 30 percent in 1970.

Now, these levels of income inequality not seen since the Great Depression might be more tolerable if they produce faster economic growth and accelerated job creation. But as Jared Bernstein along with Troy Kravitz and Len Burman of the Urban Institute have shown, lower capitals gains tax rates (contrary to the claims of conservative mythmakers) don't fuel increased investment. And as these charts from the Center for American Progress show, GDP and job creation were much faster when upper-income tax rates were higher--even much higher. It should be no surprise that recent reports from CRS and the Congressional Budget Office (CBO) showed that low tax rates for the wealthy don't drive economic growth, but greater income inequality:

There is not conclusive evidence, however, to substantiate a clear relationship between the 65-year steady reduction in the top tax rates and economic growth. Analysis of such data suggests the reduction in the top tax rates have had little association with saving, investment, or productivity growth.
However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution. The share of income accruing to the top 0.1% of U.S. families increased from 4.2% in 1945 to 12.3% by 2007 before falling to 9.2% due to the 2007-2009 recession. The evidence does not suggest necessarily a relationship between tax policy with regard to the top tax rates and the size of the economic pie, but there may be a relationship to how the economic pie is sliced.

With the fiscal cliff agreement signed by President Obama at the start of this year, capital gains and dividend tax rates were increased from 15 to 20 percent for households earning over $450,000. But as the American people contemplate the Republicans' refusal to countenance even another dime in new revenue from the well-to-do, they would do well to keep in mind how federal tax policy is helping give the wealthy few a bigger and bigger slice of that economic pie.


Jon Perr
Jon Perr is a technology marketing consultant and product strategist who writes about American politics and public policy.

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