American workers vs. investors: Who pays more taxes?

Politicians have intentionally set tax rates on wages much higher than those on long-term investment returns

By Bloomberg News

Sep 15, 2017 @ 1:06 pm EST

Let's say you and I are neighbors. You're an emergency room doctor, and I don't work, thanks to a pile of money my grandparents left me.

You spend your days and nights stitching up gunshot wounds and helping children survive asthma attacks. I've gotten really good at World of Warcraft, winning EBay auctions and frying shishito peppers to just the right crispiness.

Let's also say we both report $300,000 in income to the Internal Revenue Service this year. Who pays more in taxes?

You do, by a lot. You owe the IRS about $38,500 more, assuming each of us pays the maximum with no special deductions. I also have more flexibility to lower my burden with tax planning strategies and other tricks, and I get to skip about $24,000 in payroll taxes that you and your employer must fork over each year.

This isn't some quirk of the U.S. tax code. Politicians have intentionally set tax rates on wages much higher than those on long-term investment returns. The U.S. has a progressive tax system in the sense that well-paid workers sacrifice much more than poor workers on their "ordinary income." But Americans with so-called unearned income — qualified dividends and long-term capital gains — get a break. A billionaire investor can pay about the same marginal rate as a $40,000-a-year worker, a fact Warren Buffett has famously lamented.

The last time Congress passed comprehensive tax reform, in 1986, it eliminated the gap between workers' and investors' taxes. Their rates didn't start diverging again until the early '90s, when Congresses controlled by Democrats boosted taxes on wealthy Americans' wages more than on their investments. Republican-controlled Congresses widened the gap further by slashing rates on rich investors in the late 1990s and early 2000s.

A 1986-style rebalancing is unlikely to happen this fall, however, as President Trump and his fellow Republicans in Congress attempt to tackle tax reform. The gap may even widen further.

A key goal is to "simplify the [tax] code so much that you can fill out your taxes on a postcard," House Speaker Paul Ryan said on CNN on Aug. 21. While other details of proposed tax reform remain fuzzy, Ryan and other Republicans have been promoting a draft of that postcard on social media.

The first line asks filers to write down their previous year's wages. For you — the ER doctor in the fictional scenario above — that would be $300,000. The second line asks filers to add just half of their investment income. For me, that would be $150,000.

The form's simplicity makes its priorities clear: No matter what rates are applied or which deductions or credits are allowed, a worker would end up paying twice as much in taxes as an investor with the same income.

Americans in the top 1 percent, and especially the top 0.1 percent, have seen their wealth and income multiply in recent decades as the rest of the country's share of the economic pie shrank. Since 2000, a recent study found, the top 1 percent have made those gains almost entirely on income from capital, especially corporate stock — not on labor income. One reason may be the financial options of the wealthy: Business owners can lower their tax bills by paying themselves in dividends rather than in salary, for example.

Meanwhile, the U.S. Treasury is expected to run a 2017 deficit of $693 billion, according to the Congressional Budget Office's latest estimate, some $108 billion more than in the 2016 fiscal year. As baby boomers retire and health-care costs rise over the next few decades, the government's fiscal situation is expected to worsen.

The argument in favor of lower taxes on investors — and on corporations, another GOP priority — is an economic one.

"We want a tax code built for growth," Speaker Ryan said. "We want a tax code that raises wages, keeps American companies in America, gives us faster economic growth."

Trump, Ryan and other Republicans in Congress are wrangling over a variety of competing goals for reform. The most aspirational is a tectonic simplification of the tax code that really would allow everyone to file using a postcard. But more realistic legislative targets are lowering tax rates on individuals and corporations as well as eliminating the estate tax and alternative minimum tax. They may also try again to kill the Affordable Care Act taxes — including those on all that investment income raked in by the wealthy.

By taxing investors less, some economists argue, you give taxpayers more of an incentive to save. The more savings in the economy, the more capital that companies and entrepreneurs can invest in ways that expand the economy and make workers more productive. Everyone, including workers, wins, according to this theory.

But there are potential negative consequences to such a policy. By lowering taxes on investors, you shift more of the tax burden to well-paid workers. This may give highly skilled and creative people a disincentive to work hard or improve their skills so they can earn more money, while also giving children of wealthy parents another reason not to work at all.

The most famous economic boom in U.S. history occurred when top tax rates on dividends were as much as 90 percent.

And why do people need a special tax break to motivate them to save? Aren't there already powerful incentives to be thrifty? Invested well, money can compound and multiply over time in extraordinary ways. Wealth also provides security, status and power — including the means to make campaign donations to politicians.

Join the Discussion

Most Popular

Affluence Influencers