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Taxes in America: The Leading Cause of Inequality
Matt Wirzburger | 20 Apr 2015

A look at the impact of tax policies that favor the rich in the United States from Reagan (1980) to the present


 
The Under 20 Percent
The Obama family made a little under a half million dollars in 2014. Not too shabby for the vast majority of families in the United States. They also got to keep a good portion of it, paying less than 20 percent on their federal income taxes.  A married couple filing jointly making a little more than $18,000 has a tax rate of under 20 percent, not someone making more than twenty times that amount. How is it that someone making so much is paying so little?
 
2014 Tax Brackets
(for taxes due April 15, 2015)
Married Filing Jointly or Qualifying Widow/Widower
10 percent tax rate
Up to $18.150
15 percent tax rate
$18,151 to $73,800
25 percent tax rate
$73,800 to $148,500
28 percent tax rate
$148,501 to $226,850
33 percent tax rate
$226,851 to $405,100
35 percent tax rate
$405,101 to $457,600
39.6 percent tax rate
$457,601 or more
 
President Obama and his wife, Michelle, pertain to a privilege few that actually benefit from trickle down economics, the salient feature of the U.S. economy for the last thirty years. Policies that give money to the rich,  initiated in the Reagan era, strengthened in the Bush years, and continuing unabated into the present, have been very kind to the Obamas.
 
Trickle Down Tax Reform
Trickle down policies, what President Reagan called "supply side economics," came in multiple forms. Government divested from programs that had traditionally promoted social mobility and income growth for the lower and middle classes. Funding in infrastructure and the social net declined, making it harder for Americans to reach the next rung in the social ladder or to just make ends meet. Financial deregulation allowed those with capital to more easily move it around, to speculate, take risks, and make private fortunes.
 
Numerous capital generating policies enacted in the last three decades make the top ten list of those that adhere to trickle down theory. But it was the tax cuts in the last thirty years that laissez faire fanatics cherish the most. It was also due to these cuts, more than any other reform, that placed the burden of growth onto  the shoulders of  two-thirds of the population that work paycheck to paycheck. It is thanks to these cuts that likewise channeled wealth to the better off. And it is due to these tax cuts that have produced a frightening gap between the rich and poor, one not seen since the year before the great Depression.
 
 
 
The income tax rate for the very top reached its peak during World War II at 94 percent. It then remained at 70 percent in the 1960s and 1970s. The Reagan tax reforms of 1986 and Bush's tax cuts in 2001 and 2003 lowered this rate in half to 35 percent.  Those reforms also included a number of breaks which further lowered the effective tax rate.
 
The tax rate on capital gains came down even more dramatically. It was lowered to 20% in 1997, and to a mere 15% in 2003. This cut was a financial bonanza for the rich. Three-quarters of the income of the top 400 income earners comes from interests and dividends. The rest of the population, on the other hand, depends almost exclusively on salaries and wages, receiving just 8% percent of overall income from capital gains. Cutting the rate from the ordinary 35% to 15%  "gave each of these 400, on average, a gift of $30 million in 2008 and $45 million in 2007, and it lowered overall tax revenues by $12 billion in 2008 and $18 billion in 2007." (The Price of Inequality, p. 72) 
 
The average American, depending almost exclusively on wages and salaries, gets double taxed:  paying both income taxes and payroll taxes (i.e., social security). The upper class, deriving more from capital income (interest, dividends, capital gains, and royalties) do not have to pay payroll taxes on their incomes; only the income tax is levied against capital income. This explains how Mitt Romney who earned $42 million in the years 2010 and 2011 only paid an effective tax rate of 14%, a lower tax rate than the middle class. Romney derived most of his income from investments, avoiding the payroll tax and paying the historically low capital gains tax.
 
 
 
The payroll tax that Romney did pay, meanwhile, had been capped at around $100 thousand. A family making a $100 thousand paid the same rate as Romney making some 200 times more. The Social Security tax "is a much smaller share of earnings at the top than for the low and middle income earners." (Taxes in America, p.52)
 
Give the Rich a Break
Tax reform passed by Reagan and Bush further gave the rich a number of tax deductions.
Middle-class America enjoys some of the same tax breaks as the wealthy on things like the mortgage interest on home loans, capital gains on retirement investments and donations made to charity.
However, the rich enjoy these deductions and others to a wildly disproportionate degree when compared to the rest of taxpayers. According to the National Priorities Project, America's top earners will get an average tax cut of $66,384 in 2011 while the bottom 20 percent will realize an average tax savings of about $107. Bankrate.com
 
Let's look at a few. First there is the mortgage interest reduction. This is often touted as a benefit for the middle class, but a study by the Wharton School at the University of Pennsylvania showed how much the rich benefit over the average household. Households with average incomes between $40,00 and $75,000 enjoyed just over $500 deduction on their annual taxes while incomes at $250,000 (5 times larger) earned more than 10 times as much.
 
Then there are tax-deferred retirement plans. The exemption from tax is clearly an attractive proposal to anyone worried about the futures. They are designed to help all Americans save for retirement. The issue is over who benefits. In 2011, $142 billion in personal taxes was sheltered in 401(k) plans, pension plans and individual retirement accounts. Eighty percent of this was enjoyed by the top twenty percent of income earners. The average American hardly benefits. Half don't even have a retirement plan at work. Of the bottom 60%, a paltry 7% enjoy the tax write-off.
 
 
Another freebie that coddle the well-to-do is the "step -up in basis." This allows heirs to avoid paying taxes on inherited stocks, real estate or businesses. According to the Office of Management and Budget, in 2012, Step-up in basis  saved the wealthy $61.5 billion.
 
 
The rich also enjoy overseas tax havens, "jurisdictions often small islands that levy no or only nominal taxes and offer themselves as a vehicle for nonresidents to escape the taxation in their country of residence" (Taxes in America, p.81). These tax havens advertise themselves as tax funneling lands of paradise. In 2014, Bloomberg News investigated the securities filings of 304 U.S. corporations and found an astonishing $2.1 trillion in profits stocked in overseas accounts.
 
 
 
Island nations such as the British Virgin Islands have more than three times as much capital from U.S. controlled corporations than their own GDP, and Bermuda has more than six times its GDP in tax evading profit.  This transfer of profit into overseas accounts meanwhile goes uncontested.  The rules are set up to encourage capital flight; the IRS does not levy any taxes until the capital is returned or "repatriated" into the United States. The island nations, meanwhile, promise to protect company anonymity. Joseph Kennedy, a senior fellow at the Information Technology and Innovation Foundation, a policy-research group whose board of directors includes executives from Microsoft ($92 billion stashed overseas) confessed, "Computing and IT companies especially have a lot of flexibility in where they declare their profits."
 
This "flexibility"  for those that hold large sums of capital amounts to a legal manipulation of the tax code. The result is a system that favors the already well-to-do. The Obama family is not alone in paying a surprisingly low tax rate. The top 400 income earners in the United States, each with an average of more than $200 million, also pay less than 20 percent- less than what the median American household pays.
 
The Results Are In
Over thirty years of trickle down policies offer plenty of data to look at. We can determine if the rose colored predictions touted by the political right have come true or not. Namely,  did giving buckets of money to the rich benefit the many? Did upper class freebies lead to better wages for the poor? Better incomes for the middle class? Did money rain down from the top to the delight of families everywhere? Take a look. See for yourself. Look beyond the growth rate on the aggregate level. A spike in public spending (i.e., the Iraq war), for example, leads to GDP growth. Look beyond the traditional per capita income as well. If  the Koch brothers and Bill Gates receive a  bonus, everyone's per capita income will rise. Take a closer look, a look that at least hints at the spending power of individuals and families, down to where filling the fridge and keeping gas in the car matter. Look at median household incomes, the one in the middle, where half earn more and half earn less. Look and see who truly benefited since the Reagan revolution. Look at wage rates and income growth among particular economic sectors, savings, and unemployment, and it becomes immediately clear that the picture is not pretty. In fact, it's damn ugly. The verdict is in: trickle down economics really screwed things up...well, except for a few, a very lucky few.
 
Tax cuts, tax write offs, and tax shelters did not lead to a bigger slice of the pie for all, one in which not only GDP grew and the stock market grew, but wages and savings of regular households grew in real terms. Instead, three decades of trickle down have resulted in the nascent rise of a two tier economic system: the wealthy elite has reached unprecedented economic heights on one end, and the middle and lower classes have remained stagnant on the other.  In 1981, President Ronald Reagan promised at his inaugural address that the policies "must be equitable, with no one group singled out to pay a higher price." At that time, in the early 1980s, an average American household belonging to the top 1 percent made 12.5 times the median income. By 2007, the year before the financial crisis, the income of the top 1 percent made 36 times more. The top 1 percent took 12 percent of total income in 1980. At present, they take home over 20 percent of the nation's income. (Piketty, p. 297)  That is the highest level of inequality in the United States since 1928, the year before the Great Depression. 
 
 
 
 
 
It even looks worse within the Fortune 500 companies. The pay ratio between the C.E.Os and employees is more than 200 to 1. Compare that with the 1950s when the ratio between executive and employee was just 20 to 1. Apple's Tim Cook, for example, earned three hundred and seventy-eight million dollars "which was sixty-two hundred and fifty-eight times the wage of an average Apple employee."
Families among the bottom quintile only made 2 percent more in real terms from 1979 to 2007 despite yearly GDP growth. The top 20 percent of households, on the other hand, made 63 percent more income during the same period
.  
And there are no signs that the gap between the haves and have nots is slowing down. This is because very few are benefiting from the current economic growth. Between 2010 and 2012, 95 percent of the economic growth went to the top 1 percent. Good fortunes are landing in just a few hands. The average worker within 99% of the population  earned "a microscopic $80 dollar increase" in 2010. The top 1 percent reaped all the benefits, pocketing over a $100,000 more in the same year.
 
Capital in the Twenty-First Century
 
The economy since 1980, one borne on the wishful thinking of trickle down theory, has not eroded all wages. The policies have granted a legal basis for the top income earners, those at the top quintile, to keep more money. This in turn has allowed them to accumulate more by investing more heavily in dividends, capital gains, interest payments and rents. It is this legal access to more capital, and the endemic propensity toward accumulating further capital, that is at the root of the upper strata's skyrocketing incomes. To understand and appreciate the incipient stages of a two tier economy in the United States, one in which meritocracy evokes nostalgia, one in which it takes two incomes to belong to the middle class, and most families live paycheck to paycheck, it is useful to divide society between capital (dividends, rent, interest, etc.) earners and labor (salary and wage) earners. The interplay between these two and the role of government in determining the ascent and descent of either is fully explained by French economist Thomas Piketty in his groundbreaking work Capital in the Twenty-First Century. The work offers a new economic theoretical model based on data spanning three centuries and comparing over twenty countries that explains the historic ebbs and flows of economic inequality. It unveils an underlying mechanism that lends itself either toward a more egalitarian society or towards greater inequality. Inequality grows when "the rate of return on capital exceeds the rate of growth of output and income." (Piketty, p. 1) A more balanced growth, one in which "a rising tide lifts all boats," would occur if GDP growth and wages and salaries outpaced capital income (i.e., return on investment) such as in the fifties and sixties. We are living in a time that favors capital income; it has not been this easy to be rich since before the Great Depression.  Those that accrue income via capital have enjoyed favorable conditions for generating wealth. The role of the state cannot be ignored. The tax reforms in particular and the financial deregulation have created propitious conditions for a higher return on capital. As a result, the wealth generated accrues disproportionately to those that have capital income, the top rungs of the social ladder.
 
 
 
 
 
 
This has come during a time in which the political right has glorified wealth and blamed the victims. C.E.O.s are called "job creators" and presented as altruistic social engineers despite lavishing unprecedented bonuses during times of financial ruin. Social programs, meanwhile, designed to help the less fortunate including a long overdue increase in the minimum wage are labeled "job killers."  The emergence of a super rich class in the last thirty years succeeded in  a large part due to the propaganda machine of the right which later found avid support in the Tea Party. This ideological enrapture requires another article. It suffices to say that extreme policy decisions, cutting the top tax bracket in half, reducing the capital gains to a mere 15 percent, not to mention the shredding of the social net and the neglect of the nation's infrastructure, could not have passed in the White House without the popular reception of the message that taxes kill jobs and hurt the average family. American families increasingly struggle to get by, working double the hours than a generation before.  The American family has no qualms with the idea that less taxes would equal more income. It would. The problem is that the rich got the real deal.