The 27,000 Americans with more than $10 million of income have lower average federal income tax rates than the 580,000 Americans with income between $1 million and $10 million. And though the share of federal income tax revenue from taxpayers with income in the top percentile rose from 33.2 percent in 2001 to 42.3 percent in 2020, that doesn’t mean the affluent are more oppressed or less well off. That’s because over the two decades spanning 2001 through 2020, their share of total before-tax income has risen, and their average effective income tax rate has declined.
Those observations, and others discussed below, add important context to — and counter the thrust of — assertions by the editorial board of The Wall Street Journal. First, about the income tax code, the board noted: “There is no denying that it is steeply progressive.” And second, it said, “The trend over the past two decades is that the income tax burden has been shifting even more to the highest earners.”
Left Something Out
The first shortcoming in The Wall Street Journal editorial board’s analysis of federal individual income taxation is that it uses IRS data that combines all tax returns of the top 1 percent — that is, all returns with adjusted gross income exceeding $550,000 in 2020. This categorization jumbles together both the mildly and the wildly affluent. So it’s easy to miss how the superrich are taxed at lower rates than the merely rich.
Americans filed 164 million individual income tax returns for tax year 2020; the average AGI was $77,000. Four-fifths of returns had an AGI below $100,000. For our purposes, we will call the “rich” those 580,000 households (0.35 percent of the total) that filed returns with an AGI above $1 million and below $10 million. And we will call the “superrich” the 26,000 households (0.02 percent of the total) with an AGI over $10 million.
As a group, the rich had 10.1 percent of total AGI and paid 20.4 percent of total federal individual income tax. Meanwhile, the superrich had 6.5 percent of total AGI and paid 12.3 percent of total federal income tax. The rich had an average AGI of $2.2 million with federal income tax equal to 27.5 percent of AGI, while the superrich had an average AGI of $31 million with an average tax rate that was 2 percentage points lower than that of the rich, that is, 25.5 percent. So even though federal income tax is progressive throughout most income levels, it turns out that it isn’t progressive at the highest level. This is illustrated in Figure 1.
Federal income tax is progressive throughout most income levels, but it isn’t progressive at the … [+]
The Wall Street Journal, which defines the rich as the highest-income taxpayers who account for 1 percent of total AGI, states that “the basic truth is that the rich really do pay their fair share.” What is fair is always a judgment call. But it doesn’t seem too out of line to question the fairness of our system when the superrich, as defined here, pay a lower rate of tax than less wealthy taxpayers.
That the superrich have lower average effective tax rates than the rich is mainly attributable to two simple facts. First, there is a preferential rate on capital gains and qualified dividends. The effective rate on this income for high-income taxpayers is a 20 percent income tax rate plus a 3.8 percent net investment income tax. Second, the superrich get a much larger percentage of their income in the form of capital gains and qualified dividends. For the rich (with an AGI between $1 million and $10 million), preferentially taxed qualified dividends and capital gains are 28 percent of AGI. For the superrich, the corresponding figure is 58 percent. Figure 2 provides details.
For the superrich, preferentially taxed qualified dividends and capital gains are 58 percent of AGI.
More Tax on More Income
Now for the second shortcoming of the Wall Street Journal discussion. As the editorial board highlights, the share of federal income taxes paid by taxpayers who collectively account for 1 percent of AGI was 42.3 percent in 2020, up from 33.2 percent in 2001. Those data are shown on the left-hand side of Figure 3. Left alone, that fact could leave the impression that the top 1 percent over time are subject to an increasingly greater burden.
The share of federal income taxes paid by taxpayers who collectively account for 1 percent of AGI … [+]
But what The Wall Street Journal neglects to report are the other two sets of data in the middle and right-hand side of Figure 3. The before-tax share of AGI has increased significantly for the top 1 percent — from 17.4 percent to 22.2 percent. If the average tax rate in 2001 prevailed through 2020, the share of tax paid by the 1 percent would have increased to 44.9 percent, instead of only to 42.3 percent. The smaller actual increase is attributable to the decline in the average tax rate from 27.6 percent in 2001 to 26 percent in 2020. If a group of taxpayers over time has higher income and a lower tax rate, it hardly seems like a rallying cry for granting them tax relief.
Beyond the Income Tax
The Wall Street Journal correctly notes that its analysis is incomplete because the data it presents don’t include payroll and excise taxes and that both of these taxes are less progressive than the income tax. But this third shortcoming is brushed aside with the comment that income taxes account for half of all federal revenue, so its portrayal “gives a fair picture of the tax burden.” In the right context, The Wall Street Journal’s review of facts from the IRS is useful. But it doesn’t seem that omitting half of federal revenue in an analysis of the progressivity of the tax system provides a “fair picture.”
To understand the overall tax burden by income, we can look to analyses by the Urban-Brookings Tax Policy Center. Using a moderately different method than The Wall Street Journal, the Tax Policy Center estimates that 49.2 percent of federal income tax was paid by the top 1 percent in 2020 (comparable with the 42.3 percent from The Wall Street Journal). When all federal taxes are included in the calculation, the share of federal taxes paid by the top 1 percent drops by 20 percentage points — from 49.2 percent to 29.2 percent. We agree with The Wall Street Journal that “the basic truth is that the rich really do . . . finance an enormous portion of the government.” But the use of limited data significantly overstates the size of that support.
Unrealized Gains of the Rich
Finally, The Wall Street Journal totally disregards the possibility that unrealized capital gains might be considered income. If that turns out to be the case, the denominator of the average tax rates would be much larger, the average tax rates of the wealthy significantly lower, and the tax system much less progressive.
Tax lawyers and the privileged class find it hard to accept the idea that unrealized capital gains should be taxed. In sharp contrast, among tax economists, it is widely accepted that the income tax base should — as much as possible — equal economic income, which can be defined as consumption plus changes in wealth. Unrealized gain is a change in wealth, so unrealized capital gain ideally should be taxed. Unrealized doesn’t mean unreal. The wealthy can see gain clearly on their monthly brokerage statements, even if they aren’t required to report it on their tax returns.
Perhaps the absence of unrealized gain from the tax base wouldn’t be such a big deal if working folks and the rich all had unrealized gains proportionate to their taxable income. But nothing could be further from the truth. Most working folks have relatively small or nonexistent unrealized gains (except for gains on their personal residences). For the superrich, unrealized gains routinely account for an overwhelmingly large proportion of their wealth accumulation.
Under section 1014, heirs receiving assets do not carry over basis of the decedent but receive a basis stepped up to the value of assets at the time of death of the decedent. This means that income from appreciation of those assets, from the time of acquisition by the decedent to the time of death, will never be subject to income tax.
So rich folks have not only more capital income than others but also a greater ability to defer gains until death because they are less likely to need dividends or to sell assets to maintain their lifestyles. They just don’t sell assets because the advantages are so large and the ability to avoid tax is relatively simple. Deferral of capital gains until death is the mainstay of income tax planning for the superrich.
It’s hard to see how any authoritative assessment of the taxation of the very rich can simply leave unrealized gains unmentioned — as if they don’t exist. And if unrealized capital gains aren’t income, somebody better break the news to Musk, Bezos, Gates, Buffett, and the rest of the gang in the Forbes 400 that they aren’t really wealthy.