Tax-justice watchers tweak loophole on capital gains

In feudal times and through the end of the 1800s, the aristocrats paid no taxes. Peasants and merchants did.

Economist Richard Kogan brings up this historic tidbit in relation to the latest statistics on the income and taxes of the rich in the United States.

The figures show that the inequality of incomes continued to grow through the 1990s. Moreover, the rich paid less of their income in federal income tax in 1999 than in 1995. And, notes Mr. Kogan, the tax cuts already passed or proposed by President Bush are likely to lower the tax burden of the wealthiest families further.

Instead of an aristocracy by birth, the nation will have an aristocracy of wealth, much of it inherited, warns Kogan, who does research for the liberal-leaning Center on Budget and Policy Priorities in Washington.

Here are the new data from the Internal Revenue Service:

The number of those making $1 million dollars or more rose from 87,000 in 1995 to 205,000 in 1999. That group accounted for 11.2 percent of all income reported in 1999. The average income of these millionaires increased from $2.6 million in 1995 to $3.2 million in 1999.

Since these "adjusted gross income" figures ignore tax-free income from state and municipal bonds and some business income, the share of total income of this group may actually be slightly greater.

The "effective" income tax burden - the actual tax rate and not just the marginal rate on their last dollars of income - of these millionaires fell from 31.4 percent in 1995 to 27.9 percent in 1999.

Oddly, the effective tax rate for prosperous taxpayers making at least $500,000 and under $1 million was a tad higher than for the millionaires.

They paid on average 28.4 percent of their income to Uncle Sam in 1999. So, at the upper income levels, the tax system is a bit regressive. The richest families pay proportionately less taxes than the merely rich.

That is because most millionaires, 1 in every 625 taxpayers in 1999, make much of their income from capital gains, rather than from salaries or other earned income. Many probably sold corporate shares at a good profit in the booming stock market of the late 1990s.

Net capital gains for all taxpayers rose 21.7 percent in 1999 to $542.8 billion.

That helped create the federal budget surplus. But, since Congress in 1997 cut the tax rate on capital gains from 28 percent to 20 percent, those selling stock in 1999 kept more profits.

That bothers Kogan, who holds that basic tax policy should treat capital-gains income in the same manner as regular earned income.

"Income is income," he says.

Conservatives often argue that tax cuts for higher-income Americans mean that more money will be available for the new investment that creates jobs and greater prosperity for all.

Kogan finds little evidence that lowering tax rates for the rich changes their investment behavior. It just means, he says, that the government gives a tax reward to those fortunate in the stock market, not to those people "who work for their income."

Looking at wealth, which arises from accumulated income or has been inherited, the number of families with a net worth of $10 million or more (in 1998 dollars) has quadrupled from 64,000 in 1989 to 260,000 in 1998, calculates Edward Wolff, a New York University economist. "That's incredible," Professor Wolff says.

Since 1998, prices of stocks, a major element of that wealth, first rose and then dropped. Today, stock values average about the same level as in 1998. So the number of super-wealthy has probably not changed much, suspects Wolff.

But if the complete repeal of the estate tax in 2010, as contained in the Bush tax cut plan, is left standing by Congress in later years, the number of high-wealth families could again multiply.

Wall Street Journal editorialists and other conservatives justify tax cuts mostly benefiting the well-to-do by noting that the share of income taxes paid by the top 1 percent of taxpayers increased from 34.75 percent to 36.18 percent between 1998 and 1999.

That's because their share of total taxable income rose even faster, from 18.47 percent to 19.51 percent, notes Joel Slemrod, an economist at the University of Michigan Business School in Ann Arbor.

Between 1994 and 1999, the average tax rate of the top 1 percent fell from 28.23 percent to 27.53 percent - because more of their income was capital gains.

In those same years, the average income-tax rate for all taxpayers went up from 13.5 percent to 14.85 percent, Mr. Slemrod adds.

Those making under $10,000 in 1999 paid only 1.7 percent of their income in income tax.

That actual income-tax burden gradually rises with income to 12.1 percent for those making between $50,000 and $100,000.

But these IRS income-tax numbers do not include Social Security payroll taxes, state income taxes, or various sales and excise taxes.

These usually hit lower-income people relatively more than they do upper-income taxpayers.