On Monday, Donald Trump became just the latest Republican White House hopeful to propose a Treasury-draining, tax cut windfall for the richest Americans. But while Trump calls for slashing the top marginal income tax rates at a time of record income inequality, a new study from the Brookings Institution argues that hiking those same rates will have little impact on the immense income gap in the United States.
That finding from former Obama budget official Peter Orszag and his co-authors William Gale and Melissa Kearney may seem counter-intuitive. But it’s not, for the simple reason that Orszag and company focused their attention on the wrong set of tax rates. As it turns out, historically low capital gains tax rates haven’t fueled greater investment in the U.S. economy, but instead helped fuel the biggest income gap since 1929.
Of course, you wouldn’t know that from reading Peter Orszag:
among other scenarios, raising the top individual income tax rate to 50 percent from its current level of 39.6 percent. That would create significant revenue, no question. For households in the 95th to 99th percentiles of income, taxes would rise by an average of $6,464 a year. For the top 0.1 percent, the average yearly increase would be $568,617. But how much difference would this make for after-tax income inequality?
To answer that, we calculated the Gini coefficient for after-tax income before and after the simulated tax change. (The Gini coefficient is an index that ranges from 0, if everyone has the same earnings, to 1, if a single person has all the earnings and everyone else has none.) Under the current tax schedule, we estimate the after-tax Gini coefficient to be .574. Raising the top marginal tax rate to 50 percent would reduce that only to .571.
While conservatives predictably cheered the findings from Orszag et al, the analysis ignored one of the most important causes of the dramatic upward redistribution of wealth underway since the early 1980’s. Simply put, the richest one percent of Americans make most of their money from investments. And the tax rates on their gains are now only about half the level they were when Ronald Reagan first took the oath of office.
In September 2011, the Washington Post illustrated how plummeting capital gains and dividend tax rates helped bring about an income gap and wealth concentration not seen since before the Great Depression.
As part of the Post’s series on the widening chasm between the super-rich and everyone else titled “Breakaway Wealth,” the Post concluded that “capital gains tax rates benefiting the 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 in 1998) and Bush (from 20 to 15 percent in 2003) 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.
Continue reading about capital gains and income inequality, below.