Center for American Progress
June 4, 2019
by Allison Preiss
New CAP Analysis Reveals That the Very Wealthy Pay Special Low Rates on Most of Their Income and Outlines How Tax Code Changes Have Contributed to Wealth Inequality
Washington, D.C. — A new analysis from the Center for American Progress finds that Americans with incomes greater than $10 million pay special low tax rates on 53 percent of their taxable income—and pay no tax on much of their accumulated wealth. The report points to the failings of the U.S. tax code as a contributor to wealth inequality in America; rebuts the trickle-down fairy tale that conservatives have sold to the American people over the past 30 years; and offers options for policymakers to better tax extreme wealth.
“The tax system is so unbalanced that it is undermining Americans’ sense of fairness and chipping away at the government’s ability to fund education, infrastructure, and many other investments that are essential to a strong and inclusive economy in the long term. An enormous part of the financial capacity of those at the top is not even included in the calculation of how much tax these individuals should pay, and a lot of what is taxed receives special treatment,” said Alexandra Thornton, senior director of Tax Policy for Economic Policy at CAP.
“While individuals with taxable incomes greater than $10 million enjoy low rates on more than half of their taxable income, the report explains how a great deal of their income is not even included in this statistic—and, in fact, is not taxed at all,” said Galen Hendricks, special assistant for Economic Policy at CAP and co-author of the report. “The wealthy hold a lot of assets that grow substantially in value but are not taxed.”
CAP’s report asserts that structural failings of the tax code over several decades have contributed to wealth inequality, with the recently enacted Tax Cuts and Jobs Act making the tax system much worse in this regard. Changes to the tax code that weakened taxation on the wealthy occurred roughly over the same time period that the recent surge in wealth inequality developed, and a relatively small number of wealthy individuals have reaped the lion’s share of benefits. The report outlines how conservatives have used the trickle-down myth as an excuse not just to block efforts to raise revenue from those with the greatest ability to pay, but also to cut taxes on the wealthiest in the United States.
The report also puts forward options to tax extreme wealth and use the tax code as a tool to address wealth inequality, including:
- A wealth tax. Under this type of tax, wealthy individuals would assess the total value of all of their assets at the end of the year and subtract any debts they owe to arrive at their net worth or wealth. A small tax would then be imposed on their net worth. This type of proposal has been put forward by Sen. Elizabeth Warren (D-MA). If the revenues from a wealth tax were used to improve opportunities for others through public investments in areas such as education, health care, child care and paid leave, the tax would help make the prosperous U.S. economy stronger and more inclusive.
- Mark-to-market taxation of unrealized capital gains. Under this approach, tax would be paid each year on any unrealized gain that occurred during the previous year. The owner’s basis in the asset—what they paid, plus any taxes already paid on gains in earlier years—is subtracted from the value of the asset at the end of the year, with the net gain included in income to be taxed that year, preferably at ordinary tax rates.
- Eliminate stepped-up basis and tax unrealized gains before assets are transferred to heirs. When a person dies, a final income tax return must be filed on the decedent’s behalf. However, as mentioned above, this tax return does not have to include the unrealized, untaxed gain on any assets held at death. Heirs who inherit those assets do not have to pay tax on that gain either—they take as their basis in the asset the market value at the time they receive it. Regardless of any other proposals that are adopted to rebalance the taxation of wages and wealth, lawmakers should repeal the stepped-up basis rule and require that unrealized capital gains be included in the final income tax return of the deceased.
- Tax inheritances the same as paychecks and close trust loopholes. Policymakers should reinvigorate the estate tax by lowering the exemption amount and increasing the tax rate. Alternatively, as New York University law professor Lily Batchelder has proposed, policymakers could replace the current estate tax with an inheritance tax, which would tax large inheritances above a lifetime exemption amount the same as income that is earned.
- Tax capital gains and dividends as ordinary income. One clear way to rebalance the tax system between wages and wealth would be to increase the tax on capital gains and dividends, which are currently taxed at special low rates.
- Increase IRS enforcement funding and take other steps to close the tax gap. Funding for the IRS has decreased significantly over the past several years, and this has hampered the agency’s efforts to obtain uncollected taxes from very wealthy individuals. Congress has failed to provide the resources the IRS needs to hire employees with the expertise to audit high-end tax returns; indeed, the IRS has approximately the same number of auditors today as it did in the 1950s, when the economy was a fraction of the size it is today. Increased IRS funding could be used to hire additional auditors, increase audit rates for wealthy taxpayers, and establish a minimum audit rate.