Changes in tax law that reduced the federal tax rate on capital gains income is “by far the largest contributor” to rising income inequality in the United States, according to a new paper from Thomas Hungerford, an economist at the Congressional Research Service.
Capital gains and other investment income was taxed as regular wage income from 1986 until 1996, when the capital gains rate was reduced. It was further reduced as part of the Bush tax cuts, and over the last decade, it has reversed the equalizing effects of taxes and allowed for massive income gains for the wealthy that translated directly into increased income inequality:
By far, the largest contributor to this increase was changes in income from capital gains and dividends. Changes in wages had an equalizing effect over this period as did changes in taxes. Most of the equalizing effect of taxes took place after the 1993 tax hike; most of the equalizing effect, however, was reversed after the 2001 and 2003 Bush-era tax cuts. [...]
The large increase in the contribution of capital gains and dividends to the Gini coefficient, however, is due to the large increase in the share of after-tax income from capital gains and dividends, and to the increase in the correlation of this income source with after-tax income.
Hungerford’s findings are similar to a study he produced for the Congressional Research Service in 2011, which found that while income grew 25 percent from 1996 to 2006 for all Americans, it grew 74 percent for the top 1 percent and 96 percent for the top 0.1 percent. That study also found that tax cuts on capital gains were the biggest driver of the disparity.
The capital gains rate increased to 20 percent at the beginning of 2013, and top earners will pay an even higher rate because of a surcharge to help pay for Obamacare. Still, the rate remains far lower than the top income tax rate, even as inequality in America is now comparable to countries like Pakistan and the Ivory Coast. (HT: Greg Sargent)