Is the income tax rate for the rich 8% or 23%? It depends on the math you use

What do the rich pay in federal taxes? On paper, the top marginal tax rate is 37% on ordinary income and 23.8% on capital gains. Government estimates place the average rates of high-income filers in the mid-1920s.

A new analysis from the Biden administration, however, fixes the average tax rate for the top 400 wealthiest households at 8.2% from 2010 to 2018. If this is true, the administration has a stronger case for raising taxes. taxes of the ultrarich.

But it is not that simple. To understand why, let’s move on to tax policy, but let’s start with fourth grade math. Fractions!

Percentages are basically fractions and each fraction, from the fat content of foods to presidential approval ratings, has a numerator and a denominator. If you don’t know how the two are defined: saturated fat or all fat? Probable voters or registered voters? – you don’t know what you are measuring.

Income tax rates are similar. Taxes are the numerator. Income is the denominator. Determining your rate or Elon Musk’s rate is easy. Law?

It doesn’t, and the complexities are hugely important as Congress debates Biden’s agenda.

In writing the White House study, administration economists Greg Leiserson and Danny Yagan chose a numerator and denominator to reflect their approach to tax policy analysis.

First, the denominator.

They include increases in unrealized capital gains. It is the change in the value of assets, including stocks, that have not been sold. Such gains represent a significant portion of the net worth of the wealthiest Americans; the administration’s approach effectively assumes that these paper gains should be taxable income.

Conventional analyzes and current income tax law do not include unrealized gains. Proponents of the conventional approach note that these gains fluctuate with markets and taxpayers may be forced to sell assets to pay taxes. However, “it’s another thing if they are using that to borrow money to buy a yacht,” said Garrett Watson, senior policy analyst at the Tax Foundation. Indeed, wealthy people often borrow on assets at low rates to finance their way of life.

The way the administration measures the tax rate of the rich reinforces its political preferences. President Biden points to low tax rates to justify his calls for higher taxes. He proposed to tax unrealized capital gains on death and to set the maximum rate of capital gains at 43.4%. The two plans clash in Congress.

Currently, unrealized gains escape personal income tax on death, although they may be subject to inheritance taxes. Mr Biden also supports annual taxes on unrealized billionaire earnings. House Democrats have come up with a more modest plan to set the highest capital gains rate at 31.8%. Legislative negotiations are continuing.

The White House study’s numerator, like its denominator, is selective, which the authors acknowledge. By excluding corporate and inheritance taxes, it lowers the tax rate and focuses the analysis on personal income taxes and the loopholes in that part of the tax system. But corporate taxes can be important for billionaires. Warren Buffett, who supports higher taxes on the rich, often notes his own income taxes. They would be higher if they included corporate taxes paid by his holding company, Berkshire Hathaway Inc.

Indeed, Democrats often defend higher corporate taxes precisely because they take money from wealthy shareholders. They shouldn’t ignore this effect when calculating tax rates, said Daniel Hemel, a professor of law at the University of Chicago.

Property taxes should also be included in the numerator, said Wojciech Kopczuk, an economist at Columbia University. Many wealthy people avoid them through creative estate planning or charitable bequests. But some pay.

So if you want to compare yourself to a billionaire, can you put the total taxes from Form 1040 as the numerator and adjusted gross income as the denominator?

Not for an apple-to-apple comparison with the White House estimate.

Let’s start with the denominator. Adjusted gross income is a broad income measure, but it does not include employer-provided non-taxable health insurance or pension contributions. It excludes untaxed gains on retirement accounts or 529 savings plans, which have increased with the actions of billionaires. He ignores the rise in home values, the smallest analogue of Mr. Musk’s Tesla Inc.

Stock.

“If you include unrealized capital gains in an analysis of some taxpayers, then you should include it for all,” said Alex Brill, American Enterprise Institute economist and former GOP aide in Congress.

The numerator is also tricky for middle-income households. Federal payroll taxes are not part of personal income tax, and they are larger in the middle than at the top. So they cannot be ignored, and that would increase federal tax rates.

With this confusion in mind, let’s go back to the estimate of 8.2%.

That’s well below traditional estimates from government figures, which largely exclude unrealized capital gains. Recent estimates of a larger group of wealthy people from the Congressional Budget Office, the Treasury Department and the Joint Commission on Taxation are between 23% and 26%.

Economists Emmanuel Saez and Gabriel Zucman in their 2019 book “The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay” found that the 400 richest households by income paid an average individual tax rate of 9.2%. Adding other taxes, including corporate and estate taxes, brought the average to 23%. Their analysis generally did not include latent gains.

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The White House figure looks shockingly low for a country that favors progressive taxes where the burden increases with income.

“It is significant,” said Mr. Hemel. “Jeff Bezos is getting richer. And Elon Musk is getting a lot richer, and the federal government gets a tiny bit of it. “

Who is right ?

It depends on the point you are trying to make. Every definition of income and taxes has assumptions buried within. How you choose to measure and how you apply math in fourth grade may reflect your approach to politics and wealth.

Write to Richard Rubin at [email protected] and Rachel Louise Ensign at [email protected]

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