http://www.nytimes.com/2004/05/08/business/08tax.html [New York Times] May 8, 2004 Big Gap Found in Taxation of Wages and Investments By EDMUND L. ANDREWS
WASHINGTON, May 7 - Americans are being taxed more than twice as heavily on earnings from work as they are on investment income, even though more than half of all investment income goes to the wealthiest 5 percent of taxpayers, a new study has estimated.
The study, which applied the most current tax laws to a database of 186,000 tax returns, found that federal income taxes on wages and other earnings average about 10.7 percent and that payroll taxes for Medicare and Social Security take another 12.7 percent. By contrast, federal taxes on investment income average about 9.6 percent.
The study was produced by Citizens for Tax Justice, a liberal nonprofit research organization that has criticized tax breaks for corporations and the wealthy. Extrapolating from data supplied by the Internal Revenue Service, the study estimated that 43 percent of all investment income goes to the wealthiest 1 percent of households and 60 percent goes to the top 5 percent.
"The huge disparity in taxation between earnings and investment income should shock average American taxpayers," said Robert S. McIntyre, director of Citizens for Tax Justice. Tax experts said the calculations conformed with their own sense of the current tax code. The centerpiece of President Bush's last big tax package was a provision that halved taxes on stock dividends and reduced the top tax rate on capital gains to 15 percent, from 20 percent.
Mr. Bush is proposing to exclude a huge share of investment profits from all taxation, by letting people contribute thousands of dollars a year in new retirement accounts and "lifetime savings accounts," with tax-free earnings.
"Conservatives and people like me would argue that the proper tax rate on investment income ought to be zero," said Chris Edwards, a tax analyst at the Cato Institute, a research group in Washington that advocates deep tax cuts. "The whole paradigm on the right is to move away from taxing investment income and just tax income when it is consumed."
Alan Auerbach, a professor of economics and law at the University of California, Berkeley and an informal adviser to Senator John Kerry, said Congress had steadily made the tax code more favorable to investors over many years.
"Certainly, recent policy changes have been tilted in favor of investors," Mr. Auerbach said. "But there has often been a struggle between giving people incentives to save and trying to have fairness."
The tax rate on investment profits is already an issue in the presidential election campaign. Mr. Kerry has vowed to eliminate last year's tax cut on stock dividends for the wealthiest taxpayers. President Bush has placed a priority on making the dividend tax cut permanent.
Some of Mr. Bush's economic advisers would like to go much further, essentially scrapping taxes on investment income and replacing it with a broad consumption tax.
The sweeping tax overhaul of 1986, which drastically lowered top tax rates for the wealthy but also wiped out scores of tax breaks, changed the tax rates for stock market profits and most other investment income so that they were taxed at the same rate as earnings from wages and salaries.
But within a few years, Congress began passing measures that gradually reintroduced the tax preference for investment income. In 1991, President George H. W. Bush and Congress agreed to raise the top tax rate on personal income to 31 percent from 28 percent, but the top rate on long-term capital gains remained at 28 percent. President Bill Clinton later pushed through another increase in the top bracket for income taxes, to 39.6 percent, but Congress left the top rate on capital gains at 28 percent.
In 1997, Congress widened the margin again by reducing the top rate on capital gains to 20 percent. Tax accountants began figuring out ways for wealthy clients to shelter their income. Existing laws continued to let people shelter investment income in tax-advantaged retirement accounts, co llege savings plans and tax-free municipal bonds.
Mr. McIntyre said President Bush's tax cuts widened the preference for investors, reducing taxes on investment income by 22 percent while reducing taxes on ordinary earnings by 9 percent. By his calculations, the average tax rate on ordinary earnings was 2.1 times that on investment income when Mr. Bush became president and became 2.5 times after last year's tax cuts.
If investment income were taxed exactly as earnings from work, Mr. McIntyre concluded, government tax revenues would increase by about $338 billion this year. Ninety-five percent of taxpayers would keep about two-thirds of their recent tax cuts, he estimated, while the average tax rate on the wealthiest 1 percent of taxpayers would rise to 33 percent, from 22 percent.