Focus on marginal income rates obscures the tax code’s true regressivity.

Yesterday, the New York Times editorial page editors pointed out that for the 2010 tax year, the tax rate paid by the 400 highest earning Americans on an average income of $265 million was 18%. By comparison, the average rate paid by all Americans was about 11.8%.

Arguing that this minimal overall level of progressivity was insufficient, the editors make two related points: 1) The 18% paid by the richest pales in comparison with the current top marginal tax rate of 39.6%.
2) Many upper middle-class two-income families pay significantly more than those with nine-figure salaries.  The merely affluent derive most of their income from salaries whereas the superrich glean most of their millions from investment returns which were taxed at 15% in 2010 and at a maximum rate of 23.8% under today’s code.  The editors contend that investment income should be taxed at the same rates as salaries.

While I agree with this conclusion, by focusing on the percentage of income that different groups pay in taxes, the editors wrongly imply that the code is on balance somewhat progressive.  In fact, the code is extraordinarily regressive as one sees when considering its impact on the distribution of wealth in America today.  To redress this, top marginal rates well over $50% are likely necessary.

CNN estimates the median American’s current net worth at about $45,000.  That American’s annual family income was about $51,000 in 2012.  At the 11.8% rate noted by the Times editors, the family paid just about $6,000 in income taxes or 13.3% of the family’s net worth in 2010.  These numbers suggest that most Americans can’t possibly expect to accumulate any sizable savings or ever progress past a paycheck-to-paycheck economic existence.  Moreover, the income tax paid by the median American family significantly inhibits its ability to achieve financial security.

In contrast, Forbes says that the 400th richest American in 2010 (as of today, the numbers for this cohort are up about 50%) possessed about $1 billion in assets.  The average wealth of the top 400 was $3.4 billion.  Assuming incorrectly, but for the purposes of this discussion, that the richest Americans in 2010 were identical to those with the highest incomes, the favored few paid on average $47.7 million in income tax or about 1.56% of their net worth.  Compared to actual wealth, the middle-class paid on average 7.6 times as much as their uber-rich fellow Americans.

Perhaps this remarkable degree of regressivity explains why, as noted parenthetically above, the richest of the rich have seen their net worth skyrocket over the past four years while middle-class assets have barely budged.

How much difference would equating the tax on investment earnings with current marginal income tax rates on wages make?  Some but not enough.  39.6% of $265 million equals $105 million.  In 2010, this would have equated to 3.1% of the net worth of an average member of the Fortune 400 or just over 1/4th what middle-class Americans paid.

If we want the tax code to promote fairer outcomes than the fifth most unequal wealth distribution in the world, we have to eliminate the difference in tax rates paid between investment earnings and wages but we also have to raise very significantly the top marginal tax rates.