Thursday, January 20, 2011

The Rich are Doing Even Better Than You Thought.

The income of the top 1% of the U.S. population has been growing while the income of the bottom 80% has stagnated for over a decade. Published figures claim that the top one percent garner 24% of all income (1) or 17.4% if volatile capital gains are excluded (2). Unfortunately, these figures severely underestimate the magnitude of income stratification in the U.S.

Why 29% is a Huge Underestimate.

The methodology used to determine the share of income for the top one percent of the population uses taxable income as its basis. However, not all income is taxable. Poorer taxpayers have fewer opportunities than the rich to shelter and defer income.

Some income may never be taxed (such as earnings on a 529 plan which are used to pay for qualified educational expenses or income from ROTH IRAs and ROTH 401ks). Trusts can be used to avoid estate taxes.

Income can be also be deferred with deferred compensation agreements, by not taking capital gains, increases in the value of unvested stock options, qualified retirement plans, etc.

Income can be offset with taxable losses - and those losses need not be real to be legal. For example the IRS allows you to claim that a residential building that you are renting out loses all of its value over 27.5 years (3). In the real world, we know that is not the case. Another example is that by selectively selling specific lots of stock a taxpayer can produce losses, often on investments that are actually in the black.

So, What Do the Richest 1% of Americans Really Make

If we could back out all of the tax avoidance strategies that reduce taxable income what would the real percentage of income controlled by the top 1% of the population be? It is hard to know precisely how much income is hidden in tax shelters, deferred, offset by paper losses, and so on, but changes in wealth give us a clue. Since we know that " between 1983 and 2004, in good part due to the tax cuts for the wealthy and the defeat of labor unions: Of all the new financial wealth created by the American economy in that 21-year-period, fully 42% of it went to the top 1%"(4) that sets a floor. Of course we need to add to that the percentage they consume and the percentage of assets that are depreciated for tax purposes but have real value or are otherwise hidden. Back of the envelope, I'd guess the top 1% of the U.S. population gets 45% of the nation's income.

Why it Matters

Republicans often argue that it is unfair that the top 1% of earners pay 38% of the Federal income tax (5). They conveniently ignore the fact that the overall percentage of taxes paid by the richest are much lower than that since payroll taxes are only charge on the first $106,800 of earnings (6)and that sales taxes take a far bigger share of income from the poor and middle class. However, even if we only consider income taxes it appears that the richest are not even paying their fair share.

(1) As of 2007
(2) As of 2005