The Rich, the Poor and Tax Policy Jude Wanniski June 27, 2003

Memo To: SSU Students
From: Jude Wanniski
Re: Wealth and Income

The front page of The New York Times every few years carries a story on its front page about the income gap between the rich and the poor. Several years back Paul Krugman, then an up-and-coming economist at MIT, burst upon the scene when a Times reporter plastered just such a story on top of Page One about his "research," drawn from data supplied annually by Internal Revenue Service. It did not matter that Krugman mixed apples and oranges in a genuinely worthless piece of economic analysis. The Democratic Party seized upon it as gilt-edged proof that the Reagan tax cuts of the 1980's had "favored the rich." The net effect was to encourage the Democratic presidential nominee in 1988, Michael Dukakis, to oppose a cut in the capital gains tax that the GOP nominee, Vice President Bush, was promising in his campaign. Bush won easily and the intellectuals in the Democratic Party blamed Bush for having exploited racial issues, with taxes having nothing to do with the outcome.

If you read the article that appeared Thursday the 26th, in exactly the same location as I remember the old Krugman piece, you will see what I mean about apples and oranges, "wealth and income." It is written by David Cay Johnston, a Times reporter who has written a book that will be published in October, he tells me, about how all these terrible gaps between rich and poor are being caused by tax policies. I had an e-mail exchange with him earlier this month about his views on the subject - trying to get him to see that there is the world of difference between income and wealth. It was hopeless. He could not very well agree, as his book is at the publisher's and if he agreed, he would have to call the whole thing off. This has become a problem at the major newspapers, as reporters who otherwise look at both sides of an issue write books taking sides, and then cannot possibly be objective. When the Times, or other newspapers of high standing, drift into this practice, the politicians who rely upon them are the ones hurt.

On all other topics that he covers, Johnston is a careful, balanced reporter. On this issue, he is ideological. When he reports that the 400 richest Americans had higher incomes in 2000 and paid less in income tax, he is using a methodology that equates an increase in an individual's "wealth" with an increase in an individual's "income." Wealth is what you have accumulated after you have paid taxes on your income and invested a portion of the after-tax income received in a SUCCESSFUL enterprise. In other words, if you earn $40,000 and have $30,000 after all taxes, and invest $2000 in stocks or bonds, and the $2000 becomes $3000, you have a capital gain. If the $2000 becomes $1000, you have lost a thousand and get no benefit from a lower capital gains tax rate. The same is true of dividend income. You can’t get a dividend unless you buy shares with salary income that has gone through a tax gate, and then the money is at risk. The company may not be able to pay dividends, or it may do so out of lower profits reflected in a lower share price. In our exchange, the Times reporter argues that when a successful risk-taker dies and leaves his estate to his children, the children have not risked anything, and may simply put the funds in municipal bonds. That’s another story, though.

Please follow me, students, so you will be able to see the holes in Johnston's article when you get to it. Imagine the government decides to eliminate the tax on capital gains, because it is punishing successful risk-taking. This is my opinion on what must be done... and it is also the opinion of Alan Greenspan on what should be done. Zero capital gains. If there is no capital gains tax, the select 400 in Johnston's article would disappear. That is because almost all of the "income" they reported to IRS in 2000 was in the capital gains of the dot.com companies they founded. And if there was no capgains tax, all they would report on their 1040's would be their, relatively a trivial amount. In other words, Bill Gates of Microsoft reports "income" of $100 million, of which $2 million is income and $98 million is capital gains. (I'm making these numbers up, but you get the idea.) If there is no capgains tax, Gates only reports $2 million in income, and is aced out of the top 400 by some pitcher or shortstop for the Yankees, an actress or a rock star, who only report income and have no capital gains.

Gary Robbins of Fiscal Policy Associates tells me there is no way of knowing what it is that David Cay Johnston says is obvious to him, because nobody has ever done a survey to look beneath the raw data of the IRS. Most of the "rich" people who appear in the data are farmers and small businessmen who have been reporting incomes below $30,000 a year for their entire lives. When they sell out, they report $1 million in income, much of which may be inflated capital gains, and they are classified as if they were “earning” this amount year in and year out.

If you wonder why there is so much poverty in the world, it is because there is so much confusion about these kinds of definitions. Now that the Times has added to the confusions, you can stand back and observe how much impact this has on the political dynamic. Those Democrats who can understand the difference between income and wealth will have an advantage over those who do not.

Very Richest's Share of Income Grew Even Bigger, Data Show

By David Cay Johnston

The 400 wealthiest taxpayers accounted for more than 1 percent of all the income in the United States in the year 2000, more than double their share just eight years earlier, according to new data from the Internal Revenue Service. But their tax burden plummeted over the period.

The data, in a report that the I.R.S. released last night, shows that the average income of the 400 wealthiest taxpayers was almost $174 million in 2000. That was nearly quadruple the $46.8 million average in 1992. The minimum income to qualify for the list was $86.8 million in 2000, more than triple the minimum income of $24.4 million of the 400 wealthiest taxpayers in 1992.

While the sharp growth in incomes over that period coincided with the stock market bubble, other factors appear to account for much of the increase. A cut in capital gains tax rates in 1997 to 20 percent from 28 percent encouraged long-term holders of assets, like privately owned businesses, to sell them, and big increases in executive compensation thrust corporate chiefs into the ranks of the nation's aristocracy.

This year's tax cut reduced the capital gains rate further, to 15 percent.

The data from 2000 is the latest available from the I.R.S., but various government reports indicate that salaries, dividends and other forms of income have continued to rise since then, even as the stock market has fallen.

The top 400 reported 1.1 percent of all income earned in 2000, up from 0.5 percent in 1992. Their taxes grew at a much slower rate, from 1 percent of all taxes in 1992 to 1.6 percent in 2000, when their tax bills averaged $38.6 million each.

Those numbers can be read to show that the wealthiest, as a group, carried a disproportionate share of the overall tax burden 1.6 percent of all taxes, versus just 1.1 percent of all income evidence that all sides in the tax debate will be able to find ammunition in the data.

In 2000, the top 400 on average paid 22.3 percent of their income in federal income tax, down from 26.4 percent in 1992 and a peak of 29.9 percent in 1995. Two factors explain most of this decline, according to the I.R.S.: reduced tax rates on long-term capital gains and bigger gifts to charity.

Had President Bush's latest tax cuts been in effect in 2000, the average tax bill for the top 400 would have been about $30.4 million a savings of $8.3 million, or more than a fifth, according to an analysis of the I.R.S. data by The New York Times. That would have resulted in an average tax rate of 17.5 percent.

The rate actually paid by the top 400 in 2000 was about the same as that paid by a single person making $123,000 or a married couple with two children earning $226,000, according to Citizens for Tax Justice, a labor-backed group whose calculations are respected by a broad spectrum of tax experts.

The group favors higher taxes on the wealthy, and its director, Robert S. McIntyre, said yesterday that the I.R.S. data bolsters that viewpoint. "Regardless of which party these 400 are in, these are the guys Bush wants to help, even though they have so much money they don't know what to do with it," he said. "How Bush feels about the half of the population that doesn't have much money is he got them a tax cut worth an average of $19 each."

William W. Beach, a tax expert at the Heritage Foundation, a conservative organization that favors lowering taxes for all Americans, said that the top 400 taxpayers made "the significant contribution" to government revenue about one in every $64 of individual income tax paid. Cutting taxes, he said, will prompt the wealthy to invest more in the economy's growth.

Detailed information about high-income Americans has become increasingly important in setting tax policy, because the government relies on the top 1.3 million households for 37.4 percent of individual federal income tax revenue. The half of Americans who earned less than $27,682 in 2000, paid less than 4 percent of income taxes.

All of the I.R.S. data is based on adjusted gross income, the figure reported on the last line on the front page of individual income tax returns. Interest earned on municipal bonds, which are exempt from tax, is not included.

Over the nine years of tax returns that were examined for the new report, only a handful of taxpayers showed up in the top 400 every year, according to I.R.S. officials. In all, about 2,200 taxpayers made the cut even once. There were a few incomes of more than $1 billion a year in the group, but none as high as $10 billion.

Copyright 2003 The New York Times Company