The New York Times
By: David Kocieniewski
January 18, 2012
Since 1980s, the kindest of tax cuts for the rich
The effective federal income tax rate paid by the wealthiest Americans has dropped significantly during the last several decades, largely because of tax cuts on investment income.
The last major overhaul of the tax code, signed by President Ronald Reagan in 1986, set tax rates on capital gains at the same level as the rates on ordinary income like salaries and wages, with both topping out at 28 percent. But that link was uncoupled by his successor, President George Bush, and the rates on capital gains were reduced by President Bill Clinton. President George W. Bush then lowered the rates on capital gains and dividends to a high of 15 percent -- less than half the 35 percent top rate on ordinary income.
While rates for all American taxpayers have fallen to near 50-year lows, the wealthy have reaped the most savings from the changes because they derive a larger proportion of their income from investments.
Between 1985 and 2008, the wealthiest 400 Americans saw the percentage of their income paid in federal income taxes drop from 29 percent to 18 percent, according to data from the Internal Revenue Service.
Some economists say the cuts are necessary to keep capital from fleeing the United States to lower-tax countries. Scott A. Hodge, president of the conservative Tax Foundation, has written extensively that a capital gains tax is effectively double taxation on profits that have already been taxed at the corporate level. Many investors, and political leaders in both parties, have lobbied for tax cuts on capital gains and dividends by arguing that they spur investment and, therefore, job creation.
But there is little data to support that contention: the nonpartisan Congressional Research Service issued a report last year concluding that tax cuts on capital gains reduce federal revenues and do little to stimulate economic growth. And as income inequality and tax fairness have become major concerns for many Americans, the issue of tax fairness has brought calls to alter the tax code's preferential treatment of investment income.
One outspoken critic has been Warren E. Buffett, a billionaire himself. Mr. Buffett stirred debate about the issue last year when he wrote an opinion article for The New York Times stating that the low rates for investment income had allowed him to pay only about 17 percent of his income in federal taxes, less than the effective rate paid by his secretary or any of the other 19 workers in his office.
President Obama responded to the outcry by proposing the ''Buffett Rule,'' which would stipulate that those earning more than $1 million a year should pay at least the same percentage of their earnings in federal taxes that middle-income Americans did. Though estimates showed his plan would raise tens of billions of dollars a year in federal revenue, it met strong opposition from the business community and failed to win approval in Congress. Still, the idea of taxing the wealthy at a higher rate could be an issue in this year's presidential campaign.
Another point of contention is determining which investments should qualify for lower tax rates. Appreciation on stock and real assets like property has traditionally been classified as investment income because it involves investment risk on assets held for some extended period, typically at least a year. But during the last decade, hedge fund managers -- who are frequently paid 2 percent of a fund's assets annually plus 20 percent of its profits -- have also been able to pay the lower rates on their earnings. Similar rules often apply to those who manage private equity funds and other types of investments.
Hedge fund and private equity managers have argued that their tax treatment is warranted because their earnings are contingent on whether their investments make a profit. But others have characterized it as a loophole that benefits the very wealthiest Americans, and Mr. Obama and other Democrats pledged to eliminate it during the 2008 election campaign.
In 2010, when Democrats controlled both houses of Congress, the effort to end the exemption for carried interest was met by a muscular lobbying campaign by investors and never made it out of committee.