Taxes: There's Always Room at the Top

There are a few Americans, a precious few, who have incomes that get into the ten digits. And those ten digits don’t include any on the right side of the decimal point. That means there are Americans with yearly incomes that top a billion bucks. I say more power to them. But here’s what’s interesting: the federal statutory income tax rate on the last dollars of these folks, i.e. their marginal rate, is the same as for those whose taxable income is less than 0.0005 times as much as theirs.

All of our federal individual income tax rates kick in below $500,000. Regardless of one’s filing status, if one’s taxable income is $500,000, one’s last dollars will be taxed at the same 39.6 percent rate as a billionaire’s last dollars. The chasm between incomes of $500,000 and $1B is proportionally the same as that between incomes of $500 and $1M -- the low and high of both comparisons are separated by a factor of 2,000.

So an earner who is just shy of getting into the top 1 percent is as distant, proportionally, from a billion-dollar earner as a pimply 13-year-old kid who earns $500 mowing lawns is from a CEO with a million-dollar income.

On May 6, Institutional Investor ran “The Rich List: The Highest-Earning Hedge Fund Managers of the Past Year.” It seems the top earner on their annual list is once again David Tepper of Appaloosa Management. Tepper got the top spot by earning some $3.5B in 2013. (I plan to drive to Appaloosa soon and get an interview with Mr. Tepper; I just hope he’ll save me a few bucks and validate my parking.)

There were three other such managers with billion-dollar incomes on the 2013 list. And those billion-dollar figures are for paychecks, not just book value increases in their holdings. Therefore, these titans of the hedge fund business had to list their paychecks on their 2013 tax returns.

Occupy Wall Street ruffians gripe about the top 1 percent. But the bottom 90 percent of the top 1 percent might have a beef with the top 10 percent of the top 1 percent. Yes, the top 0.1 percent seems to be getting a special deal from Congress. I’ve noticed this before, but I was reminded of it again when I saw this chart for 2011 from the Peter G. Peterson Foundation. The chart shows that in 2011 the top 0.1 percent of earners had a lower effective tax rate than did the rest of the top 1 percent. Lest one think that 2011 was an anomaly, 2010 also saw the top 0.1 percent cohort with a lower effective rate than the rest of the top 1 percent.

For 2011, the top 1 percent had an effective income tax rate of 20.3 percent while the top 0.1 percent had and effective rate of 19.8 percent.

Now, some OWS types might not care about the plight of these rich folks in the bottom 90 percent of the top 1 percent. But there’s a helluva difference between one who had an income of $532,613 (the entry point for the top 1 percent in 2011) and a hedge fund manager such as Raymond Dalio of Bridgewater Associates who had a “$3.9 billion payday for 2011.” Yet, both incomes had the same marginal tax rate.

An income of $2,178,886 was what got one into the top 0.1 percent in 2011. One might have had an income a thousand times higher than other earners also in the top 0.1 percent and still have had an effective income tax rate less than theirs. Hell, even those at the bottom of the top 0.1 percent might have some resentment for those at the very top of the top 0.1 percent.

Perhaps those with incomes above $1B should have a higher top income tax rate than do those with incomes below $1M; just a thought.

There were two main reasons why billionaire earners might have had a lower effective tax rate than millionaire earners in 2011. One is that some types of income, such as long-term capital gains, were taxed at a lower rate. However, the IRS explains that “beginning in 2013, a new 20% rate on net capital gain applies to the extent that a taxpayer’s taxable income exceeds the thresholds set for the new 39.6% ordinary tax rate.”

Tax-wise, 2013 was not a good year for the top 0.1 percent. Their capital gains rate went up by 5 percent as did the rate on their dividends. And their ordinary income rate went up by 4.6 percent. That brings us to the second reason that the top 0.1 percent has had a lower effective tax than has the rest of the top 1 percent, and that is the exceptions in the Tax Code; i.e. the exemptions, deductions, write-offs, and loopholes.

Under the new federal income tax rate regime, the new effective rate for the top 0.1 percent should be around 24.4 percent. That’s their 2011 effective rate of 19.8 percent plus their 2013 rate hike of 4.6 percent, and it assumes the same mix of exceptions, as well as capital gains and dividends.

But if all the income of the top 0.1 percent were dividends and capital gains, their new effective tax rate could not exceed 20 percent. And if they took advantage of exceptions, their effective rate would be lower than 20 percent.

If there is any group in America that can afford to be stripped of all exceptions in the Tax Code and to have all their income taxed as ordinary income it is our hedge fund managers and others with billion-dollar incomes. But if Congress didn’t also lower their tax rates, such a change would cause our billionaires to pay at the full 39.6 percent statutory rate. When compared to the 19.8 percent effective rate they paid in 2011, our billionaire brethren would experience a 100 percent hike in what they pay the IRS!

So what should the effective tax rate be for billion-dollar earners? I’d say whatever it was in 2013. In 2013 the individual income tax alone brought in more than $1.3T (Table 2.1). That’s $184B more than the previous year, the last year of the lower rates for the swells at the top. When one remembers that there are still tens of millions of Americans who pay nothing in income taxes, the guys at the top are already paying their “fair share.”

Progressives have done a remarkable job of demonizing the wealthy, the people who by taking risks provide us with products and jobs, and who pay for most of government. But if the bottom 99 percent were taxed at the same rates as the top 1 percent, America would have a revolution on her hands.

Jon N. Hall is a programmer/analyst from Kansas City.

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