NCPA - National Center for Policy Analysis


October 25, 2007

Business Week recently exclaimed, "According to new Internal Revenue Service data announced last week, income inequality in the U.S. is at its worst since the 1920s (before the Great Depression).  The top percentile of wealthy Americans earned 21.2 percent of all income in 2005, up from 19 percent in 2004."  These statistics are extremely misleading, says Alan Reynolds, a senior fellow with the Cato Institute.

For example:

  • The figures do not describe the top percentile's share of "all income," but that group's share of "adjusted" gross income (AGI) reported on individual tax returns.
  • For one thing, thousands of professionals and business owners who used to report most of their income under the corporate tax responded to lower individual income-tax rates after 1986 and 2003 by reporting more income under the individual tax as partnerships, LLCs and Sub-S corporations.

According to Peter Merrill of PricewaterhouseCoopers:

  • "Since the Tax Reform Act of 1986 . . . the share of business income earned through pass-through entities has increased by 75 percent from 29 percent in 1987 to 52 percent in 2004."
  • Business profits accounted for just 11.1 percent of the income reported by the top 1 percent in 1986, according to economists Thomas Piketty and Emmanuel Saez, but that business share leaped to 21.2 percent by 1988 and to 29.1 percent in 2005.

It is this bookkeeping shift, moving business income from the corporate to the individual tax, not CEO pay, which raised the top 1 percent's share on individual tax returns, says Reynolds:

  • Income reported on W2 forms -- salaries, bonuses and exercised stock options -- accounted for only 57.2 percent of total income among the top 1 percent in 2005, down from 63 percent in 2000 and 65.7 percent in 1986.
  • Real compensation among the top 1 percent actually fell 7 percent from 2000 to 2005.

Source: Alan Reynolds, "The Truth About the Top 1 Percent," Wall Street Journal, October 25, 2007.

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