NCPA - National Center for Policy Analysis

Tax Rates, Inequality and the 1 Percent

December 9, 2011

A recent report from the Congressional Budget Office (CBO) says, "The share of income received by the top 1 percent grew from about 8 percent in 1979 to over 17 percent in 2007."  This news caused quite a stir, feeding the left's obsession with inequality, says Alan Reynolds, a senior fellow with the Cato Institute.

But here's a question: Why did the report stop at 2007?

  • The CBO didn't say, although its report briefly acknowledged -- in a footnote -- that "high income taxpayers had especially large declines in adjusted gross income between 2007 and 2009."
  • Once these two years are brought into the picture, the share of after-tax income of the top 1 percent by Reynolds' estimate fell to 11.3 percent in 2009 from the 17.3 percent that the CBO reported for 2007.

The incomes that top earners report to the IRS have long been tightly linked to the ups and downs of capital gains.

  • Changes in the tax law in 1986, for example, evoked a remarkable response -- with capital gains accounting for an extraordinary 47.7 percent of top earners' reported income as investors rushed to cash in gains before the capital gains tax rose to 28 percent.
  • When the top capital gains tax fell to 20 percent in 1997 and remained there until 2002, realized capital gains rose to 25.4 percent of the top earners' income, and it explained much of the surge of their income share to 15.5 percent in 2000.
  • Similarly, because the CBO estimates top incomes from individual tax returns, it looked like a big spurt in top income in 1988 when thousands of businesses switched to reporting income on individual rather than corporate returns as the top individual tax rate dropped to 28 percent from 50 percent.

In short, what the Congressional Budget Office presents as increased inequality from 2003 to 2007 was actually evidence that the top 1 percent of earners report more taxable income when tax rates are reduced on dividends, capital gains and businesses filing under the individual tax code.

Source: Alan Reynolds, "Tax Rates, Inequality and the 1 Percent," Wall Street Journal, December 6, 2011.

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