Several Democratic lawmakers and presidential candidates are proposing taxes on the richest Americans as a way to reduce income and wealth inequality.
But while they agree that the wealthiest need to contribute more to the government’s coffers, they disagree over the best way to get the job done.
New York Rep. Alexandria Ocasio-Cortez wants to tax millionaires’ wages at a higher rate. Massachusetts Sen. Elizabeth Warren argues for a new tax on wealth. Vermont Sen. Bernie Sanders suggests expanding the gift and estate tax.
What’s the difference and which is the best way to reduce income and wealth inequality? As an expert on tax policy, I decided to take a closer look.
Income and wealth inequality
Americans enjoyed substantial economic growth and broadly shared prosperity from the end of World War II into the 1970s.
But in the 1980s, President Ronald Reagan dramatically slashed taxes on the wealthy twice, cutting the top rate on wages from 70 percent to 28 percent.
Studies have shown that the drop in tax rates, combined with other “trickle down” policies such as deregulation, led to steadily rising income and wealth inequality.
The top 1 percent controlled 39 percent of all wealth in 2016, up from less than 30 percent in 1989. At the same time, the bottom 90 percent held less than a quarter of our nation’s wealth, compared with more than a third in 1989.
Each of the Democrats’ proposals aims to change that.
Ocasio-Ortez’s income proposal
Ocasio-Cortez wants to create a new “60 to 70 percent” tax bracket for labor incomes over $10 million. She estimates that her plan would catch about 4,000 people and raise $720 billion over 10 years.
There are two problems with a tax that goes after income instead of wealth.
First, people who earn very high incomes usually control when they receive their income and how much they receive. The reason is straightforward: They own the companies that pay them. This control allows the rich to nimbly take advantage of whatever brings a lower tax.
When rates on ordinary income go up, the wealthy can defer that income until the rates go back down. Or, they can turn salary into a capital gain and watch the value of their stock rise instead of harvesting profits. Or, they can take advantage of retirement savings. Even death is a tax avoidance device for the wealthy.
Second, the income tax targets two types of income: ordinary income from labor and capital gains from property. Mostly, the rich earn their money from capital gains and capital gains get a much lower tax rate than wages.
That is why the richest Americans are effectively paying lower tax rates than the middle class.