Friday, December 14, 2007

Another Win for the Top

In another victory for the top 1% of income earners, The New York Times reported today that Representative Charles Rangel, Chairman of The House Ways and Means Committee, agreed to drop the carried interest proposal from the legislation that was passed by the House to adjust the AMT threshold.

The AMT was originally enacted to make sure high-income earners paid their share of taxes by limiting the amount of deductions that can be taken over certain income thresholds. The problem is that the thresholds were not inflation adjusted, so every year people with less real income get caught up in having to pay this tax unless Congress passes a law to provide relief. Now, instead of just fixing the problem by changing the law to index the income thresholds to inflation, every year Congress passes a law for the following year only, wasting many of the tax dollars the Treasury does collect in the process. The end result of increasing the income threshold is fewer taxes are collected and millions of taxpayers who don't quite make the top 10% are spared a very unpleasant surprise at tax time. In order to pay for this reduction of anticipated tax revenues, Representative Rangel had proposed a change in the carried interest rules that apply to hedge fund and private equity managers.

The carried interest proposal would have raised taxes on hedge fund and private equity fund managers who benefit from a tax gift, paying only 15% on much of their (often seven figure) income. Basically, these money managers have structured their businesses so they can claim that the income they receive from managing other peoples' money should flow through to them in the same way it flows to those investors. If the investors are getting capital gains, then the managers also get capital gains treatment on their income because their income is based on a share of the investors' income, even though it is not their own money that is at risk (the typical justification for capital gains treatment in the first place). So, hedge fund managers and private equity managers, many of who are in that top 1% of income earners, pay a 15% tax rate on much of their income. Now, if you work for a mutual fund you don't get this benefit. If you sell real estate and the owner receives a capital gain the broker doesn't get this treatment. But somehow, hedge fund and private equity managers do.

Well, there are all kinds of cerebral arguments and debates over this topic. One such argument made by the private equity and hedge fund group is the claim that because they provide such a necessary service to the economy by reallocating resources to their most efficient use they somehow deserve this special tax treatment. Teachers, firemen, and police apparently don’t contribute in ways that benefit society as much as hedge fund and private equity managers because they don’t get special tax treatment. I have written about this rule in the past and how I believe it is a sham on all other taxpayers. You can read that comment if you would like more detail.

All of these very complex and sophisticated sounding debates aside, my cynical brain boils it down to a very simple situation. These very wealthy people who do things that most of us don’t understand hide behind this complexity to gain a tax advantage over the rest of us. They take a portion of this tax savings and they donate it to their elected representatives to ensure that these representatives will not change their tax benefit. See how simple that is? Now, I don’t want to simply dismiss the plight of taxpayers, so lets take a look at the various groups of income tax payers and see how they have fared over the past few years since the Bush tax policies have been in effect.

The latest release to shed light on this issue is the Congressional Budget Office report Historical Effective Federal Tax Rates, 1979 – 2005 (the “Report”). The Report contains interesting data on the distribution of incomes since the Bush tax cuts, especially when combined with the same report from two years ago.

Here is a table of the percentage of all after tax income that went to households in the five quintiles by income (approximately 20% of households fall into each of these quintile categories):


The data make it clear that low-income households have been getting less of the total national after tax income than those in the highest quintile. In fact, the highest quintile is the only one that expanded its share of total after tax income over the period, from 48.2% in 2002 to 51.3% in 2005. Since these are expressed as a percentage of the total income, the gains come from losses to others. In this case the losers are those in the lower quintiles.

About 82.5% of the households in the highest quintile are also in the top 10% of households by income. Here is the trend in income share among those in the top 10%, 5%, and 1%:

Top 10%33.333.935.537.4
Top 5%23.524.225.927.8
Top 1%11.512.214.015.6

The top 10% did exceptionally well as compared to all others, gaining a minimum of 4% of the total national after tax income while all other groups lost share. But that’s not the whole story. Lets look at what has happened to the actual average after tax income in each group as opposed to group shares of the total. The data for 2002 are in 2003 dollars while the data for 2005 is in 2005 dollars. To compare apples to apples, I adjusted the 2003 dollars to 2005 dollars using the US Department of Labor Bureau of Labor Statistics Inflation Calculator to get inflation adjusted numbers for 2002:

Quintile20022005% Change

It looks like things have been pretty good for those in the highest quintile, with the average after tax income increase (21.7%) of 3.5 times the next best quintile. In the lower two quintiles things have been relatively stagnant with less than single digit gains in the lowest quintile. What about the top 10%?

Rank20022005% Change
Top 10%192,328246,30028.1
Top 5%269,811369,80037.1
Top 1%688,0081,071,50055.7

Now those are income gains!

The next time you hear any Republican talking about how Democrats engage in class warfare against the rich, remember these numbers. Looks as though it is the other way around, and the rich have been winning all the battles.

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