The Very Rich Really Are Different

By :: May 12th, 2011

"Let me tell you about the very rich. They are different from you and me,” wrote F. Scott Fitzgerald. He wasn’t talking about taxes (the laws were very different back in 1926) but his assertion certainly applies to the way the wealthy fare under today’s tax law.

For proof, take a look at the annual IRS accounting of the income and taxes of the 400 taxpayers with the highest adjusted gross income (AGI). The latest report added 2008 to data for the previous 16 years.

One way the super-rich are different: Their effective income tax rates have plummeted since they peaked in 1995. In contrast, effective rates for the rest of us have barely changed. Here’s the story.

To make the Fortunate 400 list in 2008, your AGI had to approach $110 million. Average income for the group topped $270 million. That’s more than 4,700 times the $58,000 average for all tax filers. And the rich paid a lot of income tax—just shy of $49 million on average, more than 6,750 times the $7,200 average for the rest of us.

The very rich not only made lots more money, they made it in a very different way. Nearly 60 percent of their 2008 AGI came in the form of capital gains, almost all of it taxed at 15 percent. These über-rich earned just 8 percent of their AGI in salary and wages. The rest of us? We got just 5 percent of our income from gains but 72 percent in salaries and wages.

But the Great Recession hit the rich—hard. Their AGI plunged by nearly a quarter between 2007 and 2008, compared to a 5 percent fall for everyone else (see first graph). And the drop was almost all in those tax-preferred capital gains: their gains fell nearly a third—$29.2 billion—almost exactly matching their drop in AGI. The rest of us also saw our investment income fall between the two years, but since gains are such a small share of our income, the drop didn’t affect our AGI as much.


Their income collapse could not have made these folks very happy but their tax situation was worse. Not only did their AGI go into free fall, but their effective federal income tax rate actually rose from 16.6 percent in 2007 to 18.1 percent in 2008 (see second graph). That’s not what you’d expect when your income falls, but that’s what happens when most of the drop came from tax-preferred gains. For the rest of us, the average effective tax rate fell from 12.8 percent to 12.4 percent.

Before you start feeling too sorry for the fortunate few, however, check out the sharp drop in their effective tax rate over the past 15 years—down from 30 percent in 1995 to the 18 percent rate in 2008. Compare that with the 24 percent rate paid in 2008 by people with income between $500,000 and $1 million. The rest of us also saw our tax rate drop from a peak of 15.4 percent to 12.4 percent in 2008. But that doesn’t take into account that AGI of the top 400 jumped 277 percent in real terms between 1992 and 2008, compared to a 77 percent increase for everyone else. Adding insult to injury, with so little earnings and so much investment income, the very rich pay a relative pittance in payroll taxes compared to the rest of us.

Now for the caveats. First, AGI doesn’t include all income. Exclusion of income from specific sources like municipal bond interest means that the IRS statistics don’t necessarily include the richest 400. And the income included in AGI has changed as well, so comparisons across years may be a bit misleading. What’s more, the Top 400 continually changes. Only four taxpayers appeared in every one of the 17 years the IRS examined. Nearly three-fourths of those who ever made the list showed up just once. That suggests that rare events—selling a business or closing a one-off killer deal—is enough to get you on the list. Once. On average, the very rich were rich enough not quite twice.

Still even a one-time appearance puts you in pretty good shape. The average taxpayer would have to work well into the 68th century to earn as much as the average “400” member made in 2008 alone. With some careful financial planning and conservative investments, even the one-timers will probably outlive their nest eggs.

36Comments

  1. ‘The Rich’ Are an Ever-Changing Group – The Wealth Report – WSJ  ::  12:40 pm on May 12th, 2011:

    […] […]

  2. Carl  ::  4:34 pm on May 12th, 2011:

    Merge payroll taxes into the income tax, treat capital gains as ordinary income and hand out a citizen’s dividend and you have the formula for a flat tax which is considerably more progressive that our current so-called progressive tax system.

    As for the double-taxation objection, cut the corporate income tax to 20% or so. After all, a corporation includes not only the big stockholders, but also pensioners and 401k account holders. With corporate rates thus cut, we can expect the multinationals to repatriate quite a bit of profits, shrinking our trade deficit — at least on paper.

  3. Michael Bindner  ::  4:51 pm on May 12th, 2011:

    Capital gains are a part of being very rich, but so is dividend income – which comes in regardless of your effective tax rate – unless you use some of that income to buy a Senator. For the amount of taxes Senators can save you, they are a relatively cheap investment.

  4. Curt Doolittle  ::  1:40 am on May 13th, 2011:

    OK, So, I made 1.2M last year, mostly in capital gains, all of which is paper wealth and none of which is in my hand, or ever will be, and I”m sitting on a 100K tax bill that I will have to pay off in stages over the next few years. My effective tax rate is something on the order of 15%.

    Technically I’m one of the ‘rich’. But realistically, I have lower disposable income than most of the married professional couples that work for me.

    Rich is determined by balance sheet, not by income.

  5. Michael Bindner  ::  12:51 pm on May 13th, 2011:

    Would you rather be taxed on the disbursements to you, irregardless of whether they represented gains or losses? A VAT would essentially do that, but if you took the entire 1.2M and decided to shift the cash to somewhere else, the tax would have to be paid sometime. Where would you rather that point be?

  6. Sid F  ::  1:42 pm on May 13th, 2011:

    Very good analysis of a difficult to interpret report. I gotta agree with this guy.

    http://dismalpoliticaleconomist.blogspot.com/2011/05/how-top-400-pay-taxes.html

  7. Jack B  ::  2:32 pm on May 13th, 2011:

    Michael….Would you rather be taxed on the disbursements to you, irregardless of whether they represented gains or losses?

    There is no such word as irregardless. The word is regardless. irregardless is a double negative.

  8. Trena  ::  3:18 pm on May 13th, 2011:

    You use the term “paper wealth”. Isn’t “paper wealth” appreciation on assets that haven’t been sold yet? If you are paying taxes on assets that you haven’t sold, I’d get another accountant.

  9. Trena  ::  3:19 pm on May 13th, 2011:

    Dividend income is taxed at 15%.

  10. Further reading | Clive Crook's blog | News on US politics from the Financial Times – FT.com  ::  6:35 pm on May 15th, 2011:

    […] The very rich really are different. Roberton Williams, TaxVox. If your income is in the hundreds of millions a year, expect to be taxed at a lower rate. See also: Rich and sort of rich. Andrew Ross Sorkin, NYT. Where did that $250,000 threshold come from? […]

  11. theorycraft  ::  2:44 pm on May 16th, 2011:

    well considering that fortune 500 mostly have CEOs that file in the US, it isn’t really surprising that they make a vast amount more than the $58,000 of the average tax payer.

  12. JM  ::  4:24 pm on May 16th, 2011:

    You would think that a place called the “Tax Policy Center” would understand the incidence of the corporate income tax. Suppose you are the sole shareholder of a corporation, it is your only source of income, and the corporate tax rate is 99%, while the tax rate on capital gains and dividends is 0%. It would be ludicrous to suggest that your “effective tax rate” is 0%, but that is precisely what this chart assumes (“income tax liability divided by gross income”).

    Reasonable people can disagree about the appropriate rates of taxation, but this kind of misinformation – whether it’s from ignorance or deliberate chicanery – detracts from the debate.

  13. JM  ::  4:32 pm on May 16th, 2011:

    Actually, the best way to see how skewed these numbers are is to compare them to the CBO’s estimates for the highest-income households, which include all federal taxes (and, of course, make some assumptions about incidence). These numbers are at http://www.cbo.gov/ftpdocs/98xx/doc9884/12-23-EffectiveTaxRates_Letter.pdf. In 2005, the top 0.01% of households (granted, the top 11,000 households or so, but it’s hard to believe that the top 400 would be so different) paid an average effective federal tax rate of 31.5%. Of course, this number has fallen over the last 30 years, but it’s a far cry from the politically-slanted and factually incorrect numbers above. Even just the individual income tax numbers don’t line up with the chart.

    It’s also worth pointing out that statements like “the very rich pay a relative pittance in payroll taxes compared to the rest of us” are highly misleading. Anyone at or over the cap pays precisely the same amount. The percentages may be different, but that’s the way social insurance programs are structured.

  14. What America’s Richest 400 Pay in Taxes | LesBnB.com  ::  1:11 am on May 17th, 2011:

    […] Read the full story at TaxVox. […]

  15. Nancy  ::  11:16 am on May 17th, 2011:

    Michael in your dreams you are one of the wealthy, 1.2 does not let you in the door. If it is just paper then you really are in some altered state if you think you are rich. You seem to be a wanna be one the right wings favorite type of sheep.That was the point the really wealth are not paying the taxes you are. People like you middle income. the top 400 are billionaires and do not have it just in paper.

  16. Nancy  ::  11:47 am on May 17th, 2011:

    Sorry Michael I meant Curt not you are dreaming lol.

  17. bah  ::  12:57 pm on May 17th, 2011:

    Not sure what your point is. The effective corporate tax rate has fallen even more dramatically than the effective rate on the rich. If you included that rate the graph would look even worse.

  18. America the Unequal « Task Force on Financial Integrity and Economic Development  ::  12:48 am on July 1st, 2011:

    […] of bills is about a foot and a half tall. The top of the graph is the Fortune 400 list. In 2008, their incomes averaged $270 million (likely higher in 2011, but similar data are not available. Their stack of bills is […]

  19. I like this article. I think I am going to have to continue to learn about Federal Tax Policy « JACOB LABURE  ::  10:37 pm on August 21st, 2011:

    […] He’s right that a billionaire whose income is mostly from investments is probably taxed at a lower rate than someone who has an ordinary job. Very little of this taxpayer’s income is wage income, so payroll taxes don’t take much of a bite. It seems likely that much of this hypothetical person’s income would be taxed around the 15 percent rate. And, in fact, as Buffett says, statistics from the Internal Revenue Service show that the 400 wealthiest taxpayers pay tax rates of less than 20 percent. […]

  20. PolitiFact-less « Don Surber  ::  8:01 am on August 23rd, 2011:

    […] He’s right that a billionaire whose income is mostly from investments is probably taxed at a lower rate than someone who has an ordinary job. Very little of this taxpayer’s income is wage income, so payroll taxes don’t take much of a bite. It seems likely that much of this hypothetical person’s income would be taxed around the 15 percent rate. And, in fact, as Buffett says, statistics from the Internal Revenue Service show that the 400 wealthiest taxpayers pay tax rates of less than 20 percent. […]

  21. the Progress Report « Point/CounterPoint  ::  2:07 pm on September 21st, 2011:

    […] tax rates paid by the “Fortunate 400” have plummeted since the mid-1990s, when their average effective rates were about 30 […]

  22. Many Millionaires Do Enjoy Lower Tax Rates | Pointer's Weekly  ::  6:31 pm on September 24th, 2011:

    […] out of their wages—let alone the federal income tax on those wages. The tax rates paid by the “Fortunate 400” have plummeted since the mid-1990s, when their average effective rates were about 30 […]

  23. Why Are Some Americans So Shockingly Cruel? – Page 80  ::  10:35 pm on October 6th, 2011:

    […] […]

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