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Top incomes soared as tax rates fell

New IRS data show that just 400 households captured 6 percent of the entire nation's income growth in 2010

November 21, 2014 10:30AM ET

For those at the very top 2010 will be remembered as a very good year. While most Americans struggled to recover from the worst economic collapse since the Great Depression, top incomes soared while tax burdens for those incomes fell.

The 400 tax returns for those with the highest reported incomes showed 31 percent more income in 2010 than in 2009, when the recession officially ended at midyear. Soaring stock prices fueled the increase at the top.

On average incomes of $265.1 million the top 400 paid 18 percent in federal income taxes, down from 19.9 percent in 2009. The lowest tax on the top 400 was 16.6 percent in 2007.

Each of the top 400 paid tax at the same rate as a single worker making $80,000 in 2010. Assuming a 40-hour workweek, it took each of the top 400 about 40 minutes to earn that much.

These figures from an IRS report released Friday show how much government policy has helped those at the top amass even larger fortunes thanks to lower tax rates. It also shows how far the United States has moved away from the ancient principle of progressive taxation, born in Athens nearly 2,500 years ago and endorsed by political thinkers and economists from Aristotle and Adam Smith to Alfred Marshall and Milton Friedman. 

Ultra-low taxes

In 2010 those at the top enjoyed income growth almost 12 times greater than American taxpayers overall. Total U.S. incomes reported on tax returns rose 2.6 percent from 2009 levels to an average of $56,610. In dollars that increase was $1,437 — compared to about $60 million for each household in the top 400.

The top 400 did so well, in fact, that divided among all 308 million Americans they captured almost six cents out of each dollar of increased income.

That someone who labors all year to gross $80,000 bears the same federal income tax burden as someone making $5 million per week illustrates how much the tax cuts signed into law by Presidents Bill Clinton, a Democrat, and George W. Bush, a Republican, benefited investors rather than workers.

The top tax rate on capital gains and dividends in 2010 was 15 percent, while salaries and interest were taxed at as much as 35 percent plus payroll taxes.

Reduced taxes on investment income compared to work help explain why since 2000 a dwindling share of Americans own stocks and other financial assets. The low tax rates mean that gains at the top snowball, growing ever faster with less lost to taxes, while workers must bear the burden of both income and payroll taxes.

Several dozen Americans earn annual incomes of $1 billion or more. But they do not show up in the top 400 reports because Congress does not require them to report their full incomes or pay taxes immediately.

Even the extremely well off have a gripe about tax rates, in comparison to what the very richest pay. The top 400 were taxed less than Americans on the 95th through the 98th rungs of the income ladder — households making between about $162,000 and $370,000, primarily from salaries and running their own business or professional firms. Their average tax rate was 17.2 percent, compared to the top 400’s 18 percent.

The top one percent — excluding the top 400 — paid about 24 percent.

Among the top 400, the IRS said 37 paid less than 5 percent of their income in taxes and 137 paid less than 15 percent. The report did not disclose how many paid nothing. In 2009 six of the top 400 paid no taxes and in 11 other years since 1992 one or two paid nothing.

Above the top 400

The “top 400” is actually a misnomer, since there is an even higher class of incomes, for which tax rates can quickly fall until they  approach zero.

Let me explain. The annual top 400 report by the IRS significantly understates incomes at the very top in America because Congress lets some people defer reporting their income — and therefore paying their taxes — for years or even decades. These deferrals are the equivalent of a zero interest loan from the government of the amount of tax deferred.

Several dozen Americans, disclosure documents show, earn annual incomes of $1 billion or more. But they do not show up in the top 400 reports because Congress does not require them to report their full incomes or pay taxes immediately. For cash to live on these people typically borrow against their assets, paying interest rates of 2 percent or less.

In contrast to these unlimited and open-ended deferrals, Congress requires that taxes be withheld from most workers before they get paid.

Congress also lets corporate executives, athletes and movie stars defer unlimited sums, though the incomes of these top performers, while still huge, are only a fraction of what the top hedge and equity managers earn without immediately being taxed.

Warren Buffett

The big money at the top comes from capital gains — from selling stocks and other assets for more than they cost. In 2010 capital gains provided 72.8 percent of the top 400 incomes, up from just 36 percent in 1992, the first year the report was prepared.

By contrast, salaries have accounted for less than 9 percent of top incomes since 2005 — down from 26 percent in 1992. And roughly seven percent of top incomes have come from interest in most years since 1992.

Of the 7,600 tax returns included in top 400 reports since 1992 only about a third were filed by people who made the list five times or more. About half of top 400 returns are from taxpayers who make the list once or twice, often because they sold a business they spent years nurturing. Even so, anyone who has made the list even once can expect dividends and interest alone will keep them in the top tenth of one percent for the rest of their lives, partly explaining why this thin slice of rich Americans increasingly depends on these forms of income rather than salaries.

The minimum to make the top 400 list in 2010 was $99 million.

Warren Buffett, for instance, would not have made the top 400 list in 2010 because his adjusted gross income, he voluntarily disclosed three years ago, was shy of $63 million.

Buffett paid $6.9 million in tax for an effective tax rate of 11 percent, the same as a single worker making $47,000.

Buffett’s income, you see, is a tiny fraction of his wealth because his main holding, Berkshire-Hathaway, does not pay dividends and he has never sold a share. He is just one of a growing number of lucky duckies who, thanks to our tax laws, continue to amass larger and larger fortunes outside the purview of IRS reporting, while salaried workers are fully taxed to foot the government’s bill.

Tax returns of the top 400 income earners
... and their tax rates

Note: Data is in 2010 dollars.
Source: IRS Statistics of Income..

David Cay Johnston, an investigative reporter who won a Pulitzer Prize while at The New York Times, teaches business, tax and property law of the ancient world at the Syracuse University College of Law. He is the best-selling author of “Perfectly Legal,” “Free Lunch” and “The Fine Print” and the editor of the new anthology “Divided: The Perils of Our Growing Inequality.”

The views expressed in this article are the author's own and do not necessarily reflect Al Jazeera America's editorial policy.

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