Workers paying higher tax rate than investors
Most Americans have to work to earn a living. But the rich are different: They get most of their income not from labor but from what they own — companies, stocks, real estate and the like.
These income-generating assets are what economists call capital. And because capital is heavily concentrated among the rich, the U.S. government taxed earnings derived from capital at a higher rate than earnings made through labor for the entirety of the 20th century.
But that’s no longer the case, according to economists Emmanuel Saez and Gabriel Zucman of the University of California at Berkeley. In their new book, titled “The Triumph of Injustice,” they present data showing that in 2018, labor income was taxed at a higher rate than capital income for the first time in modern U.S. history.
The proximate cause of the shift was the 2017 Tax Cuts and Jobs Act (TCJA), which dramatically slashed taxes on corporate profits and on estates — both forms of capital income — according to their analysis. But Saez and Zucman also note that the trend has been decades in the making, driven in large part by the same forces that have pushed billionaires’ tax rates below those of the working class.
“From the 1940s to the 1980s, the average tax rate on capital exceeded 40%, while labor paid less than 25%,” they write. “Since its peak of the 1950s, however, the average capital tax rate has been cut by twenty percentage points. At the same time, labor taxation has risen more than ten points, driven by the upsurge in payroll taxes.”
Saez and Zucman’s findings are controversial in some quarters of the economics field because they upend a number of longheld orthodoxies about the distribution of income and spending in the United States. The differences largely amount to decisions about how to assign various categories of income, wealth and taxation to different segments of the population: Are taxes on corporate profits paid by shareholders, or do they get passed on to workers? Is the earned-income tax credit a reduction in taxes or a transfer of income?
The debate over Saez and Zucman’s findings underscores that much of our understanding of how the economy works is based on formulas and models built by economists. To fill the data gaps, these models rely on the choices and assumptions of the people who make them.
For the latter part of the 20th century, many economists — particularly those who worked closely with lawmakers to craft public policy — tended to make ideologically conservative, market-oriented assumptions about how the world does and should work. In recent years, however, more economists like Saez and Zucman have started to question those assumptions.
One of the orthodoxies Saez and Zucman challenge is the idea that the optimal tax rate on capital should be as low as possible — zero, or even less. Proponents of this idea argue that keeping capital taxes low gives businesses more money to spend, which allows them to hire more workers and pay them better wages, benefiting everyone in the economy.
This thinking underpins much of the erosion of the capital tax rate that Saez and Zucman observe. It was the driving force behind the dramatic reduction of the corporate tax rate ushered in by President Donald Trump’s 2017 tax cut.
Under this line of thinking, you’d expect savings and investment to decline during periods of high capital taxation, and to rise when such taxes are low. But Saez and Zucman didn’t find any evidence of this pattern in the data: “Since 1913,” they write, “the saving and investment rates have fluctuated around 10% of national income despite enormous variation in capital taxation.”
A more recent piece of evidence also bolsters their conclusion: Proponents of the corporate rate cut in the TCJA promised it would unleash new business investment. But the data so far shows “little reason to believe the TCJA substantially boosted investment to date,” as economist Jason Furman recently summarized for the American Enterprise Institute.
Saez and Zucman contend that, rather than boost investment in American workers, falling tax rates on capital simply have served to fatten the wallets of corporations and their shareholders. “Less capital taxation means that the wealthy — who derive most of their income from capital — can mechanically accumulate more. This feeds a snowball effect: Wealth generates income, income that is easily saved at a high rate when capital taxes are low; this saving adds to the existing stock of wealth, which in turn generates more income, and so on.”