Income and wealth inequality have been growing in the United States for decades. While the middle class struggles, the richest Americans have seen their wealth skyrocket. A major reason for this disparity is the difference in how income is taxed. Regular salaries are subject to higher income tax rates, while money made from investments is taxed at much lower capital gains rates. This article will analyze how the rich minimize their taxes, the policies that enable it, and potential solutions to make the system more equitable.
Warren Buffett’s Berkshire Hathaway: Billions in Wealth, Low Taxes
Berkshire Hathaway is a holding company run by legendary investor Warren Buffett. It owns major companies like Geico and BNSF Railroad, plus stocks in Apple, Coca-Cola, and other large corporations. As these holdings increase in value, so does Berkshire Hathaway’s stock price and Buffett’s fortune along with it. He now owns close to $100 billion worth of Berkshire shares. However, Buffett pays a lower tax rate than his secretary and many average Americans. How is that possible?
The Issue of Capital Gains vs Income Taxes
Buffett’s secretary pays income taxes on her salary, with rates up to 37%. But the bulk of Buffett’s taxes are capital gains taxes levied on sold investments, which max out at 20%. So despite his immense wealth, he takes advantage of lower capital gains rates to minimize his tax bill. Buffett himself has said, “The wealthy are definitely undertaxed.”
Wealth Gap Growth: Wages vs Investments Over 40 Years
Over the past 40 years, the after-tax income of the top 1% has grown over 400%. Meanwhile, middle-class wages have only grown around 50%. There’s a clear divergence between how the rich accumulate their wealth versus how average Americans earn their income. Investments like stocks and real estate have skyrocketed, while wages have largely stagnated. And investment income enjoys much lower tax rates than salaries.
Day Trading vs 9-to-5: The Tax Differences Add Up
Consider a Wall Street day trader who earns $400k selling stocks, compared to a salaried worker also earning $400k. The trader likely pays the 20% capital gains rate, owing around $80k in taxes. But the salaried employee pays the 37% top income tax rate, owing around $150k. That’s nearly double the taxes for the same income. This disparity enables the rich to compound their wealth much faster.
Taxing Unrealized Gains: The Trillion Dollar Loophole
Huge fortunes like Warren Buffett’s and Jeff Bezos’ largely exist on paper, in the form of rising stock prices. These billionaires aren’t taxed until they sell shares and realize gains. Many billionaires can borrow against their stock as collateral to fund lavish lifestyles, completely avoiding taxes. And if they pass their stock to heirs untaxed, the “stepped-up basis” loophole resets the cost basis so virtually no capital gains taxes are ever paid on those assets. It’s a system that heavily favors the wealthy.
Increasing Capital Gains Taxes: An Easy Fix?
Lawmakers have proposed raising the top capital gains rate to match income taxes for the richest Americans. President Biden’s plan would increase the rate to 39.6% on people earning over $1 million per year. This could raise around $200 billion in tax revenue over 10 years. Importantly, it would also slightly reduce the massive advantage the ultra rich have in compounding returns and minimizing taxes. However, opponents argue this tax hike could reduce investments or encourage more tax avoidance.
Additional Solutions Beyond Capital Gains Taxes
While increasing capital gains taxes can raise revenue and reduce inequality, other approaches should be considered as well:
- A wealth tax on the assets of ultra-high net worth individuals could raise billions, forcing the rich to pay taxes on their huge stock holdings.
- Eliminating the stepped-up basis loophole would ensure capital gains taxes are eventually paid, preventing assets from passing tax-free between generations.
- Further expanding the income tax base would require more dividend income and interest income to be taxed at higher rates, not just low capital gains rates.
The Bottom Line: Everyone Benefits from a Healthy Middle Class
Rising inequality, wage stagnation, and unjust tax advantages have all damaged America’s middle class. Most agree the system unfairly favors the super rich. Taxing investment income at slightly higher rates can chip away at the problem. While it isn’t a cure-all, bringing long-term capital gains taxes more in line with income taxes should be an easy first step toward a fairer system. Ultimately, policies that strengthen the middle class improve opportunities and spending power for all Americans.
The U.S. tax system offers large advantages to the ultra wealthy, enabling spectacular wealth accumulation. Meanwhile, ordinary Americans have seen incomes and opportunities stagnate. There is growing recognition that increasing taxes on the richest citizens can raise substantial revenue while also reducing inequality. Adjusting capital gains taxes to approach parity with income taxes is sensible. But a comprehensive solution requires re-examining wealth and inheritance taxes as well. Most Americans rightly feel that the system is unfairly skewed in favor of billionaires. Policymakers have many options to restore balance and vitality to a struggling middle class.