Last Dec. 30 saw two very different news stories about taxes paid by the highest income Americans. The New York Times ran a front-page feature-length story alleging that the nation’s 400 highest earners have been “saving billions” by manipulating the tax system to drive down their effective tax rate year after year from 27 percent under President Clinton to just 17 percent in 2012, “the last year for which final data is available.”
The very same day, the IRS released data for 2013 showing that the Top 400 paid a much higher 23 percent effective rate that year. So, how was 17 percent the latest available data on the same day that the IRS released data showing the more recent rate to be 23 percent?
It is hard to understand why the Times did not wait one day for the 2013 data, which the IRS had announced months beforehand that it would release on the 30th. Did the newspaper think that 2013 was a fluke that should be ignored or did the Times get the story wrong?
It got it wrong. 2012 is well known as an unusual year, in which the effective tax rate of many taxpayers was unusually low due to the huge volume of tax-preferred long term capital gains taken that year, the last year in which such gains would enjoy particularly favorable tax treatment. Higher effective rates were virtually inevitable in 2013.
So what exactly happened between 2012 and 2013? The tax rate on long term capital gains (on assets held more than a year) increased for high earners by about 60 percent from a 15 percent rate in 2012 and preceding years to 23.8 percent in 2013 and thereafter. So, anyone and everyone sold virtually all their investments with a long term gain in late 2012 in order to take advantage of the soon-to-expire 15 percent rate.
Sales by the Top 400 generated long term capital gains (including dividends taxed in the same way) of a record-breaking $92 billion, a jump of $37 billion from the previous year, accounting for 80 percent of a whopping year-to-year increase in the Top 400’s total adjusted gross income from $87 to $134 billion. Capital gains bearing the 15 percent rate grew to the largest proportion ever of the 400’s total AGI, 68 percent, which pulled down their overall average effective tax rate to the super-low level of 17 percent.
The Top 400 were not alone. All taxpayers as a group generated 60 percent more taxable long term gains: $784 billion in 2012 versus $488 billion in 2011.
It was inevitable that this rate-volume dynamic would reverse in 2013, because of the new higher 23.8 percent tax rate and a much lower volume of long term gains available after the heavy selling in 2012.
Having sold virtually all their long term gains, most investors entered 2013 with only short term capital gains, which are taxed at much higher ordinary rates — 39.6 percent for the highest earners, plus, beginning in 2013, a 3.8 percent surcharge bringing their rate to a prohibitive 43.4 percent. Accordingly, investors rarely sell short term gains, but rather wait until they mature into long term gains.
So, the volume of long term capital sales gains plummeted in 2013, resulting in a much lower volume of tax-advantaged long term capital gain income to pull down the overall effective rate of the Top 400.
The Times should have known all this. Instead of applauding the hefty impact of a major tax increase on high earners and the wealthy, something for which it has long argued, it chose instead to rail about continuing efforts of the wealthy to reduce their taxes, both in the original article and another two days later suggesting that “the ultrawealthy will soon find ways to limit the impact of the recent rate increases…” Well, is the sky blue? Yes, all taxpayers strive to reduce their tax bills.
Something of consequence happened in 2013. While U.S. statutory income tax rates have been progressive almost from the beginning, effective tax rates have been regressive to significant degree in recent years. No one — political party or individual politician — advocates a regressive income tax system, so this development is important. With the big increase in the capital gains rate, and its major impact upon higher earning Americans, effective tax rates are now moderately progressive across the board, with only small pockets of tax payers paying higher effective rates than people with higher AGIs. Indeed, with only 1.2 percent of all AGI, the Top 400 paid 2.0 percent of all income taxes in 2013 — taxpayers with AGI over $250,000, who account for 26 percent of all AGI, paid 49 percent.
This new reality provides important context to this election year’s debate about taxes. We can debate all aspects of taxes — whether they should be higher or lower, progressive or flat, whether various activities should enjoy preferential rates or deductions or credits, and, finally, how our ridiculously complex tax system should be simplified. We can debate all of these issues, with the knowledge that it is no longer true in any broad sense that “the rich pay less,” a reality that the Times did not present — indeed, one that it obscured.
Red Jahncke (@RedJahncke) is president of The Townsend Group, LLC, a management consulting firm in Connecticut. Thinking of submitting an op-ed to the Washington Examiner? Be sure to read our guidelines on submissions.
