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Capital Investment Income Drives Income Inequality

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A recently published analysis by Thomas L. Hungerford (see highlights below) looks at factors driving the growth of income inequality for the period between 1991 to 2006.  Hungerford looked at the contributing impact of three factors, tax policy, labor wages and capital income. During the studied period he found that capital income (capital gains, interest income, business income and dividends) was by far the largest factor contributing to rising income inequality. Wages and salaries alone were not a factor and tax policies were only a minor contributor during this period, largely due to the more favorable tax treatment of capital gains.

This report doesn't trace the history of income inequality prior to 1991 where changes in wage growth in the late 1970's and the collapsing of upper income tax brackets in 1980 and 1985 were more dramatic.

It is worth remembering that for most of the past 100 years capital gains was treated as ordinary income for tax purposes.  In recent times, capital gains have be treated as a separate class of income with a more favorable tax treatment. Capital ownership has always been more concentrated at the upper end of the income/wealth continuum.  Capital is, of course, an ownership stake in our economy whether through stocks, bonds, property or business ownership. The income generated when these capital investments are bought and sold is currently taxed at 15% (if it is held for more than a year). That is less than half the top tax rate for wages and salaries.  And how is capital ownership distributed in America?

Who Owns What In America?

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The distribution of wealth ownership, as opposed to income inequality, is even more skewed towards the wealthy as the pie chart below shows.  The whole pie represents the total wealth in America.  Each of the five slices of the pie represent 20% of the US population according to how much wealth they own.


Wealth Distribution
(Image by Brian Lynch)
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Wealth Distribution by
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Brian Lynch


The slice of ownership for the poor and working poor are barely visible. Eighty-percent of all Americans own just 15.6% of America's wealth. The number of people who slipped into poverty in 2010 was at an all time high of 46.2 million, so the poorest 20% of all Americans, in terms of wealth ownership, includes 15.5 million who are technically above the income poverty line. The poorest 40% of Americans essentially own almost nothing while the top 20% own almost 85% of everything.  As a result, favorable tax policies for capital gains income has a highly disproportional benefit for the wealthiest Americans. Capital income for this wealthy segment is what drives rising income inequality today.

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Changes in Income Inequality Among U.S. Tax Filers Between 1991 and 2006: The Role of Wages, Capital Income, and Taxes  Thomas L. Hungerford 
January 23, 2013 Electronic copy available here.

HIGHLIGHTS FROM THIS REPORT:

Research has demonstrated that large income and class disparities adversely affect health and economic well-being (see, for example, Marmot 2004, Wilkinson 1996, Frank 2007, Singh and Siahpush 2006).

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Research has shown, however, that income mobility [in the United States] is not very great and the degree of income mobility has either remained unchanged or decreased since the 1970's (Hungerford 2011, and Bradbury 2011).

Earnings inequality has been increasing since at least the late-1960s (Kopczuk, Saez, and Song 2010). [The] CBO (2011) has documented that income inequality has been increasing in the United States over the past 35 years.

Three potential causes of the increase in after-tax income inequality between 1991 and 2006 are examined in the analysis: changes in labor income (wages and salaries), changes in capital income (interest income, capital gains, dividends, and business income), and changes in taxes.

Increased salaries paid to CEOs, managers, financial professionals, and athletes, is estimated to account for 70 percent of the increase in the share of income going to the richest Americans (Bakija, Cole, and Heim 2010).

A declining real minimum wage could affect lower income tax filers (the inflation-adjusted minimum wage fell from $6.57 per hour in 1996 to $5.57 per hour in 2006).

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Brian Lynch is a retired social worker who worked in the areas of adult mental health and child protection for many years. His work brought him into direct contact with all the major social issues of the day and many of our basic social (more...)
 

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