Wealth and Income II Jude Wanniski July 4, 2003

Memo To: SSU Students
From: Jude Wanniski
Re: Wealth and Income II

In our SSU lesson last week, I used a New York Times report of a Treasury study to discuss the difference between “wealth” and “income,” and how a confusion of the two impacts the political debate over tax policy. The Times reporter, David Cay Johnston, complained that I had been unfair to him in my comments about his dispatch, which he argued was a straightforward account of the Treasury report on how, in the year 2000, the “wealthiest” 400 Americans filing income tax returns had their incomes rise and their taxes paid decline from 1999. David has a point, in that this was the Treasury assertion, not his, and I regret leaving an impression that it was his “bias” on the issue that shaped his reporting. Here are the leading paragraphs:

Very Richest's Share of Income Grew Even Bigger, Data Show
By David Cay Johnston

"The 400 wealthiest taxpayers accounted for more than 1 percent of all the income in the United States in the year 2000, more than double their share just eight years earlier, according to new data from the Internal Revenue Service. But their tax burden plummeted over the period.

"The data, in a report that the I.R.S. released last night, shows that the average income of the 400 wealthiest taxpayers was almost $174 million in 2000. That was nearly quadruple the $46.8 million average in 1992. The minimum income to qualify for the list was $86.8 million in 2000, more than triple the minimum income of $24.4 million of the 400 wealthiest taxpayers in 1992."

The confusion by the government analysts becomes clear when you realize nobody at Treasury has ever attempted to find out who the “richest” or “wealthiest” Americans are. In its annual Forbes 400 issue, the magazine makes a valiant stab at toting up the net asset value those at the top of the wealth heap. While the list changes somewhat from year to year, with some folks dropping out and others coming in, it is still basically the same list. The magazine makes no attempt to discover the “incomes” of the “richest” in the previous year. For that they would have to have access to tax returns. The Times reporter does note in his article that “only a handful” of those in the top 400 showed up in every year of the nine in the study. What is really happening is that individuals who have been reporting modest incomes all their lives at one time in their later years sell the family business, their wealth being reported one time as income.

It is certainly the case, though, that when such reports are displayed on the front page of the nation’s newspapers and on the network news the public gets the impression that the “rich” are not only getting “richer,” but that they are also finding ways to pay a smaller share of their income in taxes. Liberal Democrats love these reports because they play into the class warfare, Robin Hood arguments the party has been using on and off since the New Deal years of Franklin Roosevelt. In fact, the one really interesting finding in the Treasury report is one you had to read between the lines. As Gary Robbins of Fiscal Policy Associates pointed out in an e-mail after reading the Times front-pager:

"The real irony is that the underlying cause of the increase in "income" was capital gain realizations that followed the earlier rate cut (in 1997). Remember the Democrats stated that the rate cut would lose money since no one would increase their realizations. Well the data are in. The cap gains cut lost no revenue and the share of taxes paid by the upper income people increased but not as fast as their 'income' rose. How could it after we cut the gains rate? The prior claim was that their share would fall since income would stay the same -- not that it would not 'keep up' with the drop off of the rate. These guys want it both ways. Overtaxing capital leads to less growth that leads to less revenue, just as we said. The facts are in and dumb claims to try and distract us from the results should be exposed.

"The question of how to measure income is also at issue. Economists, in contrast to those who pretend to be, recognize that capital gains are not income. Look at the National Income and Product Accounts. What's more, if you're going to treat cap gains as income you can't just include those that are realized. This means that the reported change in income is grossly overstated by ignoring the unrealized gains in the base year. When suitably adjusted the real result is most likely that tax shares for the upper group has gone up faster than consistently measured income shares."

Robbins, who was a top Treasury tax analyst in the Reagan years, also points out the realized capital gains of those in the top 400 have accrued over time. Some of the gains realized in the last year, along with other gains, occurred during the base (first) year. By any definition of income there is a measurement problem, he says, because the Treasury report ignores the accrual process. “Construct an example where gains are accruing at a constant annual rate from the first to the last year,” he says. “Assume that no gains are realized because the tax rate is too high. Lower the rate in the last year such that some of the gains are realized. The realization definition shows a large jump in income and a more modest increase in taxes. Under any correct definitions of income the change in tax will be greater than the change in income.”

My basic point last week and this week has been that the electorate in the final analysis is not fooled by faulty government reports that confuse income and wealth -- either by the U.S. Treasury economists or by news accounts of them. If it is true that an elimination of the tax on capital gain would spur more growth – by increasing the risk-taking that is the engine of all economic growth – the Democratic Party is burdened with a political agenda that holds it back in its quest for political power. The last national Democrat who advocated a lower capital gains tax was John F. Kennedy, whose proposal passed the Congress in 1964 after his death in November 1963. The Republican Party in those Barry Goldwater years fought the Kennedy tax cuts as being “fiscally irresponsible,” and then pretended that the booming stock market and rapidly expanding economy during 1964-66 were unrelated to the JFK tax cuts. The GOP did not begin groping its way back into the confidence of the electorate until Ronald Reagan campaign explicitly in 1980 on a platform to repeat the Kennedy tax cuts.

The “income gap” that shows up in the Treasury study can of course be quickly closed by either eliminating the capital gains tax or by increasing it to 100%. Without a capgains tax, the 400 unidentified taxpayers would not have reported “realized” gains in their tax returns. If the tax were 100%, there would be no capital gains because there would be no risk-taking, no growth and no “income” from realized gains. Federal Reserve Chairman Alan Greenspan understands this and routinely argues the case for a zero capgains rate, but when he does, reporters at the Times or the Washington Post or the networks never seem to be listening or reporting those views.

I append to this lesson a memo on the margin I wrote April 21 to David Broder of the Washington Post, the “dean” of the Washington press corps, "Some Tax Cuts are Better Than Others” including an op-ed I wrote that was published a few days earlier by the Washington Times, “The Laws of Capital Taxation.” If you have a Democratic friend or representative in Congress or your state legislature, you might consider forwarding this less to him or her. On this Independence Day, you might also reflect on the “tax reasons” for the American Revolution. With a federal tax code that President Jimmy Carter once called "a disgrace to the human race," we are about due for another one.