Taxes rise for rich, but favorable system endures

WASHINGTON — Is the party over for America’s superrich?

For 20 years, the effective tax rates for those at the very top of the income ladder generally dropped. Then, in 2013, after a pair of unusual tax increases negotiated by the Obama White House went into effect, taxes went up on this group.

According to data released Wednesday by the Internal Revenue Service, the average rate for federal income taxes paid by the country’s top 400 income earners rose from 16.7 percent in 2012 to 22.9 percent in 2013, almost exactly where they stood in the early 2000s, though well below the level of the early 1990s. By any measure, that’s a victory for the cause of tax justice, analysts said.

But the recent rate increases, many experts also noted, still do little to overcome the broader issue of a separate, cushier tax system for the ultrawealthy.

“The 2013 increase in the capital gains rate was a significant move towards greater tax fairness,” said Jared Bernstein, who was the top economic adviser to Vice President Joe Biden during President Obama’s first term. “But when you consider the breadth of the tax avoidance industry, much of which is about sheltering income from exposure to any tax liability at all, it’s just a drop in the bucket.”

Even with the higher tax rates in 2013, the 400 highest-earning taxpayers, who took home an average of $265 million that year, paid a significantly lower share of their reported income in taxes than those just below them. For example, the top 1 percent of earners — whose average income was $1.24 million — paid roughly 27 percent of their income to the IRS.

Moreover, when payroll taxes are taken into account, many people with much lower incomes, in the range of $100,000 to $150,000, pay effective tax rates that are similar to or even higher than those imposed on the rich.

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Essentially, the rich have benefited from two crucial developments over the past few decades: The first was a declining tax rate on investment income, which fell in the late 1990s under pressure from a Republican Congress after President Bill Clinton raised income tax rates in 1993. It fell even further under President George W. Bush in the early 2000s, who cut both ordinary income rates and investment rates. (Both went back up with the 2013 tax increase, though the rate on investment income remains lower than in the early 1990s.)

Because the ultrawealthy derive an outsize portion of their income from investments, these tax cuts disproportionately benefited them.

The tax cuts on investment income then had a second important effect: They brought back from an earlier era a host of tax shelters and made it easier for the ultrawealthy, working in tandem with highly sophisticated tax advisers, to game the tax system by transforming ordinary income into investment income, which is taxed at about half the top rate.

To take one recent example: Private equity fund managers have historically received part of their income in management fees, on which they pay the relatively high standard income tax rate, and part of their income as a share of their funds’ profits, on which they pay the relatively low tax rate on investment income.

In recent years, however, it has become common for private equity fund managers to “waive” a substantial portion of their management-fee income and instead receive an even greater portion of their income as a share of profits from their funds, which are taxed at a lower rate. (The IRS has recently proposed rules that would limit this practice.)

Historical experience has shown that partly as a result of this gaming, the ultrawealthy tend to whittle down the rates they actually pay over time for any given level of official tax rates. By contrast, the average rates for most other taxpayers tend to remain relatively stable when tax laws do not change.

In the end, the ultimate arbiter of the fate of the Obama tax increases is likely to be his successor. Every leading Republican presidential candidate has proposed reducing some or all of the rates Congress agreed to raise on the wealthy in 2012, which were part of a deal to avoid sharp tax increases for the middle class. Under any of those proposals, taxes on the rich would probably fall below even their recent lows.

By contrast, the leading Democratic candidates have called for preserving or increasing those rates. If they were to raise taxes further on investment income, it could have the dual effect of both raising rates on the wealthy and making certain tax avoidance strategies less lucrative.