Taxes on Wages and Capital Returns

Note:  I have discovered an error in this analysis, and will correct it soon.
Apologies and regards, Doug




The next major domestic policy initiative of the Trump administration and Republican Congress is expected to be tax reform.  Practically everyone would agree that our Federal tax system is hopelessly and needlessly complex, inefficient and unfair.  You might think that reform would be simple.  But the parties are in complete opposition about the direction needed for reform.  I hope that the work below can help inform the discussion of the appropriate direction for tax reform.

This post was originally published on the blog Wonky Thoughts.
http://dougrobbins.blogspot.com/2017/03/taxes-on-wages-and-capital-returns.html

Summary:

The total economic productivity of the United States in 2015 was 18 trillion dollars.  Of this total, $7.7 trillion was paid to workers as wages.  The remaining 10.3 trillion accrued to owners of capital.   Although Federal taxes are paid in several forms, the total tax burden on wages is 25 percent, while Federal taxes paid on capital returns is only 12.5 percent, half of the rate paid by wage-earners.

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Wages and Return on Capital

Economic productivity can be divided into the contributions of Labor and Capital.  More accurately, Labor and Capital, working together, both contribute to productivity.  Labor requires Capital to be productive, and Capital requires Labor to be productive.  But the benefits of productivity are divided – Labor and Capital are allocated different shares in terms of earnings, and carry away different piles of money.  The shares allocated to Labor and Capital are largely determined by actions of the free market, modified somewhat by regulations such as the minimum wage law.   But taxes on earnings of Labor and Capital are entirely arbitrary, determined by the complex rules of the Federal tax law.

The United States produced about 18 trillion dollars of income in 2015.  The measure, Gross Domestic Income (GDI), is roughly equivalent to Gross Domestic Product, (GDP).  Wages and salaries comprised 42.9 percent of GDI, or $7.7 trillion (source: Federal Reserve Database).   Capital returns represent the remainder, or about $10.3 trillion.  It should be noted that capital returns do not include unrealized capital gains.

Labor’s share of Gross Domestic Income has fallen from 51% in 1970 to about 43% today.

Gross Domestic Income ($MM)
Wages	Capital Return
7,758,250	10,326,250

Federal Taxes

Federal taxation is complex.   Wages are subject to individual income taxes and payroll (social insurance) taxes.   Wage earners also pay most excise taxes, such as tobacco, alcohol, gasoline and health insurance taxes.

Capital Returns are taxed as corporate income taxes, and taxed again as individual income taxes on dividends, interest, and capital gains when returns are distributed.  Corporations also pay a share of payroll taxes equal to employee contributions, and pay a variety of Federal taxes and rents such as mineral royalties.  

In 2015, the Federal Government collected 3.25 trillion dollars in taxes, out of 18 trillion dollars in GDI, for a total Federal take of 18 percent.  Of those taxes, about 2 trillion dollars were paid out of wages and salaries, and 1.3 trillion dollars were paid out of capital returns.

Taxes on Wages and Salaries, millions of dollars

Individual Income Taxes	1,325,860
Payroll (Social Insurance) Tax	532,629
Excise Taxes	98,279
Total	1,956,768

Taxes on Capital Returns, millions of dollars

Corporate Income Tax	343,797
Corporate Payroll Tax	532,629
Capital Gains Tax	141,754
Dividends & Interest Tax	73,188
Other	201,751
Total	1,293,119

The Federal Government taxes Capital Returns at 12.5 percent of earnings, on a 57 percent share of GDI, collecting a total of 1.29 trillion dollars.

By contrast, the Federal Government taxes Wages and Salaries at double the rate of Capital Returns.  The government taxes Wages and Salaries at 25.2 percent of earnings, on a 43 percent share of GDI, collecting a total of 1.96 trillion dollars.

Conclusion

Individual workers are receiving a smaller share of the nation’s productivity than owners of capital.  Moreover, Wages and Salaries are taxed at double the rate of Capital Returns.  This disproportional taxation doesn’t seem fair, or in the best interest of the economy.  The distribution of earnings to working-class households is more likely to see those dollars recycled into consumer demand than dollars distributed as investment earnings.  In the interest of economic fairness, economic efficiency, and the reduction of wealth inequality, it makes sense to raise taxes on capital returns, and give tax relief to wage-earners.

Note: This study did not include unrealized capital gains, which allow the owners of capital to roll-over gains from year to year without paying tax.  So, the effective tax rate paid on capital returns is actually less than reported in this post.  Taxes on unrealized gains are effectively never paid if the underlying assets are never sold, unless taxed at death by the estate tax.   I have not yet figured out a clear way to calculate (or efficiently tax) unrealized capital gains. 

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Calculations and Assumptions

Income (Federal Reserve Database)

Income attributed to Wages includes 42.9 % of Gross Domestic Income,

Income attributed to Capital is GDI minus income attributable to wages.

Taxes (Tax Policy Center and JustFacts.com)

     Taxes attributed to Wages include:

• All individual income taxes, minus 9.2 % for capital gains, and 4.75% for dividends and Interest.
• Employee payroll taxes (Social Security and Medicare)
• Federal excise taxes (alcohol, tobacco, fuel and health insurance).

     Taxes attributed to Capital Returns include:

• Business income taxes
• Corporate payroll taxes
• Individual capital gains taxes
• Individual dividends and interest taxes
•  “Other” taxes, representing diverse sources such as mineral royalty payments

 Assumptions

• The 2016 component percentages of individual taxes (wages, capital gains, dividends and interest) were assumed to apply to 2015 taxes.
• The percentage of taxes paid on capital gains was applied to dividends and interest.
• Federal Excise taxes were entirely allocated to Wages.

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References:

http://www.taxpolicycenter.org/

Federal Tax Receipts by Source, 1934 – 2021 (forecast from 2016)

http://www.justfacts.com/taxes.asp

“* In 2015, 9.2% of federal individual income tax receipts came from capital gain taxes.”

“* For 2016, the Joint Committee on Taxation projects that 6.2% of gross income earned by individuals will come from capital gains, 2.2% from dividends, and 1.0% from interest income.”

https://fred.stlouisfed.org

Tables on Gross Domestic Income, and Wages and Salary share of GDI.