[Spexxvet]

Originally Posted by classicman

Also some good discussion here

As I've said before, wealthier people pay less than their share of taxes. From class's link

But here's the weird part: Everybody above the HENRYs in the income distribution faces a lower effective tax rate too. Somewhere in the top 1% (those making more than $410,000 in adjusted gross income as of 2007) things start to turn regressive. So if you make $20 million a year, you probably pay out a smaller percentage of your income in taxes than if you make $500,000. For a full, if somewhat dated, rundown of effective federal tax rates at the top end of the income distribution, check out this December 2008 report from the Congressional Budget Office (pdf!) A less complete but more up-to-date accounting is available from the Tax Foundation. State and local taxes have the effect of shifting the inflection point somewhat lower down the income scale — right into the heart of HENRYland.

One reason for this turn to the regressive is that the top federal income tax bracket of 35% kicks in at an adjusted gross income of $373,650, which is a lot of money but much farther down the income scale than the top brackets of decades past. There's been talk in Democratic circles of changing this and adding a new millionaires' tax bracket, but no evidence so far that the idea is really going anywhere.

Another oft-mentioned explanation for the fact that the rich pay lower taxes is that they can afford expensive tax lawyers, while a lot of the HENRYs use Turbotax. The biggest reason, though, is that as you get up into the dizzying heights of America's income distribution, you start encountering lots of people whose income comes mainly from investments. And investment income — dividends and capital gains — is taxed at lower rates than earned income.

There are some perfectly valid reasons for this: 1) dividend and capital gains taxes often amount to double taxation of the same income (taxed first as corporate income, then as shareholder income), 2) inflation erodes the real value of capital gains, 3) capital is mobile, so taxing it too much will send it scurrying abroad and 4) according to neoclassical economic theory (which is not infallible, but definitely worth paying some attention to), taxing capital retards economic growth.

The flip sides are that, 5) when capital tax rates are much lower than regular income tax rates, people in the highest tax brackets will find ways to transform their regular income into capital income (hi, all you private equity guys!) and 6) you get a tax system where people making $20 million a year shoulder less of the burden of financing government (relative to their incomes) than those making $500,000 a year.