OcTaxLaw.com

It is a good rule to question every study on income inequality by asking, “Why those years?”  

The latest version is from the Congressional Research Service (CRS), and the author concludes:

“Changes in income from capital gains and dividends were the single largest contributor to rising income inequality between 1996 and 2006. Changes in tax policy also made a significant contribution to the increase in income inequality, but even in the absence of tax policy changes income inequality would likely have increased.”

And about those years:

“The years 1996 and 2006 are examined for several reasons.  First, both years were at approximately similar points of the business-cycle with moderate inflation (about 3%), a modest unemployment rate (about 5%), and moderate economic growth (3.7% in 1996 and 2.7% in 2006).  Second, 2006 was the year before the August 2007 liquidity crunch and the onset of the severe 2007-2009 recession.  Third, there were major tax policy changes between these two years.  Fourth, both 1996 and 2006 were three years after the enactment of tax legislation that affected tax rates and are unlikely to be affected by short-run behavioral responses to these changes.”

In fact, 1996 and 2006 are not even close to similar points in the business cycle: 1996 was at the beginning of an economic expansion that lasted another four years, while 2006 was at the end of an economic expansion that ended the following year.    

It is deeply misleading to talk about income inequality without properly taking into account the business cycle.  The financial crisis of 2008 and ensuing recession has devastated personal incomes to a degree not seen since the Great Depression.  The most dramatic collapse has been in high incomes, as can be seen with the most recent IRS data.  For example, since 2007 the number of millionaires has dropped 60 percent, while income reported by millionaires has dropped in half.   

Much of this volatility is due to the collapse of capital gains, as the charts below indicate.  Based on IRS data, as a share of income, capital gains went from 9.5 percent in 2006 to 3.0 percent in 2009, and this while the tax rate on capital gains remained 15 percent.  The second chart shows capital gains in dollar terms and compares it to the S&P 500.  First, capital gains track the stock market – that should be obvious.  Second, capital gains realizations went from $771 billion in 2006, peaked at $896 billion in 2007, and then collapsed to $231 billion by 2009 – a drop of 74 percent in two years.

Why is this important?  The CRS acknowledges that capital gains mainly accrue to high-income earners, and this too can be seen from IRS data.  In 2009, it is in fact the largest source of income for those making $10 million or more.  Thus, the collapse of this income since 2007, as well as other sources of income such as business income, completely disrupts the story that income inequality has increased since 1996.

Lastly, the third chart below shows a standard measure of income inequality, the Gini coefficient, for the years 1986 to 2009, again based on the most recent IRS data.

It shows just how much measures of income inequality depend on the business cycle, and why 2006 or 2007 are terribly unrepresentative years.  They are in fact the two peak years for the Gini coefficient over this time period, at 0.567 in 2006 and 0.574 in 2007.  From there, the Gini coefficient falls 7 percent to 0.535 in 2009.  This is not quite as low as it was in the 2002 recession, but then we haven’t seen 2010 data yet.  From the trajectory it seems likely that 2010 will be still lower.  As it is, the Gini coefficient in 2009 is lower than it was in 1998, and close to where it was in 1997.

It must be acknowledged that the Gini coefficient has an underlying upward trend between 1986 and 2000.  The steepest increase follows the 1986 tax reform, which dramatically lowered the top marginal rate on ordinary income (see the last chart below), and began a long trend of business income moving from the corporate code to the personal code in the form of pass-through entities such as partnerships and S-corporations.  This alone might explain much of the measured increase in income inequality over this period.   However, Clinton raised the top marginal rate in 1993 to 39.6 percent, and this also ushered in a long period of increasing income inequality.  The Gini coefficient went from 0.498 in 1993 to 0.555 in 2000 – an increase of 12 percent.

In contrast, the period since 2000 has exhibited no underlying trend in income inequality, but rather dramatic fluctuations resulting from the business cycle.  The CRS is right to connect this to capital gains, which have likewise cycled up and down, but wrong to conclude this represents an underlying trend.  Income inequality at the beginning and end of the Bush years was virtually unchanged, with the Gini coefficient going from 0.555 in 2000 to 0.557 in 2008.  In 2009 the Gini coefficient fell further, to 0.535, for a 4 percent drop since 2000.  There is therefore no evidence that the Bush tax cuts in either the top marginal rate or capital gains rate had any long term effect on inequality.

It may be the case that lowering the tax rate on capital gains created more volatility in the stock market and thus capital gains realizations and personal incomes.  More likely, the stock market moves for many reasons more important than the tax rate on capital gains, such as the internet revolution, war, monetary policy, demographics, and the housing bubble. 

Here is our earlier critique of a CBO study that claims income inequality increased between 1979 and 2007. 

Follow William McBride on Twitter @EconoWill

In 2009, the top 1 percent of taxpayers—1,379,822 of them—paid more than the bottom 90% combined.  Geographically, this is equivalent to a city the size of San Antonio, TX paying more in income taxes than every person living west of the Mississippi.

Likewise, the top 0.1 percent—138,000 taxpayers—paid a greater share than the bottom 75%.  In other words, a city the size of Dayton, OH would have paid more than a country the size of Germany.

Would Dayton San Antonio be agreeable to such a reality?

Doubtful. 

Follow David S. Logan on Twitter @Loganomix

Yesterday I wrote a post about a chart that appeared in a Wall Street Journal editorial last month. The chart was nonsense for a variety of reasons, but it got me thinking about possible ways to make a less misleading chart that makes the same point.

The basic argument the Wall Street Journal makes is that it’s not possible to put much of a dent in the deficit by raising taxes only on the rich. One of the main reasons for this is because the income tax is based on marginal rates. If, as President Obama proposes, you raise tax rates on income over $250,000, you’re only increasing the tax on income above that amount.  A person who makes $260,000 only sees a tax increase on $10000 of that income. So while it’s true that the a lot of the nationwide taxable income of this country is made by a relatively small proportion of well-off people, it’s not the case that most of their taxable income would be subject to a tax increase that affects only them.

To that end, I’ve made another chart illustrating this point, again using 2006 data.

Instead of placing taxable income into bins based on the gross income of its earner (as with yesterday’s charts), I’ve instead regrouped taxable income according to the income range it falls into for any given person.  For example, the first bin in the chart below is for taxable income between $0-$5000. A person whose entire taxable income is $5000 sees it all go into that bin, but so does the first $5000 of Bill Gates’s taxable income. The reason for this is that it’s a more accurate reflection of the way taxes work – both the entire taxable income of the first person, as well as the first $5000 of Bill Gates’s taxable income, are taxed at the same rate. (This is also why the introduction of the low 10% bracket was the single most expensive provision in the Bush tax cuts, because it lowered taxes for anyone with any taxable income at all.)

The dark blue line shows the accumulated income in and below the particular income bracket. One thing to notice is that over half of all taxable income constitutes the first $57K or less of taxable income for its earner, and 76% for the first $192K. Even if Obama were to lower his threshold from $250K to $192K, the tax increase would still only cover 24% of nationwide taxable income.

Here’s a table of the data presented in the chart above:

There are a few caveats here, as always: in practice, there are different rate structures depending on one’s filing status, which isn’t reflected here. This is one reason why I didn’t make the bins correspond to the actual 2006 tax brackets.  The bins, at first glance, might seem somewhat arbitrary. There isn’t really an analagous percentile concept as in yesterday’s graph, but, at the same time, I didn’t want to pick arbitrary bin ranges and thus be guilty of the same distortion I accused the Wall Street Journal of yesterday. Therefore, each bin threshold is about 1.5 times as large as the previous bin.

Are you planning to live and work abroad?

If so, you may still have to pay some tax on any income you continue to receive from the UK. The rules on paying tax when you are non-resident in the UK can be complicated, so here are the top ten things you should know about paying income tax when you are leaving the UK.

Becoming non-resident for UK tax

When you leave the UK to live and work you will be non-resident from the day after your departure if:

• You have left the UK to move overseas permanently or your work abroad lasts at least the whole tax year
• Your visits to the UK are less than 183 days in any tax year (and average under 91 days a tax year over a maximum of four consecutive years)

The same rules apply to your spouse, civil partner or partner.

Non UK Resident? Claim Your Tax Back

You should contact your tax office when you leave

If you are leaving the UK you have to tell HM Revenue & Customs (HMRC). Your Tax Office will give you the form P85 ‘Leaving the United Kingdom’ which you should complete and return. HMRC will then work out if you will be non-resident and will also calculate any tax rebate that you are owned.

If you have to complete a tax return after you leave the UK, your Tax Office will also let you know.

Paying tax on your income from working overseas

If you become non-resident (as above), you won’t pay any UK tax on the income you earn from your overseas work.

Paying tax on income from working partly in the UK

Even if you are non-resident, you may still work partly in the UK. In this situation you will pay UK tax on the part of your earnings allocated to that work.

Paying tax on UK bank and building society interest

If you are non-resident, the only UK tax you will usually pay is the tax that is deducted before you get the interest.

If you are also ‘not ordinarily resident’ (i.e. you normally live outside the UK), you can register to receive your interest gross (without tax deducted) by completing and providing a form R105 to your bank or building society.

Double Taxation agreements

If you have income from a source in one country and are resident in another, you may find yourself in a situation where you are liable to pay tax in both countries under their tax laws. To avoid ‘double taxation’ in this situation, the UK has negotiated Double Taxation (DT) treaties with more than 100 other countries.

If you are a resident of a country with which the UK has negotiated a double taxation treaty, you may be able to claim relief or exemption from UK tax on certain types of income from UK sources.

Paying tax on your UK pension

If you are non-resident, you will pay UK tax on your UK pensions – including your State Pension. However, if the country you live in has a double taxation agreement with the UK (as above), you may not have to pay any tax.

Paying tax on UK rental income

You are liable to pay UK tax on income from any UK rental property.

If you are non-resident and your rent from your UK property is paid directly to you, your tenant must deduct UK tax at the basic rate. If you let your property through a letting agent, they will deduct the tax from the ‘net rent’ -after any allowable expenses they have paid.

If you dont believe you have to pay any UK tax, you can apply to have your rental income paid without tax deducted.

Paying UK tax for certain specialist professions

There are a number of jobs which have specific rules. If you work in one of the following professions you should speak to your Tax Office regarding the rules that govern what UK tax you should pay:

• Seafarers
• Oil and gas workers
• Students
• Entertainers
• Sports people

Paying UK tax on overseas income

If you are non-resident and receive income from overseas, no UK tax is due. However, if it is paid or collected by a UK agent (e.g. a bank) they will ordinarily deduct tax at source. To prevent this, you will have to complete a form a PA1 or a CA1.

Non UK Resident? Claim Your Tax Back

Six congressional Democrats from New York are pushing a tax cut for people who live in high-income areas. The idea is to index everyone’s income tax brackets to the cost of living, giving a big tax break to everyone who lives in the nation’s most expensive areas.

“In Westchester County, when the median cost of a home is $666,000, with $200,000 income you’re not feeling very rich,” explained Rep. Nita Lowey.

Amusingly, the group calls itself the Tax Equity Caucus. Rep. Steve Israel said the new caucus would focus on language similar to a bill by introduced by Rep. Jerrold Nadler last year (HR 1943) that would require regional cost-of-living adjustments for tax rates. CQ explained how the law might affect the expiration of the Bush-era tax cuts at the end of this year:

The proposed $200,000 ceiling for extension of the George W. Bush administration tax cuts, for example, could be multiplied by a factor reflecting how the cost of living in a region, county or city compares with the national average.

Rep. Israel’s quotation, “A six figure income in Islip is not the same thing as a six figure income in Idaho,” reminded me of the unemployment office scene in the Albert Brooks movie, Lost in America (1985).

In the film, advertising executive Brooks and his wife have been working $100,000 jobs in New York for several years. They’ve saved up such a nest egg that they decide to quit, live on the interest, and go on a cross-country road trip, kind of a yuppie version of the movie Easy Rider — in a Winnebago instead of on Harleys.

At a hotel in Vegas, Brooks’s wife can’t sleep, so she wanders down to the casino floor, and by morning she has blown their entire nest egg. The couple is so broke that when they run out of gas in a small Nevada town, they have to stop and look for work. Brooks walks into the unemployment office looking for a high-paying job.

The real-life economic lesson is that high-paying jobs are clustered in major metropolitan areas. Productive people compete for these jobs and bid up the price of housing to live there. Meanwhile, they create a culturally rich lifestyle that attracts more people, and so the city grows. But sorry, no, those same people can’t pretend that their six-figure salaries ought to be taxed as if they were the equivalent of smaller salaries elsewhere. They’re not.