Unearned v. Earned Income

From dKosopedia

Current Republican tax policy is designed to favor unearned income.

Capital gains and dividends were taxes at the same rates as other income in 1986, but are now taxed at highly preferrential rates. Additionally, provisions like the 1031 tax exchange allow real estate investors and business owners to indefinitely defer their capital gains taxes by reinvesting sale proceeds into 1031 exchange real estateand other like kind property, instead of taxing owners when the propety is sold. Also, depreciation for capital investments in plant and equipment have been accelerated, allowing the owners to deduct the cost of these investments of a period much shorter than the actual useful life of the property.

A wide array of new tax free accounts for everything from medical savings, to educational savings to retirement savings has made it possible to amass a considerable fortune without paying a single dollar of tax upon the gains. Republicans favor elminating the estate tax, the burden of which falls entirely on heirs who have done nothing to earn the funds.

In contrast, income from earnings is subject to double taxation. A self-employed person pays 15.3% in self-employment taxes on the first $90,000 of earnings for FICA taxation (employed people split the tax half to the employer and half to the employee with the same economic effect), and must also pay income taxes at the ordinary income rate on top of the social insurance taxes. A Federal Unemployment Tax (FUTA) applies in addition to the first $7,000+ dollars of wage per year. A typical worker in the 15% marginal income tax bracket is paying taxes at a combined rate of 30%+, while wealthy individuals pay nothing on municipal bond income and pay just a 15% tax on capital gains and dividends.

As a result of FICA, some employees in the 25% marginal income tax bracket pay a 40% tax rate, which is higher than the 35% tax rate which applies to the unearned ordinary income (e.g. taxable interest) of millionaires.

Republicans, politically, are motivated by their desire to help wealthy contributors, and theoretically, support the tax preferences for unearned income on the grounds that they claim it supports savings and investment which will lead to greater economic growth. However, there is good reason to doubt that encouraging savings and investment through tax preferences is sound economic policy.

A preference for savings and investment over labor, among other things, creates a situation where tax policy urges firms to eliminate jobs with technological measures, even if in a neutral tax policy the economics would modesty favor having people rather than machines do the work. In other words, it is an incentive to eliminate jobs.

There is also convicing evidence, offered in books such as the "Creative Class", that human capital, which is tax disadvantaged in the current tax system, is more important to economic growth in our current information economy, than physical capital which was crucial in the industrial economy. Among the most graphic examples given of this is the situation after World War II. The Soviet Union and Eastern Europe got many of the European factories left standing after the war, but the United States got a large share of Europe's scientists and engineers. We know who prospered and who did not.