Let’s value work over wealth in the tax code

Yesterday, the United States celebrated Labor Day. First recognized as an official federal holiday in 1894, the day offers an opportunity for all of us to come together and celebrate the remarkable achievements American workers have made over the years.

Labor Day also gives us a chance to reflect on how far we still need to go to protect and rightly reward workers in America. Unions remain under attack, the minimum wage hasn’t been raised in thirteen years, and some workers at digital platforms like Uber and DoorDash struggle even to be recognized as employees.

It’s less recognized, but the tax code is another critical area where workers lag behind in the fight for economic justice. For all of the respect American society gives an honest day’s work, our modern tax laws actually do the opposite; they put working Americans at a structural disadvantage compared to wealthy people like us.

Since the inception of the federal income tax in 1909, lawmakers have consistently privileged income from capital – resulting from the sale of stocks, bonds, mutual funds, etc. – over income from traditional labor. In the process, they have given an unnecessary break to wealthy Americans like us, who make most of our money from investments.

Today, the top marginal rate that workers pay on their income is 37%, while the top rate that investors pay on capital gains is just 20%. That puts the maximum tax rate for someone earning hundreds of millions of dollars passively, through selling assets, lower than the top rate paid by someone who works for a living earning just $70,000 per year. It also means that every dollar a working person earns is worth less after taxes than every dollar earned by an investor making the same amount of money. 

There is a common misconception that investors like us need lower tax rates. Without them, the argument goes, we will have no incentive to invest and the economy will tank. This is utter nonsense, as research has found that changes in capital gains tax rates have no significant effect on private savings behavior or economic growth. Even if tax rates on gains are very high, investors will always choose to invest because it’s more lucrative than the alternative: hiding our money under our mattresses. (Last we checked, mattresses didn’t have a very high rate of return.)

Besides rates, another way that the tax code privileges capital over labor involves the timing of tax collection. Nearly every working American pays taxes every few weeks – you work, you get a paycheck, and some money is withheld for taxes. Rich Americans like us, on the other hand, only pay capital gains taxes when we decide to sell our assets, which effectively means that we get to pick and choose if and when we pay taxes. And if we die before we sell our assets? Thanks to a provision known as the “stepped-up basis,” our heirs can inherit our stocks, bonds, and real estate holdings without having to pay a penny to the IRS on the increased value of those assets.

All of this has led to a situation where the wealthiest Americans pay next to nothing in taxes. Between 2014 and 2018, Elon Musk – currently the richest man in the world – paid an effective tax rate of just 3.27% – a far cry from the 13.3% average rate that the rest of America pays. And if that wasn’t enough, in 2018, Musk paid no federal income taxes whatsoever.

This all needs to change. To start, we need to equalize tax rates for capital and labor income. There is no reason a janitor should be paying higher tax rates than a wealthy investor who sits around all year waiting for the stock he owns to increase in value. Furthermore, we also need to tax capital gains on a more regular basis. We can do so through a “mark-to-market” tax – like those recently proposed by President BidenRepresentative Bowman, and Senator Wyden – that taxes capital gains as they accrue, not just when assets are sold. This would raise hundreds of billions in tax revenue each year and ensure that ultra-wealthy investors don’t get to opt out of paying taxes.

Democrats took a big and important step by passing several key tax reforms in the Inflation Reduction Act last month, but they need to go much further than this to make the rich pay what they owe. Labor Day presents the perfect opportunity for them to strengthen their resolve to do just that and finally start the long-overdue process of rewarding work over wealth in the tax code.

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