October 31, 2023
October 31, 2023
This originally appeared in the October 2023 edition of Human Rights Magazine, a publication of the American Bar Association Section of Civil Rights and Social Justice.
One of the most glaring problems facing workers today is tax inequity. The preferential treatment of capital gains (income from wealth) over wage income in both federal and state tax codes is a prime example. The wealthy’s income has vastly risen over the past few decades, while workers have fared much worse by comparison. While tax policy alone will not resolve injustice in our economy, fixing the tax code can play a role in redefining how that economic relationship works. No one wants to live in a country where a social worker pays a higher share of their income in taxes than a CEO.
The federal income tax, and state taxes, are littered with special treatment toward certain income. People who earn income through work tend to pay higher tax rates than people who derive income from wealth. The prime examples of this are federal and state tax preferences for capital gains income.
Capital gains are the returns generated on assets like stocks, dividends, art, antiquities, and bonds. These gains can be either realized (sold for money) or unrealized (not yet sold). They can also be short-term (sold within one year) or long-term (sold after many years or passed down after death). If you buy stock and keep it for more than a year, any growth in its value is considered a long-term unrealized capital gain until you sell it. At that point, you must pay a tax on your profit from the sale.
It has long been understood that capital gains income flows overwhelmingly to wealthy families and that tax subsidies for this income disproportionately benefit the rich. Less studied, however, is the distribution of capital gains tax preferences by race and ethnicity. Against this backdrop, the U.S. Treasury Department’s recent analysis of preferential federal rates for long-term capital gains is nothing short of jaw-dropping. While non-Hispanic white families comprise 67 percent of the population, they receive a staggering 92 percent of the tax cuts from this provision. Hispanic families make up 15 percent of the population, by contrast, and yet receive a paltry 3 percent of this tax cut. Black families, at 11 percent of the population, receive a grand total of 2 percent of this tax preference.
While the Treasury analysis did not examine disparities by gender, this divide is surely even worse for women of color given the staggering pay gap they face. Race and gender discrimination combined with a lack of investment in the care economy means that Black and Hispanic women have much lower wages than white women or men of any race. Simply put, this makes it harder for women of color to pursue—and reach—their own version of economic justice, liberation, and freedom.
To be clear, most families derive no meaningful benefit from federal tax preferences for capital gains income. Preferential treatment of income from wealth hurts the average family of any race or ethnic background. Workers of all races and ethnicities would be better served by a system that puts investment income on the same playing field as salaries and wages.
Recent Federal History
The Tax Reform Act of 1986 was a revolution in that it taxed realized capital gains at the same rate as wages. There is no justification for advantaging income from wealth over income from work. But the parity between them did not last long. By 1991, the gap in tax rates between capital gains and ordinary income was reopened. And in 2003, President George W. Bush signed a bill that reduced the top rate on long-term capital gains to just 15 percent.
There have been some positive steps at the federal level in recent years. Part of the Bush tax cuts pertaining to capital gains income were eventually allowed to expire, and a new 3.8 percent “net investment income tax” was enacted to fund health care reform under President Barack Obama, thereby raising the rate on long-term capital gains income to 23.8 percent. This is still well below the 28 percent rate in effect at the end of the Reagan years and below the 37 percent top tax rate that workers pay on their income today.
The tax code has come close to providing equity between capital gains and regular income before, and it can again. In fact, the federal code currently taxes short-term capital gains and wage income at the same rate. It is not unimaginable to think Congress and the states can do the same in their treatment of long-term capital gains.
There is no shortage of options for making the tax code more equitable in this regard. Senator Ron Wyden (D-OR), for instance, has proposed a “mark-to-market” tax, which he also calls “anti-deferral accounting.” Under his plan, wealthy people with capital gains would pay income taxes on all their income (even gains on assets they have not sold) each year. This income parity means the wealthy would pay income taxes every year just like the rest of us. What a great idea.
Policymakers could also end or restrict the provision known as “stepped-up basis,” which allows heirs to inherit an asset without anyone ever paying taxes on its increase in value. Currently, investors benefit from tax deferral throughout their lifetimes, and no income tax bill ever comes due if the investor passes away without selling their assets. Changing this rule would ensure that capital gains can no longer vanish into thin air through the inheritance process, raising billions of dollars for public investments that benefit everyone. President Joe Biden and other policymakers support reforming this tax code defect.
Research shows that low taxes on capital gains are not an effective way of promoting broadly shared prosperity. The revenue lost from under-taxing income from wealth could be used to fund worker training programs, a more efficient infrastructure network, expanded childcare and preschool access, unemployment insurance benefits, or any number of other programs that help workers and their families. On the tax side, lawmakers can provide targeted tax cuts like restoring the 2021 changes to the Child Tax Credit, Child and Dependent Care Credit, and Earned Income Tax Credit. If workers are going to pay withholding on every paycheck, they should have a government that puts their needs ahead of those of the wealthy.
It’s also important to note that states don’t need to wait for the federal government to begin taking action. States should consider taxing capital gains at a higher rate than wage income to mitigate some of the impact of the unfairness in the federal tax code’s preferential treatment of capital gains income—from the lower rates levied on long-term realized gains to the deferral benefit and stepped-up basis provision for unrealized gains. Encouragingly, Minnesota lawmakers opted this year to do just that. The wealthy can afford it.
At the state level, the push for equitable taxation of capital gains is made all the more important by the fact that low-income families typically pay a higher share of their income in state and local taxes than wealthy families. States should be asking more of their wealthiest residents, not less.
There are many solutions to ending the problem of taxing income from wealth less than income from work. But all we need to do is start with one solution and fight on. Workers of all races and ethnicities are confronting a tax code that puts them at a disadvantage relative to those with immense wealth, and people of color and women are among those most likely to be negatively impacted by this injustice. The wealthy know they can pay more. And we know: Tax justice is labor justice.