Where the Rich Get Their Money From ... and How It Affects You

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For anybody who caught last year's brouhaha over Mitt Romney's taxes, it should come as no surprise that poor, middle class and wealthy people all get their money from different places -- and pay taxes in very different ways. This week, the nonpartisan Tax Policy Center released a report that made the differences between the classes much more explicit -- and went a long way toward explaining America's tax policy.

In some ways, the TPC's analysis looks like a bell curve. On the lower end of the spectrum, the poorest one fifth of workers get 49 percent of their income from wages and 40 percent from transfer payments -- another name for benefits like Social Security payments and food stamps. Over the next three segments of the population -- the second, third and fourth quintile of households -- the amounts of wage income steadily increase to 73 percent of household income and the amount of transfer payments steadily decrease to 7 percent of income. In other words, as households move from the lower class to the middle class, they get less money from the government and make more money at their jobs. At the fourth quintile, the second-to-top level of households, the vast majority of money is coming from work, with a little sliver coming from transfer payments.

But among the richest 20 percent of households, the income structure suddenly changes. For them, only 60 percent of income comes from wages, and only 2 percent comes from transfer payments. Filling the gap, the income from business and investments vastly increases. In the fourth quintile, the top of the middle class, 8 percent of income comes from business and investments; in the top quintile, that more than triples, to 28 percent.

The difference is even more noticeable within the top quintile. The richest 1 percent of households only get 39 percent of their income from wages and salary, contrasted with a whopping 53 percent from investments and business earnings.

Uncle Sam Cares Where Your Money Comes From

Again, as should come as no shock to people who watched the 2012 presidential contest, the differences between these income sources figure heavily in your tax bill: Long-term capital gains tax rates top out at 23.8 percent, while standard income taxes go all the way up to 39.5 percent for earners in the top percentile. Put another way, income from long-term investments is taxed at a nice discount compared to income that comes from wages.

January's fiscal cliff tax deal was designed to make the tax structure a bit more equitable, but -- given the income distribution revealed by the TPC's analysis, it's clear that the compromise was still favorable to the wealthy.
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For example, taxes on wages above $450,000 went up by 4.6 percent --m but that had a limited impact on the wealthiest households: As Census figures show, the top 5 percent of households make an average of $186,000 and up, a large percentage of which comes from investments and business income. And, because so much of that money isn't coming from salary, they likely aren't on the hook for the increased tax rate. Similarly, the tax compromise's Medicare surtax increases would have an attenuated effect on the rich, because those taxes are payroll deductions.

But what of the rest of the grand 2013 tax deal? Cuts in dependent exemptions and itemized deductions will hardly touch the richest households, which get only 2 percent of their income from transfer payments. However, those cuts will hit families in the bottom 20 percent especially hard -- after all, they get 40 percent of their money from such transfers.

This isn't to say that the richest households aren't paying more than they did: The 5 percent increase in long-term capital gains should increase the taxes paid by the wealthiest households. It's worth asking, however, if the increased burden on poor and middle class families is being equally carried by wealthier ones. Or, to put it another way, is each quintile getting the tax rate it deserves -- or the tax rate that its political donations are paying for?

Bruce Watson is a senior features writer for DailyFinance. You can reach him by e-mail at bruce.watson@teamaol.com, or follow him on Twitter at @bruce1971.
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