How does the 1 percent capture the surplus?

Posted: 12 January 2016 in Uncategorized
Tags: , , , , ,

fig2

The share of income captured by the 1 percent more than doubled (from 10 to 20.1 percent) between 1980 and 2013.

How did they do it?

Well, we know the tiny group at the top received much higher CEO salaries as well as stock dividends, capital gains, interest payments, and rent on the land and buildings they own. Those sources account for about 60 percent of the increase.

What about the other 40 percent? According to a new study from the National Bureau of Economic Research, the rest stems from the rapid growth in so-called pass-through businesses.

fig1

The basic idea is that “pass-throughs”—businesses whose annual income is taxed at the owner-level (such as partnerships and S-corporations)—now account for more than half of all U.S. business income, thus passing traditional (so-called C) corporations. The figure above shows this dramatic transformation in the structure of business activity: 54.2 percent of U.S. business income in 2011 was earned in the pass-through sectors, compared to only 20.7 percent in 1980.

The key is that pass-through participation and income are especially concentrated among high-income individuals.

Relative to households in the bottom half of the income distribution, households in the top-1% of the income distribution are over fifty times as likely to receive positive partnership income. And the average top-1% household earns over six-hundred times the amount of partnership income as the average household in the bottom half. Overall, 69% of pass-through income earned by individuals accrues to the top-1%. S-corporate income is similarly concentrated, but other business income (typically considered very concentrated) is substantially less concentrated. For instance, only 45% of C-corporate income (as proxied by dividends) accrues to the top-1%, and top-1% households are only eight times as likely to receive C-corporate income as households in the bottom half. Furthermore, the majority of partnership income earned by the top-1% derives from partnerships in finance and professional services.

In addition, the pass-through income of partnerships is taxed at a much lower rate than traditional corporate income.

What the study shows, then, is that the change in the structure of U.S. business activity over the past three and a half decades means that members of the top 1 percent have managed to capture (via pass-through income) and keep (via lower taxes) a growing share of the surplus. That, as it turns out, is the major reason their share of total income has grown so dramatically. It’s also the reason why U.S. tax revenues from business income have decreased during that period.

The consequence is that rest of us, the 99 percent, have been forced to accept a smaller share of total income but to shoulder a higher tax burden.

That’s because the 1 percent have found new ways of both capturing and keeping the surplus.

Comments
  1. lpsdlwyer says:

    “In addition, the pass-through income of partnerships is taxed at a much lower rate than traditional corporate income.”

    How does this figure? I thought the corporate rate, as well as the rates for capital gains and dividends, were taxed at lower rates than for individual earned income, which is what I thought partnership income was, and thus it would seem the 1% pay more in taxes for income from the “pass-through” type of business than the corporate form. Please explain.

    • David F. Ruccio says:

      I thought so, too. But here’s what the authors of the NBER report found:

      “We estimate that the average income tax rate on income earned in the partnership sector in 2011 was 15.9%. Extending our tax rate definition to other sectors, we estimate the average tax rate in 2011 in the C-corporate sector to have been 31.6%, in the S-corporate sector to have been 24.9%, and in the sole proprietorship sector to have been 13.6%. Hence, partnership income is taxed at the lowest income tax rate in the major formal business sectors (i.e., non-sole-proprietorships). . .

      Why are partnerships taxed at a relatively low rate, even though they are owned mainly by high-income Americans who face high statutory ordinary income tax rates? Three mechanisms push the average partnership rate below owners’ statutory ordinary income tax rates. First, capital gains and dividend income, which are taxed at preferred rates, amount to 45% of partnership income. This fact is especially clear in our partnership tax rate estimates by industry, with finance and real estate subject to an average rate of only 14.7%. Second, tax exempt and foreign entities earn roughly fifteen percent of partnership income and pay tax rates below 5%. Third, unidentifiable entities and circular partnerships pay an estimated tax rate (10.6%) that is one-third lower than the average tax rate on partnership income overall. The relative flexibility in the allocation of income and deductions among partners can also combine to make the average tax burden on partnerships relatively low.”

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