What’s the secret to making money like the rich? Capital gains.
A study from the non-partisan Tax Policy Center looked at the sources of income for American taxpayers of different income levels. It found that the higher you go up the income ladder, the greater share of income comes from capital gains.
For the 99 percent of taxpayers making less than $500,000, salaries and wages account for 75 percent of their adjusted gross income for 2012, the latest period available from Internal Revenue Service returns. Of the remaining income, about half came from retirement programs such as pensions, annuities and Individual Retirement Accounts.
For taxpayers making $500,000 to $1 million, salaries and wages account for more than half of earnings.
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But for those making $10 million or more, salaries and wages only account for around 15 percent of their income. Their real money comes from capital gains, with capital gains accounting for about half of their earnings. Another 15 percent to 20 percent came from interest and dividends. About 25 percent of their income came from business income, which means they owned or held a stake in a private company.
It’s no surprise that the really rich make their money from, well, money. But Roberton Williams of the Tax Policy Center said the data doesn’t mean that all of the wealthy are just sitting around making millions from the stock market every year. Many of the people in that $10 million-or-more group don’t repeat their mega-earnings every year. Their income came from a one-time sale of a business or asset, leading to a capital gain.
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“A lot of the people at the very top are there because they sold a major asset or business they’ve built for years,” he said. “It’s a one-time big payday.”
Williams said one of his previous studies found that among those in the top 1 percent, about half were only in the 1 percent for one year over the course of a decade.
From a policy perspective, Williams said the importance of capital gains to the wealthy could be seen in two ways.
Some have argued for hiking the capital gains tax from its current federal rate of 20 percent (plus 3.8 percent for top earners under the Affordable Care Act’s Net Investment Income tax). This includes President Barack Obama, who proposed raising the rate to 24.2 percent in his 2015 budget. The argument is that because the capital gains rate is lower than the income tax on salaries and wages, the very rich sometimes pay lower rates than everyday earners. (Remember Warren Buffett and his secretary.)
“It looks like a ripe area to tax,” Williams said.
But, capital gains are also voluntary: Owners can choose when to sell their business or asset depending on the optimal tax environment. That’s why the incomes of the wealthy can be so volatile. If capital gains were to increase, the rich could simply sell their assets and take the gain before the tax increase, therefore leading to lower revenue from the capital gains tax.
“The higher you make the tax, the more people will resist it,” he said. “We know from history that people respond to capital-gains tax rates.”
Watch “Secret Lives of the Super Rich” on Tuesdays at 10 p.m. ET/PT.