Why Does it Seem Income Taxes are Unequal?

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The latest Congressional Budget Office report revealed that the top 1% of earners, real after-tax income, jumped 275% between 1979 and 2007. The top 20% made more in after-tax income than the remaining 80%. The lowest income group’s income after-tax rose only 18%.

The income gap has become a hot issue in the media and in the public.

So why the huge gap? Obviously that’s something you could write an entire book on. But, these are some nuggets revealed in the CBO report:

1. People who earn income from investments are taxed less.

Most low or middle class folks earn their money from wages, which are subject to Social Security, Medicare, Federal, State and Local taxes. But income from business, like capital gains and dividends are usually taxed at lower rates. So, if you are on a salary or getting paid by the hour, you get taxed regularly through your paycheck. But if you hold stocks, bonds or other property or business investments, your capital gains tax can be delayed for years.

2. How you are paid makes a difference.

Some high level executives can structure their compensation so that it is tax-deferred, paid in stock options or paid as capital gains. Others can structure it so as to receive dividends. All of these devices put off paying taxes and are usually at a lower rate. For example, capital gains are taxed at 15%.

3. Lower income earners pay more in payroll tax as a percentage.

Lower income wage earners don’t necessarily pay more in total payroll tax however, they pay a higher percentage of their income in payroll tax. It revealed that the lowest fifth of families paid an average of 8% of their income in payroll taxes, while the highest group paid 2%. The reason is again because of investment income or business incomes that are taxed later and at lower rates.