Taxing the rich: A guide to the controversy

Are millionaires paying lower tax rates than the middle class?

Most of them aren't. The 238,000 American households with taxable incomes of $1 million or more will pay an average of 29.1 percent in federal income and payroll taxes in 2011, according to the nonpartisan Tax Policy Center. That's almost twice the average rate of 15 percent paid by middle-class households making between $50,000 and $75,000. But some millionaires do get off lightly; one out of 10 of them will pay less than 15 percent, and about 7,000 will pay no income taxes at all. Warren Buffett, whose August call for higher taxes on the rich generated a fierce controversy, says he paid federal taxes of only 17.4 percent last year, half the rate paid by his secretary.

How is that possible?

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The truly rich usually make most of their money as capital gains on investments and assets, rather than as salaries or other forms of income. Capital gains are taxed at 15 percent, while income beyond $379,150 per year is taxed at 35 percent. The lower rate on capital gains is meant to encourage people to take the risk of investing money in companies, new ventures, and stocks, so as to promote economic growth and job creation. That's why President Clinton lowered the capital gains tax from 28 percent to 20 percent in 1997, and George W. Bush cut it down further to 15 percent. Now there's pressure to raise that rate again, or at least to require hedge-fund and private-equity managers to pay usual income tax rates on their mammoth profits, which can exceed $1 billion per year.

Didn't the rich used to pay more?

A lot more. The top marginal income tax rate was 91 percent during the 1950s, 70 percent during the 1970s, and 50 percent during all but the last two years of Ronald Reagan's presidency, when it fell as low as 28 percent. Today, the rich have historically low tax rates, but are paying a higher share of the U.S. federal tax haul. The wealthiest 1 percent of taxpayers alone pay 40 percent of all federal income taxes, and 21 percent of total taxes, including payroll, state, and local taxes. Meanwhile, the share of the U.S. population that pays no federal income tax at all has shot up to 47 percent, thanks largely to tax credits promoted by George W. Bush and Barack Obama.

Why has the burden shifted?

Mostly because the rich are so much richer than they used to be. The top 1 percent of Americans earn 21 percent of total income in the U.S., and hold a third of the country's cumulative wealth. The top 10 percent pull in almost half of total income, and own 73 percent of the total wealth. Due to globalization, technology, tax policy, and myriad other factors, income inequality in the U.S. has soared since the 1970s and is now more marked than in China, according to data compiled by the CIA.

Would raising taxes hurt growth?

Evidence linking high top tax rates to slow growth is thin. President Clinton raised the top U.S. marginal tax rate from 31 percent to 39.6 percent in 1993 — yet the economy boomed during his presidency. George W. Bush reduced the top rate to the current 35 percent in 2003, but there was anemic economic growth in the 2000s, and most of it was fueled by the housing bubble. Most economists agree that tax policy has a modest impact on the economy. What really drives job creation and growth, says Bruce Bartlett, a former economic adviser in the Reagan White House, is whether companies think the overall economic climate will reward them for expanding. "Businesses are not going to invest, no matter how low the tax rate is, if there is no demand for their output," he says.

Will taxing the rich fix the budget deficit?

It would help, but with the annual deficit now at $1.3 trillion, the rich alone won't provide a solution. The 5.6 percent millionaires' surtax that Obama recently proposed would generate about $45 billion a year. Ending the 2003 Bush tax cuts on households earning more than $250,000 a year would add about $87 billion a year. Put those two increases together, and the deficit would still exceed $1 trillion. Ending the Bush tax cuts for all tax brackets, however, would yield close to $400 billion per year — and make a real impact on the deficit. Clearly, if the country is serious about getting its fiscal house in order, it will require not only that the rich surrender tax cuts and loopholes, but that the middle class pay more too. It will also require major cuts in spending, primarily by reforming Medicare and Social Security — which inevitably would mean reducing benefits in some way. As former Republican Sen. Alan Simpson, the co-chairman of the White House fiscal commission, recently said, "You can't get this done without hits across the board."

Who makes up the 1 percent?

It takes an annual income of just above $516,000 to qualify as one of the richest 1 percent of Americans. The poster boys of that privileged set, heaped with the rancor of the Occupy Wall Street movement, are bailed-out bankers and securities traders, hedge-fund managers, and other plutocrats from the world of finance. But in fact, only about 14 percent of the richest taxpayers work in the finance sector. Many more of them — almost a third according to Internal Revenue Service data — are executives in nonfinancial firms. One out of six is in medicine, and one out of 12 is a lawyer. The select club of the top 1 percent includes more information-technology specialists and engineers than it does entrepreneurs, and more scientists and professors than celebrities from the arts, sports, and media. Not incidentally: More than half of U.S. senators and members of the House are part of the top 1 percent.