Confusing Income with Taxable Income

November 26, 2014

The Washington Post’s Wonkblog yesterday got to write a dramatic lede: “This is what oligarchy looks like.” The data described in the blog post are, in fact, fairly dramatic, but Wonkblog does not do a good job describing the data.

The problem starts with the headline: “The top 400 households got 16 percent of all capital gains in 2010.” While this accurately describes the data from an IRS perspective – that the top 400 households reported 16% of all taxable gains – it does not describe “capital gains” as a whole.

I am amenable to using “capital gains” as a shorthand for taxable capital gains in discussions about the IRS and revenue. But in broader discussions of the economy in general, one should, at a minimum, be clear on what one is actually measuring. The reason is that equivocating – or using the same term for multiple concepts – eventually leads to confusing the two definitions, which eventually leads to wrong conclusions.

Wonkblog writes:

That's right: one out of every six dollars that Americans made selling stocks, bonds, and real estate (worth more than $500,000) went to the top-third of the top-thousandth percent of households.

Nope. That’s wrong. Lots of Americans make money selling stocks and bonds when they reach retirement. In fact, the balance of individual retirement accounts, 401ks, and other pensions, combined, is about $20 trillion, a staggering amount. (See, eg, the Federal Reserve’s measurements. The Federal Reserve, unlike the IRS, is concerned with all income, not just taxable income. Household ownership of retirement assets can be found in table L.100.)

If one’s point is simply to point out that America’s top 400 households are very rich, of course, this remains true either way. But if one cares about the capital income of the rest of America, these distinctions matter. The rest of America is quite a bit richer, and quite a bit better at earning capital income, than Wonkblog gives it credit for.

Furthermore, if you are interested in explaining the trend visualized in the chart, the confused definition will once again get you in trouble. Wonkblog posits a variety of reasons that the top 400 households got an increasing share of gains, ultimately attempting to connect the trend with the housing crisis.

While that theory may have some explanatory power, one of the real answers may be much more banal. In the last twelve years, the limit on IRA contributions has almost tripled, from a paltry $2,000 to a much more robust $5,500. Middle class Americans are getting more and more of their capital income through retirement accounts, and less through regular taxable gains. This is a good thing: it means their capital income is being treated properly by the tax code.

An unfortunate side effect, though, is that exempting income from tax leads people to forget the income exists.



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