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How do payroll taxes and capital gains affect the tax share of the top 1%?
Executive Summary
Payroll taxes and preferential capital‑gains treatment materially lower the share of total federal taxes paid by the top 1% compared with what headline income‑tax figures alone suggest; capital gains timing and lower long‑term rates concentrate tax advantages for the wealthy, while payroll taxes are capped and therefore bluntly regressive at the very top. Estimates that the top 1% pay roughly 40–42% of individual income taxes reflect income‑tax receipts only; including payroll taxes, or counting unrealized wealth gains, changes that picture significantly [1] [2] [3]. Policy options — from equalizing capital‑income and labor rates to wealth or unrealized‑gain taxes — would shift both revenue and distributional outcomes, but each approach carries tradeoffs in administration, economic behavior, and political feasibility [4] [5].
1. Why the headline “top 1% pays 40%” misses the fuller tax picture
Analyses showing the top 1% pay about 40–42% of federal individual income tax focus on income tax receipts and therefore omit crucial components that affect true tax incidence: payroll taxes, the treatment of capital gains, and unrealized gains. When payroll taxes are added, the top share falls because payroll taxes are capped (Social Security wage base) and not proportionally applied to very high wages, reducing the top group’s share relative to income‑tax only statistics [1] [6]. Similarly, the timing of capital‑gains realizations causes year‑to‑year volatility in the top 1%’s tax share: years with large asset sales can spike their income‑tax liabilities, while non‑realization years understate their economic capacity to pay [1] [2]. That means statements about “who pays” depend heavily on which tax flows and which measurement period you choose [1].
2. How capital gains policy shapes who appears to pay taxes
Capital gains are taxed at preferential federal rates for long‑term holdings (0–20% plus the 3.8% NIIT for some taxpayers), while short‑term gains are taxed as ordinary income; this structure generates a persistent tax wedge between capital and labor income and benefits high‑wealth taxpayers who derive most of their income from asset appreciation [7] [8] [2]. Research and advocacy pieces argue that equalizing capital‑gains and ordinary rates or taxing unrealized gains would reduce inequality and raise revenue, with some models showing measurable falls in the top‑1% wealth share if capital‑income were taxed more heavily or wealth taxes were imposed [3] [5]. Opposing analyses and policy notes flag administrative complexity and economic behavior responses — such as deferred realizations, valuation disputes, and potential capital flight — as limits on how much collectable revenue and redistribution such changes would realistically achieve [4].
3. Payroll taxes: a blunt instrument that shrinks the top share when counted
Payroll taxes (Social Security and Medicare contributions) are levied on wages with a Social Security cap and Medicare applying broadly; for very high earners, the Social Security cap means a declining effective payroll tax rate as income rises, and thus including payroll taxes lowers the top 1%’s share of total federal tax receipts compared to income‑tax measures alone [6] [2]. Additional levies aimed at high earners — the 0.9% Medicare surtax on wages above thresholds and the 3.8% NIIT on investment income — do increase top taxpayers’ burdens, yet they do not fully offset the concentration advantages created by preferential capital‑gains treatment and the Social Security cap [2] [7]. This creates a mixed picture: payroll taxes improve progressivity up to a point but are structurally limited in taxing the ultra‑wealthy.
4. Unrealized gains and wealth taxes: changing the baseline of “who pays”
A significant portion of the wealth of the richest individuals is unrealized; research shows the top 1% hold a disproportionate share of unrealized gains, meaning conventional income‑tax accounting misses a large slice of their economic capacity [3]. Proposals to tax wealth or unrealized gains would materially increase the top 1%’s tax share on paper and potentially in cash receipts, but academic work and policy analyses caution about valuation challenges, administrative cost, avoidance risks, and international mobility effects that could erode projected revenues [4] [5]. Empirical simulations indicate that combining a wealth tax with higher capital‑income rates yields larger equalizing effects than raising capital‑income taxes alone, though outcomes vary by base definitions and enforcement assumptions [5].
5. The tradeoffs: revenue, progressivity, and economic behavior
Policymakers face clear tradeoffs: raising capital‑gains rates or taxing unrealized gains can boost progressivity and revenue, yet they invite avoidance strategies, valuation disputes, and potential impacts on investment incentives; counting payroll taxes narrows the top fiscal share but does so imperfectly because of caps and rate structures [3] [4] [6]. Different analyses reach varied conclusions about magnitude: some suggest modest equalizing gains from capital‑income reforms, while others argue wealth taxation is more effective but harder to implement [5] [4]. Any comprehensive assessment of the top 1%’s tax share must therefore state which taxes and which definition of income or wealth are being used, because the answer shifts significantly with inclusion criteria and policy assumptions [1] [3].