CRS: Capital Gains And Dividends Drive Income Inequality

January 04, 2012 4:01 pm ET — Walid Zafar

Last year, the Washington Post published this insightful piece examining how capital gains tax rates were accelerating the gap between the rich and poor. Lobbying by the very wealthy, coupled with the fact that many members of Congress are themselves millionaires, has led to a situation where the Warren Buffett's of the world pay a lower effective tax rate than their administrative staff.

Now, a new report by the nonpartisan Congressional Research Service (CRS) sheds more light on widening income inequality in America, a trend that at least one GOP presidential hopeful, former Pennsylvania senator Rick Santorum, has said he supports. (The GOP contenders have promised to cut taxes even further if they're elected.)

CRS' Thomas Hungerford looked at three potential causes of inequality — wages and salaries, capital income, and changing tax rates — and concluded that the income earned through capital gains, dividends, and business income has had the most to do with the increasing gap between the country's haves and have nots.

Between 1996 and 2006, the last year for which tax data is available, the inflation-adjusted income of the poorest 20 percent of taxpayers decreased. During the same period, the income of the very rich, the top 0.1 percent, nearly doubled.

This occurred, the report concludes, because wealthier earners started benefiting less from wages and salaries and more from investments. In 2006, the top 0.1 percent of earners derived 51.9 percent of their income from just dividends and capital gains. In contrast, just 0.7 percent of the income of the bottom 80 percent came from dividends and capital gains. During the decade, the poorest Americans saw their capital gains as a percentage of income decrease while those in the top quintile saw a sizable increase.

Here is how the distribution looked in 2006, via Mother Jones:

But it wasn't just that the poor didn't benefit from capital gains as much as the rich; they're actually poorer than they were before. Here's a chart from CNNMoney:

The Republican candidates for president want to keep the current capital gains tax system in place, with some promising to eliminate capital gains taxes altogether. While conservatives complain that having a more progressive income tax code "soaks the rich," the trend is that the rich are earning a greater percentage of their income in capital gains and dividends. Since, as the report notes, "about half of the total income of the top 0.1 percent comes from capital gains and dividends" and the disparity will likely increase in the coming years, income inequality will not only grow, but it will do so at a much more rapid pace — especially if conservatives are successful in reducing rates even further.

That will make Rick Santorum really happy.