The 15% tax rate

Date posted: February 21, 2012

Controversy has arisen about the tax rate some higher income folks pay. It is sometimes much less than what middle- and maybe lower-income households pay. How can this arise? And is it fair? N.C. State University economist Mike Walden responds.

“Well, you’re talking about the controversy over one of the political candidates regarding his payment of about an average 15 percent rate on his income tax return. And as you said, for many people — middle-income people, in particular — that’s much lower than the marginal rate that they pay. And so the question is … how does this come about? And it comes about in terms of how the income is earned. There is a special low rate for income that is earned from investments — things like capital gains (That’s where you maybe buy an investment, sell it later. There’s a gain there.) — you’re taxed at this low rate.

“Or in recent years it’s also had to do with dividends, which are investment returns that you get from investing in companies. And there is a special low rate of 15 percent for these kinds of returns from investments.

“And the reason that policy makers give for having this special low rate is really two (fold): They argue that investment income is often taxed twice. It’s first taxed by the business or for the business, and then it’s secondly taxed when that business takes the return and supplies it to the investor. So the idea is to have a level playing field, you need to tax that income for the investor at a lower rate.

“And then the second reason is to encourage people to invest in businesses, which obviously cause the economy to grow and potentially add jobs.

“This is an old policy debate. Not everyone agrees with those reasons given for having the special low rate. But this has been in our tax code for a long time. Still, it’ll be a topic of concern down the road.”

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