There are two words that define both how the rich got rich and how they stay that way: capital gains.
IRS tax return data shows that in the years before the recession, nearly half the income of the 400 richest individuals came from capital gains, which is the profit derived from investments. Less than 10 percent of their income came from traditional wages.
The average income of the top earners grew by 650 percent between 1992 and 2007 to $344 million, while average capital gains payout during that time increased by an astounding 1,200 percent, according to IRS data.
The long-term capital gains tax rate is currently 15 percent. In 1990, it was reduced from 28 percent to 20 percent, and then to 15 percent in 1997. If the Bush-era tax cuts are not extended after 2012, the effective capital gains rate for the rich will rise to 25 percent on Jan. 1, 2013. Perhaps even more alarming for the wealthy, qualified dividends will be taxed as ordinary income, thereby increasing from the current 15 percent to the top individual tax rate of 39.6 percent.
Sharply higher taxes could result in the rich selling securities toward the end of this year. So how would that affect the already-volatile stock market? The answer is significant because much of the stock market’s performance relies on wealthy investors, who have taxable portfolios that are sensitive to the changes in tax code.
That tax rates will change after 2012 is certain. The uncertainty lies in the details, which are likely to remain so until after the November presidential elections. While President Barack Obama maintains that steep tax increases on the rich will help pay for health care reform and level the playing field for all taxpayers, Republican candidate Mitt Romney favors keeping taxes lower to stimulate economic growth.
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