Capital Gains and the Incomes of the Wealthy

Yesterday’s release from Statistics Canada on the income share of the wealthy generated some interesting coverage and commentary.  It reported that the top 1%’s share of total income in Canada remained steady in 2011 in Canada, at 10.6 percent — but still significantly higher than in the 1980s.

Most observers did not mention, however, that this oft-cited income share statistic does NOT include capital gains in the calculation of incomes and income shares.  A capital gain, of course, is a realized benefit resulting from the disposition of an asset (buy low, sell high … unless you are a short seller, in which case you should buy high and sell low!).

Realized capital gains fluctuate greatly, depending on the ups and downs of the stock market and other macroeconomic forces.  For that reason, many analysts exclude them from regular income distribution calculations.  However, the reality is that for wealthy Canadians, capital gains are always — even in bad years — a substantial source of income.  Receipts of realized capital gains are among the most precariously unbalanced sources of income in our economy.  And making matters worse, capital gains receive highly preferential treatment under our tax system (in general, only half of realized capital gains need be declared on income tax returns — an extraordinary and arbitrary loophole that is usually justified with neoclassical mumbo-jumbo about “incentives to save” and similar self-serving arguments).

For all these reasons, I think it is better to include capital gains in our analysis of income distribution.  StatsCan’s CANSIM Table 204-0001 allows us to do that, providing options for selecting market income and total income with or without capital gains included.

If we consider “market income with capital gains,” then the income share of the top 1% in 2011 was significantly higher than the headline number reported yesterday: 13.2% of total income, down a notch from 2010, but about 5 percentage points higher than in the early 1980s (when StatsCan started collecting this information).  For the richest of the rich, the top 0.1% took in almost 5 percent of total income (no change from 2010, but more than double the shares of the early 1980s), and the richest 0.01% took 1.7% (likewise).

For “total income.” the top income shares (including capital gains) are reduced slightly (by virtue of government transfers received disproportionately by lower-income tax-filers): to 11.7% for the top 1%, 4.3% for the top 0.1%, and 1.5% for the top 0.01%.  But regardless of the income concept used, the extent of income concentration is significantly higher when capital gains are included.

Over the last 5 years, capital gains have accounted for about 12% of the total market income of the top 1%, and about 15% for the top 0.1% and 0.01%.  So excluding capital gains significantly understates the total income received at the top of the income ladder.

Another way of making this point is to calculate the average capital gains received by tax-filers at different income levels (a figure which can be derived from the Table 204-0001 data).  Those in the richest 0.01% category received, on average, over $1.1 million worth of capital gains each.  Those in the richest 0.1% received $300,000 each, and those in the top 1% received $60,000 each.  To put this in context, the richest 1% of the population received more than twice as much income from capital gains alone, as the median total income of the bottom 99% of society (which was $29,300 in 2011).

The top 1% has consistently claimed about half of all capital gains, implying that about half of the underlying wealth is also owned by that group.  (The role of pension fund wealth and other forms of wealth which do not generate taxable capital gains would serve to dilute that ownership share somewhat.)

And half those lucrative capital gains could be simply ignored when it came time for the 1% to file their tax returns.  If there was ever a reason for revolution in the streets, it should be the fact that wealthy Canadians pay tax on only half of the income they derive from flipping stocks, bonds, and real estate — while fast food workers pay tax on every dollar of the hard-earned income they derive from flipping burgers in greasy, dangerous kitchens.

Of course, in today’s “shareholder economy.” we can all play the markets through our mutual funds, RRSPs, and soon (if the Harper government has its way) PRPPs.  So surely more humble Canadians must also benefit from capital gains and their preferential tax treatment.  Just not to quite the same degree.  The average capital gains income received by a tax-filer in the bottom 50% of the income ladder equaled all of $100 in 2011.  (StatsCan rounds average and median income estimates to the nearest 100.)  Adding insult to injury, the puny effective tax saving to those tax-filers from the capital gains partial inclusion (worth $7.50 in federal taxes at the 15% marginal rate) was only half the effective savings pocketed by the top 1% tax-filers (realized at a 29% rate) on EACH $100 of their capital gains partial inclusion (which was then applied against a capital gains flow that was 600 times larger).  The system of capital gains partial inclusion thus benefits the average 1% tax-filer an incredible 1160 times as much (through an average $8700 saving on federal tax alone) as for the bottom 50% tax-filer (average $7.50 saving at most, assuming the tax-filer was paying any income tax at all).

Maybe the “shareholder economy” is not all it was cracked up to be, after all.

There is a moral dimension to considering capital gains, since it is a form of income derived from ownership, rather than through direct work effort.

Capital gains are also worth emphasizing in discussions of income distribution because they reveal an important qualitative difference in the role that the wealthy play in our economy.  It is very wrong to assume (as some liberals do) that the wealthy are just like the rest of us, only richer — and hence that the dangers of income inequality stem solely from the quantitative gap in bottom line incomes (and the comforts and opportunities that those incomes allow for).  Wealthy individuals are fundamentally and qualitatively different from the rest of us.  In particular, they own most business wealth in Canada (both direct ownership of businesses, and ownership of business equity).  That’s precisely why they receive the lion’s share of capital gains.  This dominant ownership position is obscured by the rhetoric of “people’s capitalism” — but confirmed in gory detail by the data on the maldistribution of capital gains (and other wealth-related income flows, such as dividend payouts which are almost as badly concentrated at the top of the income ladder).  Wealthy people are not just wealthy.  They are the major owners and top managers of the profit-driven businesses which are the major driving force of our economy.  This gives them a power, and a vested interest, that goes beyond their claim to a vastly disproportionate share of incomes.  And in turn, that power helps to explain why THEIR incomes receive such favourable taxation treatment, and other government favours.