This story is a partnership between the Center for Public Integrity, a newsroom that investigates inequality, and Bloomberg Tax, a news organization that provides legal and regulatory information for tax professionals and their advisers.
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A dense fog rolling in off the Pacific enveloped President Ronald Reagan’s majestic 688-acre ranch, high in the hills above Santa Barbara, California.
Visibility was limited, but a crowd of cameramen, photographers and reporters were gathered on that day in 1981 to record the president signing a major piece of legislation.
Wearing jeans, a faded dungaree jacket and cowboy boots, Reagan strolled out of the adobe farmhouse where he and first lady Nancy Reagan were vacationing to a table on the gravel driveway below the house. As he slid into an old leather chair, Reagan flashed his radiant smile to the journalists awaiting the ceremony.
He had much to smile about. Stacked on the table was ERTA, the 185-page Economic Recovery Tax Act of 1981, whose passage fulfilled a campaign promise to cut taxes in a big way.
Signing the bill repudiated everything he had once believed in as a New Deal supporter. ERTA slashed personal, corporate and estate taxes and was stuffed with other tax favors for high-net-worth individuals and corporations. The tax cuts carved a $750 billion hole in the federal budget, prompted cuts in multiple public programs and added to the deficit. The cuts, spread over six years, totaled $2.4 trillion in today’s dollars — basically the cost of the Biden administration’s multi-year, scaled-down Build Back Better bill that never made it out of Congress.
But that was just the beginning. The bill signing on that foggy day set in motion a trend in tax policy that is supercharging America’s escalating income inequality. In the past four decades, Congress after Congress has cut taxes on the richest people and corporations — billions of dollars that would otherwise have gone to the federal till for spending that could help the rest of the public get ahead.
Along the way there were some tax increases, most recently the Inflation Reduction Act signed by President Joe Biden in August that levied a 15% minimum tax on corporations and a 1% excise tax on stock repurchases by public companies. That law was a modest but significant breakthrough for the Democrats after years of Republican-driven tax cuts.
To some, the value of the reforms isn’t just monetary: “They will help restore the public’s confidence in the fairness of our tax system,” said Frank Clemente, executive director of Americans for Tax Fairness, a coalition that advocates for progressive taxation.
These increases notwithstanding, the trajectory over the past two generations has been in the opposite direction.
In 1980, the top income tax rate for individuals was 70%. Today it’s 37%.
The political forces behind that seismic shift haven’t stopped pushing for more. Already, House Republicans are proposing to extend or make permanent some of the most recent tax cuts.
Before the income tax was enacted in 1913, average Americans paid the bulk of federal taxes through levies on imported goods. Democrats succeeded in passing the income tax as a way to compel the wealthy to pay more of the cost of running the national government.
Until World War II, the income tax was levied on only the richest Americans. Even after that, the system was designed so people with more money paid higher rates — much higher for the wealthiest.
Elected officials, largely Republicans with some assists from Democrats, have spent the past four decades pulling that system apart.
They’ve tucked large breaks for the rich into proposals with small cuts for millions of other Americans, effectively disguising the main beneficiaries. They’ve promoted tax cuts with claims about economic benefits that have not panned out.
“It’s vastly oversold that tax cuts will generate job and economic growth,” said William Gale, co-director of the Urban-Brookings Tax Policy Center. “When you cut taxes for the upper income, you give them more after-tax income, but you don’t do anything for growth.”
All but a few states take a greater share of income from poor people than the wealthy. Systems designed by white supremacists are part of the reason.
The nonpartisan Congressional Research Service reached essentially the same conclusion in 2012 that tax cuts don’t spur growth but do increase income inequality. After Senate Republicans heatedly objected to the report, CRS withdrew it.
ERTA charted the course in 1981. It cut the top tax rate from 70% to 50% on so-called unearned income — dividends from stocks and interest on bonds and savings. While modest tax breaks sprinkled throughout the bill affected millions of taxpayers, the top rate cut had just one constituency. Only the richest 2% of taxpayers were subject to taxes up to the 70% rate.
Lowering that rate had long been a Republican goal, but the party’s lawmakers had been reluctant to propose it in ERTA for fear that voters would see them as favoring the rich. Instead, it was the Democrats who proposed it. It was a trade, a way to get Republican support for other provisions in the bill.
ERTA gave the wealthiest Americans who received dividend and interest payments a hefty yearly tax cut of $6.7 billion, the equivalent of $21 billion today. Out of 95 million taxpayers who filed that year, this bounty went to just 82,000: the richest sliver of the top 1%.
People in this group who received $250,000 in dividends owed $175,000 in taxes on them for the 1981 tax year. ERTA gave them a tax cut of $50,000 the next year — more than twice what the majority of American families lived on at the time. It was a gift that kept giving, year after year.
To fully understand the amount of money involved, think of it this way:
If the 70% rate were still on the books, taxpayers with more than $1 million in income in 2019 could have owed $87.9 billion more in taxes that year, according to a Center for Public Integrity analysis of IRS data. That’s more than enough money to rebuild and repair all the bridges and water systems across the country slated for work under the Infrastructure Investment and Jobs Act passed by Congress in 2021.
Cutting taxes for the rich over the past 40-plus years has had a huge impact, leaving less money for public programs that benefit millions of Americans while enriching a tiny percentage of the population. Where once the code strove for a certain balance — the more you earned, the more you paid — the rates have been reduced so much that there’s not nearly as much difference now between the top tax rate a billionaire investor pays on their income and what a middle-class salaried professional pays on theirs.
Income inequality in America is at heights not seen for a century. A variety of factors have contributed, including the erosion of good-paying manufacturing jobs, deregulation, a weakened trade union movement and the elimination of pensions and other rungs in the safety net. But taxes have been a principal engine of worsening economic inequality simply because the wealthy, thanks to their success in Congress, now have more money — to buy stocks, invest in real estate, build megayachts, blast off into space and make campaign contributions to politicians so the cycle isn’t interrupted.
It wasn’t just a result of lowering the top rate to 35%.
For decades, dividends paid to shareholders — predominantly wealthier people — were taxed like salaries and wages. But the 2003 law created a new category called “qualified dividends.” What constituted such a dividend was complicated, largely how long the stock was held, but its main benefit was that it would be taxed at 15% rather than 35% for upper-income people.
An auto worker in Detroit who received $5,000 in qualified dividends might have saved $500 under the new law. An auto executive who received $100,000 in such dividends would have saved $20,000.
This tax break, narrowed since then but only modestly, has cost the U.S. Treasury an estimated $350 billion since 2004. Upper-income taxpayers have benefited the most. In 2019 alone, it was worth $16.2 billion to taxpayers earning $1 million or more.
To put that $16.2 billion in perspective: It’s the equivalent of the federal income taxes paid by everyone earning $50,000 or less in California, Idaho, Iowa, Kansas, Minnesota, Nebraska, New Hampshire, Oklahoma, Pennsylvania, South Dakota, West Virginia and Wisconsin — combined.
President Barack Obama later signed legislation that made the tax break permanent, but he also steered tax increases through Congress, pushing the top rate back to where it had been under Clinton as well as imposing a surtax on investment income and hiking Medicare taxes for high earners to help pay for the Affordable Care Act.
All this led to what would be the signature legislative triumph of the Trump presidency, the Tax Cuts and Jobs Act of 2017. The sheer magnitude of the tax cuts it gave to the wealthy and corporations made the law the most significant since the Reagan era.
The arguments for it sounded very familiar.
“I not only don’t think it will increase the deficit, I think it will be beyond revenue neutral,” Senate Majority Leader Mitch McConnell declared after the bill’s passage. “In other words, I think it will produce more than enough to fill that gap.”
Instead, with its generous tax cuts for individuals and companies, it gushed red ink. The Congressional Budget Office estimated in 2018 that it would add $1.9 trillion to the deficit over the next 10 years.
In 2019 alone, the tax cuts cost the U.S. Treasury $259 billion. Virtually half that money flowed to those earning $200,000 or more, according to data from the Joint Committee on Taxation.
Workers earning between $50,000 and $75,000 that year got a tax cut of $840 on average. Those earning $1 million or more? Over $64,000.
Over the past four decades, the federal tax system has been transformed into something akin to a private-equity fund for wealthy taxpayers, giving them remarkable returns from multiple sources. As Congress showered them with benefits, most Americans struggled to keep up with the cost of living.
Median household income in 1981 was the equivalent of $62,000 in today’s dollars. Since then, the earnings of the majority of American families have been mostly stagnant, just barely keeping up with inflation. Think of it as standing still financially for 40 years.
Social Security and Medicare taxes add to the brutal squeeze. They take 7.6% of wages from workers who earn $60,000. It’s only a 2% bite for someone earning $1 million because Social Security taxes are capped for high earners.
The flow of money to those at the top is at the heart of the growing concentration of wealth. The more money you make, the more opportunities to save and allow your excess income to compound.
No group of working Americans has paid a steeper price for income inequality in the tax-cutting past four decades than African Americans. Their median household income of $45,870 is nearly 40% lower than that of white households. Over the decades, “next to no progress has been made in closing the black-white income gap,” concluded a report for the Federal Reserve Bank of Minneapolis in 2018. “The typical black household remains poorer than 80 percent of white households.”
Because Black families have fewer opportunities to set aside money and accumulate assets, the wealth gap between white and Black families is even worse. White families on average have six times more wealth than Black families: $983,400 for whites; $142,500 for Blacks, according to Federal Reserve data. Half of African American families have assets of less than $25,000.
And those numbers were compiled before COVID-19, a bigger financial hit to African Americans than any other racial or ethnic group, according to the Census Bureau.
For most of the period when the country had a more progressive tax system, racial discrimination was legal. By rule and practice, the U.S. government largely blocked Black families from accessing federal programs that helped white families build generational wealth.
In the past four decades, meanwhile, wealth-building opportunities for people with modest resources have been in short supply. Sixty percent of the country — the people on the less-income side of the scale — have a lower share of total assets in the U.S. now than in the late 1980s, according to the Federal Reserve.
It would take big change to turn that around. The tax provisions in the Inflation Reduction Act are only a modest step in that direction.
Biden’s original tax proposals were much more ambitious than what wound up in that law. He called for raising top tax rates on individuals back to the Clinton-era 39.6% and on corporations from 21% to 28%, taxing capital gains like wages, eliminating the “angel of death” loophole that allows the wealthy to pass their stock holdings to heirs tax-free, and many other provisions to shift more of the tax load to those at the top.
Public opinion polls show significant support for most of his tax proposals. But there’s virtually no hope for their adoption by the politically split incoming Congress.
Yet some believe that these proposals show a shift in thinking about taxes that could pave the way for more in the future.
“Biden’s investment and tax plans were more impressive than in any other previous election campaign, and he followed through with those proposals in his budget,” said Clemente, the Americans for Tax Fairness executive director.
To Chuck Collins, a senior scholar at the Institute for Policy Studies who has been tracking income inequality for years, it is more urgent than ever that the U.S. do something about the growing chasm between those at the top and everyone else — something besides making it worse.
“Our current policies are propelling us toward a society that even the rich don’t want,” he said, “with the ultra-wealthy living in walled, gated communities driving bulletproof Mercedes, a precarious middle class with a larger percentage of people with no financial reserves.
“You don’t want your children growing up in an apartheid society. It creates volatility and social and political instability. Which is what we are wading into now.”
Journalist James B. Steele has twice won the Pulitzer Prize for coverage of federal taxes and is the co-author most recently of America: What Went Wrong? The Crisis Deepens.
Clarification, Dec. 12, 2022: We added a note to a graphic showing business income taxes as a share of the total to clarify how the IRS defines those taxes.
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Journalist James B. Steele has twice won the Pulitzer Prize for coverage of federal taxes and is the. More by James B. Steele
Investigating the systems and circumstances that contribute to inequality.
