Business Income

The national accounting of personal income includes a category for Business Income, and we’ve seen that it’s a major component of income at the 1% level. Business income is earnings from “closely held” companies often organized as “pass through” entities such as “S corporations”, partnerships, and limited liability companies. What that means is that there are few shareholders (often from one family), shares don’t trade publicly, and income passes through to the shareholders rather than the entity itself. While numerically most S corps, for example, are tiny mom and pop operations, there are also many large ones. In aggregate, S corps alone employ over 29 million people in the US. Here are a few of the largest closely held companies and their revenue:

• Mars (the candy co) with revenues of $45 billion
• Publix (supermarkets) $48 billion in revenues
• Cargill (food, agriculture, etc.) $165 billion in revenue
• Enterprise (car rental) $30 billion

The list of large, closely held, companies is quite long and clearly the earnings of these companies when passed through to their small pool of shareholders can generate a lot of business income on tax returns. It is perhaps surprising that business income is only 9% of total personal income as noted in Table 12, but business owners often prefer to grow a business by investing rather than taking out most earnings as income. The fact that capital gains, when taken, are taxed at a lower rate than income helps encourage this[RF1] .

Capital Income and Capital Gains

Capital income and capital gains are the dominant sources of income at the .01% level. Capital income in national accounting includes interest, mostly from bonds, and dividends, which are corporate profits distributed to stock owners. By themselves, interest and dividends account for 17% of personal income, or a little over $3 trillion in 2019. Needless to say, you need to own bonds or stock to collect these payments, and not surprisingly wealthy people own the largest share as we will see when we look at wealth distribution^[1]. Capital gains, realized or not, are not included in Table 12, or in the graph of income distribution based on the national accounting of personal income. Owners of capital, such as stock or property, can decide when they want to sell and often match losses with gains to limit tax liability. For this and other reasons, realized capital gains vary pretty widely from year to year. The IRS tells us that declared, taxable, net capital gains amounted to around $880 billion net in 2019 on several trillion dollars of sales (the net is the amount the stock or other asset sold for, minus its original cost). That number was $1.7 trillion in 2021 reflecting higher stock prices. Since 1980, taxable realized capital gains have averaged about 4% of national income, but a lot of realized capital gains are exempt from taxes: the gain on the sale of a principal residence, and gains made that are sheltered by retirement plans, for example^[2]. Adding realized (not net worth) capital gains to the income distribution makes the top 10% and above stand out even more.

Rental Income of Persons

To quote the Bureau of Economic Analysis:

Rental income of persons is the net income of persons from the rental of property. It consists of the net income from the rental of tenant-occupied housing by persons, the imputed net income from the housing services of owner-occupied housing, and the royalty income of persons from patents, copyrights, and rights to natural resources. It does not include the net income from rental of tenant-occupied housing by corporations (which is included in corporate profits) or by partnerships and sole proprietors (which is included in proprietors’ income). Like other measures of income in the national income and product accounts (NIPAs), rental income of persons measures income from current production and excludes capital gains or losses resulting from changes in the prices of existing assets^[3].

At first it is quite surprising that this is only about 4% of total personal income, or $698 billion in 2019, given that it includes the “imputed” value of owner-occupied housing. Imputed value is roughly how much an owner would have to pay for their home if they rented it. However, the operative word is “net”. In effect, every homeowner is treated as a business and all expenses, including mortgage interest, are deducted from the rental value. Of the $698 billion “rental income of persons” in 2019, $532 billion was for owner occupied housing.

Transfers

The final income item shown on Table 12 is transfers, which includes the big entitlement programs of Social Security, Medicare, and Veterans benefits, and the means-tested transfers of Medicaid, CHIP, SNAP, and SSI. These are income to those that receive them and of course costs to those that pay them. At 17% of Personal Income, or over $3 trillion in 2019, they are quite significant. Social Security and Medicare are programs for the elderly and are evenly distributed among the elderly across income levels. Medicaid and the other means-tested transfers are by design geared toward those with lower incomes. They have helped boost incomes of the poorest quintile, but mostly through the provision of medical coverage. Social security benefits are paid from current Social Security payroll taxes, with any surplus or deficit going into, or coming out of, the Social Security Trust Fund. Social Security is financially stand-alone and does not receive money from other sources^[4].  The Social Security tax has a cap: in 2019 you paid the same amount whether you made $132,000 (the cap in 2019) or $10 million. It’s one of the reasons some rich people acknowledge that they pay a lower tax rate than their assistants^[5]. The other big entitlement is Medicare which also has a payroll tax source. However, Medicare runs a deficit of almost 50% which is made up through general revenue.  Medicaid is financed from general Federal and State revenues.

^[1] In 2019, the top 10% had a mean net worth of $5.7 million and owned 80% of stock and a similar percent of bonds. In round numbers that implies that $2.4 trillion of interest and dividends went to the top 10% in 2019.

^[2] Robbins, Jacob A. 2018. “Capital Gains and The Distribution of Income in the United States.” In 2019 Meeting Papers 202, Society for Economic Dynamics. Brown University. https://users.nber.org/~robbinsj/jr_inequ_jmp.pdf.

^[3] https://www.bea.gov/help/faq/64

^[4] During the Baby Boom working years, Social Security ran a surplus which was added to the Social Security trust fund which grew to over 2 trillion dollars. The trust fund is limited to investing in Treasury bonds which, while secure, pay a low rate of interest. In short, to finance debt spending, we “borrowed” our own Social Security savings. Social Security is projected to be able to pay full benefits until around 2037.

^[5] Warren Buffett has stated this on several occasions over the years.

 [RF1]Note that for inheritance tax purposes, the fair market value of stock is used. After the stock is inherited its step up bases is used. Edit the proscription final section to reflect this.