The top tax rate wealthy Americans pay on their investment gains today runs barely half the top rate the rest of us pay on our wages. But that only begins to tell the story of how lightly taxed our richest have become compared to the rest of us.

On the surface, the nominal tax rate on long-term capital gains from investments seems somewhat progressive, even given the reality that this rate sits lower than the tax rate on ordinary income. Single taxpayers with $48,350 or less in taxable income face a zero capital gains tax rate. Taxpayers with over $533,400 in taxable income, meanwhile, face a 23.8 percent tax on their capital gains, a rate that includes a 3.8-percent net investment income tax..

But these numbers shroud the real picture. In reality, we tax the ultra-rich on their investment gains less, not more. The rates we see on paper only apply to gains taxpayers register in the year they sell their investments. But we get a totally different story when we calculate the effective annual tax rate for long-held investments, especially for America’s wealthiest who sit in that nominal 23.8 percent bracket.

For members of America’s top echelon — the wealthiest 2 percent or so of American households — the effective annual tax rate on capital gains income, the rate that really matters in measuring the impact a tax has on wealth accumulation, actually rates as sharply regressive.

That sound complicated? Let’s just do the simple math.

The federal tax on capital gains doesn’t apply until the investment giving rise to those gains gets sold, be that sale comes two years after purchase or twenty. During the time a wealthy American holds an asset, the untaxed gains compound, free of tax. In other words, as the growth in the investment’s value increases, the effective annual rate of taxation when the investment finally gets sold decreases.

The graphic below shows how the effective annual tax rate on investment gains — all taxed nominally at 23.8 percent – varies dramatically with the rate of the gain and how long the taxpayer hangs on to the asset.

If an investor sells an asset that has averaged an annual growth of 5 percent after five years, the one-time tax of 23.8 percent on the total gain translates to an effective annual tax rate of 22.1 percent. In effect, paying tax at a 22.1-percent rate each year on investment gains that accrue at a 5-percent rate would leave the investor with about the same sum after five years as only paying a tax — of 23.8........

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