The rich, it turns out, are different from the rest of us. The wealthy, for example, can assemble a diversified portfolio of securities, or can invest through hedge and private equity funds. When the rest of us invest, we do so largely through mutual funds. Nearly half of American households own mutual funds, and mutual funds represented a significant portion of the financial assets held by U.S. households. The tax rules governing mutual funds create an investment vehicle with significantly worse tax treatment than investments available to the wealthy. In particular, the tax rules governing mutual funds force shareholders to pay taxes on “forced realization income,” even though such income does not increase their wealth.Because mutual fund investors must pay taxes on non-existent gains, while the wealthy can use alternative investment strategies to avoid such taxes, the taxation of mutual funds violates the tax policy objective of vertical equity. To correct the inequities faced by mutual fund investors, the tax law needs to permit low- and middle-income taxpayers to exclude from their income 10 percent of the capital gain dividends they receive each year.