The report by ProPublica about how the very rich pay almost no taxes shows the problem with the tax system that taxes income and not wealth. As a result, the wealthy use devices to massively increase their wealth with things like stock options and other assets that do not get taxed until they are sold and get converted into income. But we know that the wealthy live a lavish lifestyle. So where does that money come from? Don’t they have to sell assets to get money and thus be liable for taxes on that amount? Ha! Such things apply only to peons like us.
This article explains what is going on here.
Jesse Eisinger, senior reporter and editor at ProPublica, told the Today Programme: “We were pretty astonished that you could get [tax] down to zero if you were a multi-billionaire. Actually paying zero in tax really floored us. Ultra-wealthy people can sidestep the system in an entirely legal way.”
“They have enormous ability to find deductions, find credits and exploit loopholes in the system,” he said.
So while the value of their wealth grows enormously through their ownership of shares in their company, that’s not recorded as income.
But there’s more than that, he said: “They also take aggressive tax deductions, often because they have borrowed to fund their lifestyle.”
He said US billionaires buy an asset, build one or inherit a fortune, and then borrow against their wealth.
Because they don’t realise any gains or sell any stock, they’re not taking any income, which could be taxed.
“They then borrow from a bank at a relatively low interest rate, live off that and can use the interest expenses as deductions on their income,” he said.
The website said that “using perfectly legal tax strategies, many of the uber-rich are able to shrink their federal tax bills to nothing or close to it” even as their wealth soared over the past few years.
The wealthy, as with many ordinary citizens, are able to reduce their income tax bills via such things as charitable donations and drawing money from investment income rather than wage income.
Simon Jack explains in more detail how this racket works.
What’s going wrong here? Let’s take a very simplified analysis. If the shares I own in the company I founded are worth £1bn at the beginning of the tax year and rise to a value of £2bn by the end of the tax year – how much income tax do I owe? Easy – zero. Because while I am twice as rich, I received zero income.
On the other hand, if I have zero assets, and I make £30,000 in income, I will pay roughly £6,000 in income tax and national insurance. That’s why the revelations that some of the richest Americans paid little or no income tax may provoke outrage but should not come as a surprise. It’s not comparing apples with apples.
That’s not to say these super rich folks have no money coming in to pay their yacht bills. There is a widespread tactic employed by the rich to borrow cash secured against their vast wealth – which again is not income – it’s proceeds of a loan and here’s the (perfectly legal) biscuit-taking bit.
The interest on that loan can be deducted from any other income to further reduce income tax liability. It sounds egregious – but it’s legal.
Small wonder that many politicians around the world (Elizabeth Warren in the US and Jeremy Corbyn/John McDonnell in the UK) and academics such as Thomas Piketty have argued that we need a way to tax wealth, not income.
The billionaire in our example WILL pay capital gains, currently 20% in UK, the moment he or she sells those shares and realises a profit
UNLESS, that is, the profit is sunk into another business, which the tax system as it stands is designed to encourage to promote economic growth and new jobs – jobs that will produce income and therefore tax.
That, say its defenders, is capitalism at work – but as with the new global consensus on taxing multinationals – the clamour for tax change is getting louder.
So, even though I am by no means a tax expert, as I understand it, this is how at least one strategy works.
If I have $10 million in assets, I can use that as collateral to get a loan of that amount and spend it on myself. A loan is not income and hence this amount is not taxable. If the interest rate is 5%, then I have to pay the bank $500,000 just as interest each year. Most of us, when we get a loan such as a mortgage, have to pay interest and part of the principal over the lifetime of the loan, a process known as amortization. But these people do not have to pay back the principal. It is like an overdraft on their accounts, the kind of thing that most people use just for emergency cash shortages. But for them it is a permanent tax dodge. This is because the interest is tax deductible and so it can be used to offset up to $500,000 in taxable income. So, voila! The next taxable income is zero, even though I have $10,500,000 million to spend on my expensive toys, like Jeff Bezos on his yacht and his rockets. So the only cost to me on the $10 million is $500,000 (i.e, 5% rate) and that too is not to the government but to the banks.
The loan/overdraft can be maintained until their death at which point many other loopholes involving trusts and credits and the like kick in, which I have even less of an idea about. In his daily newsletter of June 9, 2021, New York Times reporter David Leonhardt discusses the ProPublica report and explains some of the other strategies used.
A central reason that very wealthy people can avoid taxes is that the U.S. system taxes only so-called realized gains — like wages or stock sales. But the wealthy often live off unrealized gains — in the form of stocks and other assets that grow more valuable over time. The wealthy borrow against these assets to pay for houses, islands and private planes and then use a variety of strategies to avoid paying taxes on the debt repayment.
One such strategy is waiting until after death to repay the loan — or what Edward McCaffery, a tax expert at the University of Southern California, calls “buy, borrow, die.” Robert McClelland of the Tax Policy Center called it the main revelation of the ProPublica story.
All the while, the wealthy are often able to keep their taxable income low. In 2011, Bezos reported so little income that he qualified for — and claimed — a $4,000 child tax credit. In both 2016 and 2017, Carl Icahn, who’s a billionaire, paid no federal income taxes. [My emphasis-MS]
You sometimes hear the cynical view that raising taxes on the wealthy is pointless, because they have the resources to evade any taxes the government tries to impose. But history suggests otherwise.
While some tax avoidance is inevitable, the federal government has largely succeeded in raising taxes when it has tried. The very richest Americans paid more than 50 percent of their income in federal taxes during the 1950s and ’60s (and were less successful at shielding their wealth from taxation). Today, that percentage has fallen below 30 percent.
There are three main ways to reverse the decline in tax payments by the wealthy, Gabriel Zucman of the University of California, Berkeley, said. One is a direct tax on wealth, like those proposed by Senators Bernie Sanders and Elizabeth Warren. Two is a tax on unrealized gains — assets that have become more valuable — as Senator Ron Wyden of Oregon has proposed. Three is an increase in corporate taxes, as President Biden favors. There are also more modest ideas, like a larger estate tax.
Societies can choose how much they do or don’t tax their wealthiest people, Zucman said. “For billionaires,” he added, “the federal income tax — the pillar of the U.S. tax system — has become a voluntary tax.”
This shows the need to tax both income and wealth and to increase resources for enforcement in order to combat tax evasion.
I have seen some commenters adopt a world-weary cynicism about the ProPublica report saying that it did not tell us what we did not already know, that the US taxes income and not wealth. But there is a big difference from knowing how things work in theory and showing how named wealthy individuals, including people like Warren Buffet and Bill Gates who adopt a stance of being philanthropists, are using every trick in the book to avoid paying almost any taxes. Such naming and shaming will help if we are to get any change at all.