This article is part of the Debatable newsletter. You can sign up here to receive it on Tuesdays and Thursdays.
It’s not every week that the national discourse catches fire over tax policy. The match, of course, was the investigation ProPublica published on Tuesday of anonymously leaked tax documents that revealed that the 25 richest Americans — billionaires such as Jeff Bezos, Elon Musk and Warren Buffett — pay very little in taxes to the federal government relative to their astronomical wealth. In some years, they paid nothing at all.
Depending on your point of view, it was either one of the most important stories of the year or an invented scandal. Here’s a closer look at the report and what people are saying about it.
Inside the report
In recent years, ProPublica noted, the median American household made $70,000 in annual income and paid about 14 percent in federal income taxes. The highest marginal tax rate, 37 percent, kicked in this year, for couples, on income above $628,300.
But the report showed the ultrarich pay just a fraction of that rate:
Most Americans make money by working a job and earning a salary, and only a small portion of that income can be channeled into investments — stock or housing, say — that might yield a profit.
The ultrarich, on the other hand, make a vast majority of their money from assets. In Bezos’s case, his wealth increased by $99 billion between 2014 and 2018, but he reported a total of only $4.22 billion in income. As a result, he paid just $973 million in income taxes — a 1.1 percent “true tax rate” on the rise in his fortune. ProPublica estimated that the top 25 richest people collectively paid a true tax rate of only 3.4 percent during those years.
Even looking strictly at what the top 25 richest people reported as their income, ProPublica found that they paid about just 16 percent to the government between 2014 and 2018. That’s because the ultrarich have perfectly legal strategies of lowering their income tax liability, like using business credits and deducting interest expenses on debt. The results can be perverse: In 2011, Bezos, then worth $18 billion, filed a tax return reporting he made so little because of investment losses that he received a $4,000 child tax credit.
A scandal that wasn’t?
Many critics of the ProPublica story took issue with its “true tax rate” metric, which The Wall Street Journal editorial board called “a phony construct that exists nowhere in the law.” There is a reason wealth isn’t taxed like income, as the ProPublica report itself noted:
In 1920, seven years after the 16th Amendment was ratified, giving the federal government the power to tax income, the Supreme Court considered the case of a woman named Myrtle Macomber, who owed taxes under the new law on a stock dividend. But she hadn’t received any money — just more shares of the stock.
The court ruled that this wealth couldn’t be treated as income. It could be taxed only if and when the underlying assets were sold, or “realized.” This distinction has persisted ever since. Today, when assets are sold or pay cash dividends, the gains are taxed at no more than 23.8 percent.
“I thought the ProPublica analysis of billionaire taxes was going to be exciting,” Megan McArdle, a columnist for The Washington Post, wrote on Twitter. “Instead, it told me things I already knew: that the U.S. tax code offers deductions for charitable donations, loan interest, and business operating expenses, and only taxes capital gains when you sell.”
The report’s central claim is not that this state of affairs is new but, rather, that it has produced unjust outcomes. “The investigation my colleagues kicked off today makes concrete something that economists have understood and debated for years: Wealth inequality has actually increased much more than income inequality, and the tax system isn’t doing much about it,” Lydia DePillis of ProPublica wrote. “What this investigation lays bare is the mechanisms by which the very rich are pulling away from most Americans, with all the democracy-skewing consequences that entails.”
Why has the tax system allowed for such runaway inequality? My colleague Binyamin Appelbaum places the blame with the Macomber standard, which he argues rests on false assumptions:
The first falsehood is that unrealized gains are unusable. The report shows the wealthy do use their unsold assets, by borrowing against them for spending money: Elon Musk, for example, pledged Tesla stock worth $57.7 billion as collateral for personal loans. Such loans often aren’t repaid until death, a strategy known as “buy, borrow, die.” Until then, payments on the interest can be used to reduce income tax liability.
The second falsehood is that people must eventually pay taxes on their wealth, even if that doesn’t happen until their death. But the wealthy have strategies to avoid even this final taxation. One is a loophole known as step-up in basis: When an appreciated asset is bequeathed, its value is reset, or stepped up, in the eyes of the law, allowing inheritors to bypass billions in capital gains taxes. Another strategy is to pass down assets through complicated trusts and philanthropies, allowing the rich to avoid taxes on almost half of their estate value.
The third falsehood is that taxing wealth is simply too impractical for the government to do. But as Appelbaum notes, the government manages to collect property taxes, which is a kind of wealth tax, just fine.
So what should change?
There is no shortage of ideas about how to rein in wealth inequality.
Tax wealth: The Berkeley economists Emmanuel Saez and Gabriel Zucman have put forward several proposals for directly taxing wealth, including a relatively modest 3 percent tax on fortunes over $1 billion, which would merely slow the rate of their growth, and a more aggressive 10 percent tax, which would gradually shrink them.
The politics of this kind of tax, though, are difficult: Even if a direct wealth tax managed to pass, there would almost certainly be a constitutional challenge.
Less constitutionally fraught is a proposal from Senator Ron Wyden, Democrat of Oregon, to tax unrealized gains, which account for a majority of billionaires’ wealth. Wyden’s proposal would tax these unrealized gains every year, and at the same rate as income, for Americans who report income above $1 million or assets above $10 million for three years in a row.
The logistics of this, too, would be tricky, as Robert Pozen, a senior lecturer at the M.I.T. Sloan School of Management, has written for MarketWatch. Would it cause big yearly sell-offs, for example, or lead to tax schemes by which the rich offset their income with unrealized losses?
Zucman and Saez recently proposed a potential, if temporary, way around this pitfall: a one-time income tax on the totality of every billionaire’s unrealized gains, which they say would raise approximately $1 trillion.
Fix the estate tax: President Joe Biden has proposed a tax plan that would close the step-up in basis loophole that allows for the seamless intergenerational transfer of wealth. Doing so could raise $113 billion over a decade, according to an analysis from the Wharton School at the University of Pennsylvania.
Raise corporate and capital gains taxes: Biden’s plan would raise the corporate tax rate, from 21 percent to 28 percent, and crack down on companies that avoid this tax by shifting profits abroad. The Times editorial board wrote in favor of this idea in April, though some progressive economists say it doesn’t go far enough.
Biden’s plan would also tax capital gains at the same rate as income. This would effectively close what DealBook calls “one of the most egregious and persistent loopholes” in the tax code, which allows investment managers to pay less in taxes by treating their pay as capital gains rather than income.
Make income tax records public: In the 1860s and 1920s, income tax data was made publicly available, just as local governments now disclose property tax records. “It’s time for another revival,” Appelbaum wrote in 2019.
The bottom line
As my colleague David Leonhardt writes, the current tax system does not derive from a law of nature. “While some tax avoidance is inevitable,” he says, “the federal government has largely succeeded in raising taxes when it has tried.”
Do you have a point of view we missed? Email us at firstname.lastname@example.org. Please note your name, age and location in your response, which may be included in the next newsletter.
“A shocking exposé of superrich people’s tax bills should prompt a big rethink” [The Washington Post]
“How to tax the rich, explained” [Vox]
“Tax the Rich? Here’s How to Do It (Sensibly)” [The New York Times]
“Taxing Unrealized Capital Gains Is a Nutty Idea” [National Review]
“Is there anything wrong with ProPublica’s story about the taxes of the rich?” [Poynter]
Source: Read Full Article