Is the system rigged for the richest 1%? This new report shows just how bad it's gotten.
The rich have always lived by a different set of rules as the rest of us, but what are they up to these days? They have more motive and more resources to avoid paying taxes than anyone, and they're getting better at it. Is it possible that people like Warren Buffett, Michael Bloomberg, and Jeff Bezos are paying less income taxes than a typical middle-class American?
You bet! The not-for-profit news organization Pro Publica has started a fascinating series about the richest 1% and how they successfully avoid paying taxes. As a CPA who prepares taxes for mostly small businesses and a wide range of individuals, I've always suspected that they have rigged the system in their favor, but it's never been laid out as plainly as in this report. Accountants in the top echelon work hard to set up financial plans that cover multiple countries, generations, and tax entities, all with the goal of shielding their clients from the burdens of paying their fair share of tax.
Using anonymous whistle-blowers and sources, Pro Publica puts together a wealth of information on how they do it and it is both maddening and impressive. I almost wish this report had never seen the light of day because now more people will use these strategies, because they work. Using perfectly legal tactics, these wealthy billionaires end up paying effective income tax rates of less than 1% in some cases! They accomplish this with a fiendishly simple two-pronged strategy not available to the average person- make their income untaxable, and maximize deductions to offset what is taxable.
The vast majority of income for these people is investment income, and that can be shielded overseas or left to grow untaxed as capital gains. Rather than pay taxable dividends, many of them plow money into stock buybacks and new investments that grow their massive portfolios. According to the report, billionaires avoid having to sell investments and generate income by instead borrowing against it and deducting the interest. By the time they die, huge amounts of their wealth have never been taxed, and then the estate tax strategies kick in to protect the money for the next generations.
Salaries, which are taxed at the highest rates, are shunned according to this study. I always try to praise my tax clients when their salaries go up, (as do their taxes) because I see this as progress. At the top, salaries are irrelevant. Investment income is taxed at up to half the rate as earned income, which is upside down in my opinion.
The wealthiest 1% maximize deductions by claiming losses on paper, buying things, contributing to wasteful charitable foundations, and borrowing money. People are only taxed on their net income, so many tricks can be found that wipe out the taxable income that's unavoidable. Itemized deductions, that used to help a wide swath of taxpayers, are now only used by the rich.
The report covers a wide variety of perfectly legal tax avoidance strategies, some of which were new to me. It did not, however, cover the illegal ones, which are even more destructive. The lack of oversight by the IRS means that most wealthy people are on the honor system in reporting their income, because audits are rare and often toothless. Putting people who value money above all else on the honor system is about as bad as putting a room full of second graders in charge of a cookie jar.
The entire system of taxation only works if people think that it's fair and legitimate, and that consensus gets weaker every year. Over $400 Billion in taxes are lost to tax cheats every year according to the IRS, and the common perception that the rich get richer by gaming the system erodes everything. Without an agreed upon system of funding common goals and projects, our country breaks down into chaos and nothing gets done.
There are now billions of dollars worth of lawyers, lobbyists, financial planners and accountants all trying to game the system (legally) for every last penny, and all I can think is what a waste. For Montgomery Burns to get his third yacht and twelfth mansion, we give up on taking care of our veterans and schools? We give up on infrastructure because with private jets there's no need for roads? Why not ask all these brilliant, high-payed professionals to solve something that actually matters- like improving cybersecurity, inventing carbon capture, or preventing the next pandemic? There are real problems that are being ignored because of this worship of accumulated wealth at any cost.
Thornton Wilder said that "Money is like manure; it's not worth a thing unless it's spread around encouraging young things to grow." Our young things, aka generation Z, are struggling to pay off their student loans and find decent jobs while Jeff Bezos is headed to outer space. What's wrong with this picture?