Taxes were already set to be a key area of political contention this year, amid President Joe Biden’s proposal to increase taxes on businesses and high-income Americans. But now that the leaked personal tax records seem to show billionaires pay little or nothing in income taxes, the debate could take center stage.
ProPublica released details of the personal income tax returns of 25 of the richest Americans, documents the news agency said it received from sources within the Internal Revenue Service. The non-profit outlet did not say who provided the documents. Merrick Garland, the United States Attorney General, has promised to investigate the case as a matter of priority.
The revelation of truly miniscule tax rates among the richest Americans comes amid a yawning wealth gap and heightened discussion about what to do about it. Even before COVID-19 arrived, more of the country’s wealth was in fewer hands. The pandemic has widened this gap. Low-income Americans fell behind with job losses and other disruptions, but the rich thrived as real estate, business interests and the stock market soared.
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The timing of the leak does not seem to be a coincidence. ProPublica argues that “the public interest in knowing this information at this critical time” outweighs legitimate concerns about a breach of privacy. The organization, a nonprofit newsroom that investigates abuse of power, has promised further updates on the tax practices of billionaires, including their use of loopholes and audit avoidance tactics.
What the report revealed
In some ways, the ProPublica report was not that shocking.
It is widely suspected that many of the wealthiest Americans pay relatively little in taxes, sometimes even below what middle-class households pay. Much of this is because the rich get most of their wealth from investments rather than wages, salaries, or other income taxed each year. Tax rates on capital gains are lower than those on ordinary income, and there is more flexibility to delay taxes on gains.
What was telling, however, were the details of the actual tax returns. Many of the wealthiest people have paid no income tax for one or more years in the past fifteen years. According to the report, this list includes Jeff Bezos, Elon Musk, Michael Bloomberg, Carl Icahn and George Soros. Others, like Warren Buffett, paid far less than 1% in taxes, as a percentage of their increased wealth.
The 25 wealthy Americans whose leaked returns paid a total of $ 13.6 billion in income taxes over the five years from 2014 to 2018, ProPublica said. Yet their collective wealth surged by $ 401 billion during this period, meaning they paid the equivalent of 3.4% in taxes, based on the increase in wealth, over the course of of the period.
You may have noticed that ProPublica mixed apples and oranges in their comparison. The news agency calculated what it believed to be the tax bill if changes in billionaires’ net worth were taxed on an ongoing basis, like income. Under current law, increases in wealth are not taxable. Gains are also not taxable if the underlying assets are not sold.
How is it possible?
ProPublica’s analysis looked at several tax avoidance strategies – all legal – that the wealthy rely on more than most Americans.
Some billionaires pay little or no income taxes just because they don’t earn a lot of income. This is because they don’t get much in the way of wages or salaries, instead preferring to drive their substantial portfolios higher.
But they still need living expenses, and for that, many of the wealthy have borrowed against their growing assets, ProPublica said. The loan proceeds are not taxable and certain debt-related expenses are deductible. Some wealthy people also live off dividends and are generally taxed at the lower rates applicable to capital gains.
Another practice was for billionaires to make large donations to charities or other philanthropic causes, allowing them to reduce their taxable income.
But the main strategy used by the rich, as ProPublica points out, centers on capital gains. Since profits or long-term investment gains are taxed at lower rates than ordinary income, the rich can reduce their obligations. This allows them to pay an effective overall tax rate that may be lower than that of middle-class Americans.
Why are earnings so crucial?
All Americans have access to low rates of capital gains, but not everyone has stocks, real estate, or other assets on which to generate such gains. Millions of Americans do not own such assets, which also helps explain the widening wealth gap.
Not only are tax rates lower on long-term earnings – the top rate of 20% versus 37% for regular income – but owners of stocks and other investments have more control over the income. when they have to pay those taxes. Salaries are taxed in the year of receipt, collected through payroll deductions or estimated payments, but capital gains taxes are not triggered until an investment is sold. It could be years or even decades later.
In fact, taxes on certain earnings may never be collected due to various estate planning rules. One is the automatic exemption of almost $ 11.7 million in tax assets per person on death (or $ 23.4 million for a married couple).
Another relates to the ability to eliminate much or most of a taxable gain accrued on the death of the owner through what is known as the “base” markup. The base is the amount of an asset not subject to tax. Raising or increasing this to the value of the asset at the time of death, as allowed by the tax code, can clear the tax slate for heirs.
“The result is that great fortunes can be passed largely intact from one generation to the next,” ProPublica said.
Where does the debate go from here?
The reforms proposed by Biden would change the country’s policies in several ways, which could generate more tax revenue for the richest (or at least the richest) Americans. These include raising the maximum income rate for individuals from 37% to 39.6% (on annual income over $ 400,000) and ending the lower rates on capital gains for these individuals, which means that earnings would be taxed in the same way as income.
Then there is a proposed millionaire surcharge of 10 percentage points that would apply to income as well as capital gains / dividends. The Democrat-backed measure would affect 0.2% of taxpayers – those with incomes over $ 1 million (or $ 2 million for couples).
As a more fundamental change, the government could tax unrealized capital gains.
According to a proposal from Sen. Ron Wyden, D-Oregon, accrued earnings would be taxed annually, treating those assets as if they had been sold. This provision would apply to no more than 99% of taxpayers, and it would exempt retirement accounts, family homes and farms. It would also not apply when assets lose value. The tax revenues collected, according to Wyden’s proposal, would strengthen social security.
Taxing unsold property would be easy enough on assets such as stocks, mutual funds and the like whose prices are updated regularly. It would be trickier for assets that are more difficult to value, such as works of art or shares of private companies. Wyden suggested a “look back” rule that would impose the tax when the asset is ultimately sold for those assets.
The complexity of taxing unrealized gains poses obstacles. But if the wealth gap continues to widen, these and other proposals may be given a fresh look.
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