How The Rich Avoid Paying Taxes
It is a nice object lesson in how a couple of obscure changes in the tax law can save a few people a lot of money. The IRS has reported that the number of those earning $200,000 or more who paid no taxes rose sharply in 2005. More than 7,300 of these worthies avoided U.S. income tax entirely, two-and-a-half times the year before. About 85,000 paid worldwide taxes of less than 10% of their income.
The study, by the IRS’ Brian Balkovic, cites two big reasons for this plunge in tax liability. One was a 2004 law that let individuals use foreign tax credits to reduce their Alternative Minimum Tax. The other, passed in response to Hurricane Katrina, opened a temporary window for people to make big cash charitable contributions without facing the normal limits on how much they can deduct. The 2005 tax return data are the most recent available.
The impact of just these two changes was stunning. Balcovic reports that in 2004, 412 of 3 million high-income taxpayers reported about $16 million in foreign tax credits. In 2005, more than 3000 wealthy filers took nearly $450 million in these credits. The increase in reported charitable contributions was also dramatic.
Of course, these were not the only reasons the wealthy were able to cut their tax liability to zero or near-zero. They also relied on such golden oldies as tax-exempt bond interest, large casualty losses, and deductions for investment interest.
To be fair, the study also shows many high-income folks paid hefty taxes. While 2.4 percent of the $200,000-plus crowd paid little or nothing, one-third paid effective rates of 20 percent to 25 percent and nearly one-quarter paid 25 percent or more.
Of course, it is worth remembering that a $200,000 earner in 2005 was very different than one 30 years ago. In 1977, only 53,000 taxpayers reported adjusted gross income of $200,000 or more. In 2005, that rose to more than 3.5 million. To put it another way, you might say that $200,000 of 30 years ago is the new $700,000. But even if you adjust for inflation and look at it in 1976 dollars, the pattern is the same, Many of these folks are hardly super-rich, but they have accountants and can figure out how to take advantage of a loophole-ridden tax code.
Thanks to Pete Davis over at the blog Capital Gains and Gamesfor pointing out the study.
Income tax needs to be repealed, replaced with consumption tax. That way, all participants in economy contribute, expanding the tax base to include tourists, black marketeers, and illegal aliens.
Of course you ignore the option of ending taxation on income under $100,000 per year for families and taxing the remainder with a simplified income tax – thus satisfying both progressivity and allowing low income individuals to escape taxation.
By the way, black marketeers would still evade taxes. Most drug dealers and prostitutes would evade charging the consumption taxes they would otherwise pay if their activities were legal – so the whole argument is a canard.
I don’t think its a canard. The only advantage a drug dealer or prostitute would have is they would be taxed at the SAME rate as any other wage earner – the moment they buy a product from a store. The only thing they aren’t doing is collecting tax on illegal drugs. Prostitutes are selling services so its not even clear what the product is there, just labor, just like all the wage earners. The idea is to collect revenue at the supermarkets and brick and mortar retailers, which is infinitely preferable to tracking 100 million tax payers.
Corporations with plenty of capital stock don't really need to attract any, so given the double taxation of dividends and the opportunity to provide above the tax line lifestyles for their fair haired boys, the motivation is to plump up the expense side of the ledger, thus reducing corporate income to as close to zero as feasible without hurting the share price. When Joe carpenter travels or eats out, his expenses come out of after income tax savings, not a pre-income tax expense account. If the tax system were consumption instead of income oriented this gaping hole between tax treatment of executive and labor lifestyle would be eliminated.
Income taxes inhibit capital planning, i.e. they inherently presume that there will always be income in the next year, completely shunting the possibility of spending less in one tax period in preparation for (possible) hard times to come. Income tax takes the money in advance, thereby reducing (or eliminating) the capital cushion for the working classes. When hard times hit, labor classes must borrow. Income taxes thereby foster indebtedness.
Demanding the cash in advance of the individual's voluntary conversion of capital (brass in pocket) into goods and services (spending), is the moral equivalent of being held up at gunpoint – it’s anything but voluntary.
Despite widespread preference for consumption instead of income tax, we still have government redefining what you can deduct every year. Loopholes and market distorting tax credits subvert natural economic forces – evidence our insane stimulation of the corn ethanol market. Corn ethanol has a net negative energy output, from seed to gas tank, it has diverted agricultural resources from feed stock and other agricultural products, increasing the cost of food prices worldwide. Score another point for government stimulated economic insanity.
Income tax is not fair to all, it's riddled with loopholes, that the wealthy leverage through skilled technicians (lawyers and accountants), while working class people miss the coupons in the loopholes because they can't afford to hire outside expertise. Income tax is thereby the principal mechanism for expanding the gap between capital and labor classes.
Politicians look like they’re wringing their hands over what to do about the expanding wealth gap, when there are examples like Anguilla's pure consumption tax policy – in an economy where the job market is dominated by relatively low paying hospitality jobs (hotel, restaurant) they've made huge improvements in citizens' average wealth over the last three decades. That increased wealth provides robustness (like automotive shock absorbers), when the economy hits a pothole, savings smooth out the ride. Without grassroots capital stocks, those bumps hit much harder.
Here in the 'free' U.S., government condemns earned income, while granting year after year preferential treatment to passive earnings (rents, royalties, capital gains, etc.). Could there possibly be a more efficient mechanism for inhibiting the conversion of income into savings and thereby the transition from working class to financial security?
The U.S. has neither embraced capitalism nor socialism – instead, it has institutionalized class warfare and enlisted the IRS as its fingermen. Wake up and smell the cherry blossoms.
Well the tax system doesn't is not equitable for everybody and as far as I am concerned I have already coped with that. We could use some more equity though. Federal Income Tax Forms are made for everybody.
Why not abandon income tax and associated loopholes altogether. If replaced by consumption taxes, business expenses will become taxable, rather than being written off as pre-tax expenses. Consider a flat consumption tax on new goods and services. Low income taxpayers can escape most tax if they are willing to buy used goods. A consumption tax has a broader effective taxable population, so it should have a lower rate than the average effective income tax. People drawing their income from gray and black market activities (cash businesses, prostitutes, bookies, drug dealers, and illegal aliens) will no longer be subsidized by the middle class. Even tourists will contribute. I hope to put together a team interested in building a long term agent-based simulation of such a consumption tax policy. Getting grant money will be easier with the right people. If interested, please let us know at:
Thanks, Mike
You might also note that the interest rate differential means that some bond owners receive net tax subsidies while others end up worse off. If the rate differential is 30 percent, for example, a bond owner in the 35 percent tax bracket saves 5 percent, while a bond owner in the 25 percent bracket effectively pay an extra 5 percent. The obvious question is why people in lower tax brackets ever buy those bonds.
Of course, with a tax-exempt bond you are paying an implicit tax equal to the difference between the tax-exempt bond rate and the rate on an equivalent taxable bond. The difference varies but is often around 25-30 percent.