The rich are not easy quarry

August 5, 2009

Cash-strapped politicians are more willing to play Robin Hood than at any time in a generation. Tax rates on the rich may soon hit levels not seen since the 1980s.

The wealthy, alas, are not easy prey. Backed by highly paid lawyers and accountants, no other group is better able to run circles around the taxman. As a result, America’s politicians may get less cash than they bargained for and more economic distortions.

There are many easier and less disruptive ways to get the cash.

Of course, the temptation to launch a direct strike on the rich is understandable. The past three decades have been very good to the affluent. The top 1 percent of earners now account for 19 percent of America’s income, up from 9 percent in 1980. This elite group has also been quiescent, dutifully paying 40 percent of all income tax, according to the non-partisan Congressional Budget Office.

It has been many years since the rich had a powerful incentive to test the limits of the tax code. The top rate of income tax has fallen with only minor interruptions since its vertiginous peak of 92 percent in 1953. But a foretaste of what might be expected was offered by Maryland’s ill-fated creation of a millionaires-tax bracket in 2008.

A year later 1,000 millionaires had disappeared — a third of the total — and revenues from this group had fallen by $100 million. Some may have left the state while others may have found ingenious ways to reduce their reported income.

The U.S. tax code is replete with legal dodges for the wealthy, whether you are a top executive, independent business owner or the lucky recipient of inherited wealth.

Well-paid salaried employees often have considerable leverage over how they are paid. For this group, tax-efficient fringe benefits — including lavish health plans, and use of the corporate jets and other perks — may increase. Stock options may become more popular still, enabling employees to defer tax until they retire and have lower incomes.

Business owners have even more flexibility and can deliberately muddle personal and business consumption. And as income tax surges above corporation tax, business owners may choose to pay themselves risible salaries, locking up their wealth in their companies.

The wealthy may also choose investment strategies that avoid income and maximize capital gains, further reducing potential tax revenues. The capital gains tax is preferable because there is flexibility in when gains can be taken. Tax-exempt municipal bonds could also become more popular.

Significantly higher taxes on the wealthy, then, could reduce tax reduces while encouraging businesses to waste more money on executive perks. Such unintended consequences could undermine efforts to stabilize the financial system. Politicians should avoid this lazy and wasteful solution.

Tidying up the fabulously complex tax system and closing loopholes could raise just as much money and be easier to market politically. Many of these measures have the advantage of extracting cash from the rich in ways they will find harder to avoid.

Scrapping the tax exemption of municipal bonds would eliminate a favorite haven for the wealthy.

Reducing or eliminating the gulf between income and capital gains — as Ronald Reagan’s 1986 tax reform did — reduces sharply the opportunity for hiding money.

A number of other quirks in the code also primarily benefit upper-income groups — including breaks on employer-provided healthcare, mortgage interest and state and local tax.

For the less progressively minded, the gradual imposition of value-added tax, as proposed by Bill Gale at Brookings, could raise a great deal of cash in the future while actually encouraging people to spend now.

A clumsy increase in top rate taxes, by contrast, will mainly be a bonanza for tax accountants and lawyers.


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