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.

17 comments

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I noticed nary a mention of tax cuts as a way to increase revenue, only alternatives to the millionaire tax. That surely reveals the author’s fundamental approach to revenue capture.

Posted by wildbiker | Report as abusive

I say…throw the existing tax code out.
Apply a flat tax, accross the board.
Fix the percentage
You make more, you pay more.
You make less, you pay less.
Can you be more fair than that???

Why should 43% of Americans pay nothing in taxes as they currently do? If every American reaps the benefits of this great society, why should not everyone pay for it as well.

It’s only fair!!!

Posted by Marky | Report as abusive

@marky:

the difficulty with a flat rate tax is that it becomes regressive. The effective burden for the poor is greater than that on the rich.

Consider a flat 30% rate:

$30000 to someone who makes $100,000 a year is bearable

$3000 to someone who makes $10,000 a year is devastating

This dilemma is part of why I believe virtually all tax should be scrapped (I’m with you there), including different tax treatment for different legal business structures. A dollar should be taxed at a single, flat rate when it passes between the consumer and a business (effectively a limited form of sales or excise tax). No tax on transfers from business to business, nor from consumer to consumer, and never as a tax on dividends or capital gains.

Posted by hariolor | Report as abusive

Need some new ideas? Try http://www.fairtax.org for a comprehensive idea on how to address the issue. Honestly ask yourself, is there a difference between “representation without taxation” as noted by Marky or “taxation without representation” as addressed by our founding fathers? I don’t have all of the answers, but the current administration is certainly not asking enough questions before they invoke life-changing policies.

Posted by Dale | Report as abusive

Marky: Because the fix percentage, whatever it is, will have a greater impact on the life of the person making 30k/year than on the one making 3mill/year.

Posted by Ale | Report as abusive

This issue of taxes will always seem unfair to someone at the top or bottom. It is only tolerable to most when they are doing well. Regardless, we want to keep as much of what we earn as possible. That would be possible if we were in the dark ages. Imagine today if every different mile of freeway had multiple owners who built it to their own standards and had different charges for use of their section. So we agree to share the cost to build a highway that in turn we be shared by all. Once we do Plight of the Commons steps in. Do we tax the trucks more because they wear it more? Do we tax parents with 16 year olds more because their teenagers are more prone to accidents? Do we tax fuel – and if we do and are close to a state border where the taxes are less will our own gasoline stations go into decline as people cross the border to buy fuel. There are no definitve answers because it is like a balloon that pops out whereever we squeeze it. My own belief is that if the wealthiest keep taking until everyone around them feels like a kicked dog, there will eventually be a revolution that rightfully cuts off their heads.

Posted by fanfare100 | Report as abusive

The underlying problem is that taxes based on income is the dumbest idea since the square wheel. Taxes based on what we call “taxable income” is acting even more “stupidly”.

First, “taxable income” does NOT equal increases in wealth nor actually how much money one makes in a year. And the difference is far more pronounced as you go up the wealth scale. We all talk about “tax the rich” as though it is the same. At lower incomes, workers have few or no ways to manage the difference … comes right out of paychecks from the first $1 and that’s that. The “already rich” have many ways to make their taxable income smaller than their actual income.

Second, why would we tax income (production) instead of consumption? Isn’t that backwards? We WANT people to create wealth by applying themselves at all levels. At the same time, we want to consume less, reduce dependence on foreign oil and save the earth.

Third, why is this can’t-touch-that dogma? When we say “tax the rich” don’t we mean “tax the rich lifestyles”? What is spent by the already-rich is far more than what ends up as “taxable income” … wouldn’t that yield more revenue – from the “rich”? Why is the system protecting the Kerrys, Bushes and Rockefellers this way?

Consider the subprime mortgage crises … billions of dollars drawn out of cash-out refinancings and spent … and NONE of that taxed. ALL of it would have been taxed, and may have provided disincentive to do so had we been taxing the right thing.

Every man and woman should be able to retain the fruits of their labor; and choose how to live from that. And pay their taxes when they (voluntarily) spend. Exemptions from consumption taxes for food and necessities is easy, we know how do to that in many states.

WAKE UP .

Posted by Richard | Report as abusive

Chis, I just love it when people who do not make or have very much money talk about the “free ride’ the “rich” get all the time. I am not a member of the ultra-rich club but I do pay more the 50% of what I make in taxes; federal and state income tax, property tax and sales tax on big ticket items. That does not even take into account the alternative minumum tax which has not been ajusted, I think, since its creation. When are the great unwashed going to happy, when I contribute 60, 70, 80% of the money I work 60 hours a week to make? There is point when working less may net me more, then alot of those like me will shink our earning and who will be left to pay holding, the pay the tax, bag? Chris, pay taxes for a couple of decades and then tell me how the world works.

Posted by Bob | Report as abusive

If we all had to pay consumption tax, including on all food, then we would all be paying a truly fair tax. We would also have a much more stable tax base, as no one lives without consuming. The Fair Tax is one incarnation of this idea, but the greater concept of a consumption tax is what should be noted. You can’t avoid or hide your true consumption if there is a consumption tax. If you have a problem paying tax for what you consume than you are partaking in the decimation of America.

Posted by Daley | Report as abusive

OK guys:
I was the first in my family to go to college

There was zero family money

I have worked hard my whole life

I have paid my taxes on time on properly

I started a business and took ALL the risks and have worked my tail off

According to the Democratic politicians, “I am rich”

According to Mr Biden and the others, the rich “have had it to good for too long” and I need to pay more taxes

Now-you tell me what is fair!

Posted by Ed | Report as abusive

Sparky, a flat tax is not fair. It only passes the burden to the lower incomes. You are giving the rich a lower rate and the rest of the country a higher rate. is that fair when most of what we make is used to just survive?

Posted by Eric | Report as abusive

The problem with income tax is how to define taxable income. Like the article says, the rich have ways to hide income from tax. This is why some are talking about a national sales tax. that evens things out a bit. the more expensive items have more tax on them, assuming it is a percentage of the price.
Those that work hard, should get some rewards. I think most people would agree with that. All in all, I think the feds need to cut spending on the military as well as other programs, cut the deficit, and reduce taxes (dollars).
Ultimately though, we are now competing with the rest of the world and generally, our standard of living is going to decrease…either now or later.

Posted by Eric | Report as abusive

Truly,
I don’t care what income bracket you fall into. All should pay something to live here. Making below $16-18K may be impoverished, but if you call the police, do they come? Yes. You call the Fire dept, do they come? Yes. You apply for welfare, do you get it? Most do.
Do others in third world nations get benefits like this? NO, not in many cases. America affords some level of benefit to all who live here.

There should be no allowance for a proportionate tax scale. Its America, you work hard, you make more. You work less, you make less.

Pres Obama is telling minorities, don’t look for hand outs. Educate yourself and invest in your self with education. Get a good job..and maybe you can become a president some day. No more entitlements. Hard Work and pay your fair share of taxes is what he espouses.

I say apply a Flat Tax percentage to all, everyone pays – no exceptions, even illegal migrants. And all who work hard or work little yields some benefits and there should be no proportionate tax, which is a penalty, exacted against those who work harder and apply themselves more. They paid a price to get their just like ED and President Obama.

America can not sustain a business model where all do not contribute to offset the cost – rich and poor alike.

And that..is fair in my opinion

Posted by Marky | Report as abusive

Just because there are easier targets for the taxman to chase it does not mean that they should not require the rich to pay their fair share of taxes. JFK famously said, “We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard,…..”
Shouldn’t our government lead by example here and take the right course of action even though it is the harder route?

Posted by Rick Shaw | Report as abusive

Perpetual taxation is forbidden by the constitution.
Income tax was set up by President Lincoln for the sole purpose of covering costs created by the Civil War.
Need I say more??

Posted by FV | Report as abusive

The solution is to increase random audits on the most wealthy, a practice that was abandoned under George W. Bush’s IRS and resulted in the missing of an extraordinary number of illegal tax avoidance schemes.

Posted by Mark Lainer | Report as abusive

Oh, and we have also seen a massive transference of wealth from the middle class to the ultra rich. They system is gamed and the field needs to be evened.

Posted by Mark Lainer | Report as abusive