Taxes are Good: Why the ProPublica Report Matters

ProPublica recently released their first in a promised series of articles based on private tax data of some of the United States’ richest citizens. The report has generated a lot of buzz, with a mixture of individuals admonishing the ultra-wealthy for paying so low of taxes, those defending the low tax rate for the wealthy due to its cause of unrealized gains, and those upset with ProPublica for obtaining and releasing the findings of their investigations of the confidential tax records of private US citizens. Senate Minority Leader, Mitch McConnell, and Attorney General, Merrick Garland, recently vowed support for investigating and potentially holding the tax leakers criminally liable for exposing private information.

The report is a bombshell in terms of absolute numbers unknown to the American public, but the gist is probably known by everyone already – the rich do not pay anywhere close to the marginal top income tax rate, often through schemes to avoid drawing an income, yet still enjoy massive lifestyles. For instance, from 2014-2018 Warren Buffet reported a total income of $125 million against a total tax liability of $23.7 million for a tax rate of 18.9%. Leaving aside ProPublica’s “true tax rate” calculation, which incorporates unrealized capital gains of held stock options, this is still far below the highest income tax rate of 37%.

The report highlights a key example of the means the wealthy have to exploit the tax code. Primarily, these founders are not realizing their stock gains. Warren Buffet’s income from 2014-2018 of $125 million is extraordinary, but at least 14,000 individuals reported higher income than the world’s sixth-richest person during this period. Furthermore, companies like Amazon, Facebook, Google, and Berkshire Hathaway do not pay a dividend to shareholders that would trigger a capital gain. By focusing on reinvestment instead of issuing a dividend, these corporations can kick the capital gains tax bill further down the road.

Don’t be fooled by the constant concocted caricature of the thrifty CEO taking on a $1 salary. Or even the—gasp! -- $81,840 salary that Jeff Bezos has been taking home in recent years. Tech founders like Elon Musk, Jack Dorsey, Larry Page, Sergey Brin all benefit tremendously by declaring a low-income salary from their companies. There is a key method the wealthy have to afford an extravagant lifestyle without a large salary and they won’t even have to sell their precious stock. In fact, by accepting a low salary they often can get additional tax incentives. How do the billionaires manage this tightrope?

Debt. And lots of it.

If you are an ordinary American, you probably have used debt in the past to finance either a car, an education, or a house. The sort of debt that might be needed to afford a steep cost and spread payments out over a distant time frame. If you are a billionaire, you probably use debt to avoid taking on salary and thus having your salary taxed as income.

The tax code incentivizes this sort of behavior. You could take a million-dollar salary but at a 37% top income tax rate. You could sell some shares of your company, but at a 20% capital gains rate and lose some power within your company. Or, you could take out a loan that confers no taxable status. With interest rates as low as they are, and with as much collateral as these CEOs have to put up for stake, the rich can take out billion-dollar loans with 1-2% interest rates.

Most CEOs should expect their company to eclipse a 1-2% return on investment and thus have an incentive to take on debt. In some cases, this debt then allows the affluent CEO to deduct the interest of the loan from their income tax bill. So, even the income the shareholders do collect is taxed at a lower rate than the general public.

Or, maybe you prefer the Michael Bloomberg method. Bloomberg in 2018 reported an income of $1.9 billion but only paid taxes of $70.7 million – a tax rate of 3.7%. This was largely achieved by using charitable deductions and tax credits for foreign taxes. There exist many ways for the wealthy to enjoy their riches without paying their share of taxes. The key finding here is that if you can avoid taking income, you can avoid taxes, but even avoiding income isn’t entirely necessary.

The CEOs and tech founders, and generally those who derive most of their income from shareholding, appear to not be paying taxes proportional to the income they live on. At the very least we probably should expect CEOs or founders to have to sell shares of their company to live a wealthy life and being subjected to a capital gains tax rate of 20%, instead of taking out personal loans and avoiding their entire liability. There is little value from having founders avoid the obligation of selling shares of their company, they contributed to building their billion-dollar behemoths and must shave off their stake to afford the lifestyle they would like to enjoy.

But, even then, let's dare to dream just a little bigger. Even 20% capital gains tax is pretty damn unfair to the income tax of people that work for their living and derive income. Doctors, lawyers, and other high earners may be subject to the highest income rate of 37%, and the shareholding class is not more worthy of retaining a larger share of their profits before the tax bill. President Biden has made a considerable goal of a 39.6% capital gains tax rate, signifying a change from the notion of the past that capital should be taxed lower than labor.

ProPublica runs with the notion that the wealthy should be paying higher taxes with the inclusion of their "true tax rate". Their true tax rate is total taxes paid divided by wealth grown, as seen in figure 1. This results in Buffet, Bezos, Bloomberg, and Musk paying a tax rate under 5%. Including wealth-grown or unrealized capital gains is in some ways unfair, as the rich would never pay more than the government will make them.

Unrealized gains are not taxed at all in the United States. Billionaires in the United States now own $4.25 Trillion, out of which $2.7 Trillion are unrealized gains that they haven’t paid any taxes on yet. These same billionaire's untaxed gains increased an additional $1.25 trillion during COVID alone. The government should absolutely consider taxing unrealized gains, and there are significant proposals from scholars already.

Some say an unrealized capital gains tax would be impossible to incorporate into the tax code as stock prices can change rapidly, but current proposals avoid implementation issues by advancing a one-time forced realization of taxes on a certain date. For instance, Saez and Zucman recommend realizing all gains effective on April 1st, 2021, and allowing individuals to pay the resulting tax bill over ten years. The ten-year repayment period would allow founders the time to sell their shares to pay their liabilities. Their proposal only impacts billionaires and is estimated to bring in an additional $1 trillion in revenue to the United States federal government.

$1 trillion spread over 10 years could be a huge boon for the United States. It could be the pillar of revenue to pay for the Biden infrastructure package, used in negotiations to pay for child benefits, or used to build public housing for all in major cities across the country. The importance of taxation may not be that we "need" this trillion to pay for public utility, but it is still important for the tax code to uphold a modicum of fairness.

Taxes are good. They can go to great things and every single friend and family member you have has been impacted by public goods in some form. Tax fairness is important for all classes to feel a collective appreciation for a shared vision of a better world for our children. Increased social security, universal healthcare, universal basic income, free post-secondary education, and free childcare all are possible, with or without taxes, but the political realm today requires "pay fors" or establishing the means to pay the cost of a new program.

Taxing the rich can get us a healthy stretch of the way there.