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Tax Loopholes for the Rich

November 2008

Whether we call them loopholes or just tax policy, there are many specific ways for the wealthy to avoid paying taxes. Many of these special laws cannot be used by the poor and middle class. Is that fair? To answer that, let's start with an overview of the income tax.

According to Wikipedia, the federal budget for 2009 totals $3.1 trillion. This probably doesn't include the more than a trillion in various bailouts, so lets round it off at 4 trillion dollars. Now, what if each of the 138 million taxpayers in the country (there are children and those who have no income who don't pay) paid an equal share? That would be almost $29,000 each.

Obviously, this would be impossible for most of the taxpayers out there. Many tens of millions don't make enough to pay that even if they were taxed at 100%, and I'm pretty sure they would not show up for work if tax rates came anywhere near there. So the "everyone pay the same amount" idea of taxation is not practical. Nobody has advocated this anyhow.

What is a practical and fair way to share the cost of government then? Most people would prefer a system in which you pay more as you make more money. This seems fair. Those who make more have more that is protected by the army, the police and the courts, so why shouldn't they pay more?

Of course, the wealthy do pay more under the system we have. But some may not like the fact that "A heavy progressive or graduated income tax," is tenet number two of Marx's Communist Manifesto. A "flat tax," on the other hand, which applies the same rate to all income, would still mean that Warren Buffet would pay a lot more on his millions than you and I pay on our tens of thousands. I think that many, if not most, people could accept this asa somewhat fair tax system.

However, the reality is that even with the current supposedly graduated tax system many of the wealthiest Americans pay a lower effective tax rate than the poor and middle class. This is due to the many tax laws and tax loopholes available to help them. These don't allow the rich to take from the poor directly, but doesn't paying less mean someone will have to pay more? We'll return to that in a moment.

In 2007, at a $4,600-per-seat fund raiser in New York for Senator Hillary Clinton, Warren Buffet stood up and told the crowd, "The 400 of us [here] pay a lower part of our income in taxes than our receptionists do, or our cleaning ladies, for that matter. If you're in the luckiest 1 per cent of humanity, you owe it to the rest of humanity to think about the other 99 per cent."

As an example, he noted that he was taxed at 17.7 per cent on the $46 million he made in 2006, while his secretary, who made $60,000, was taxed at 30 per cent. Apart from the seeming unfairness of this, he suggested that this tax policy had accentuated a disparity of wealth that hurt the economy by stifling opportunity and motivation.

Buffet also noted that a Republican proposal to eliminate elements of inheritance tax would widen the gap between rich and poor. The inheritance tax raises about $30 billion a year from about 12,000 wealthy families. Buffet believes (reasonably, I think) that taxes would have to be raised on those who are less prosperous in order to replace the lost revenue.

An inheritance is income, and the fact that it's treated differently than other income is based less on a principled argument and more on tradition and feelings that giving money to family members is different somehow. In a country that prides itself on self reliance and "self made" men and women, we could probably honor our country's founders' wish to keep stagnant wealth from accumulating in family dynasties. In any case, property rights are philosophically derived from the right to life, and the wealthy are free to do as they wish with the money while alive.

Now, you may wonder how the wealthy get to pay a lower rate than the rest of us. They get it by using their wealth to lobby for laws that change the rules to favor them. These tax loopholes for the rich are usually justified as being for some good purpose (and they often do serve some good purposes despite their unfairness). Of course, given that many in congress are in the ranks of the rich, their is an element of self interest at play in the law making too.

For example, capital gains rates are lowered to "encourage investment," and they probably do that. But should a government be trying to influence how money is used by citizens? In any case, this is the primary reason Warren Buffet pays a lower total tax rate than his secretary. He gets much of his income in the form of capital gains.

Then there are the myriad of laws that try to alter behavior in other "good" ways. Deductions for charitable contributions, for example, allow a wealthy family to deduct from income the value of a painting they give to a museum. Here's how to play this game, if you're interested: Buy a painting for $10,000, hold it for a year or two, get a friendly appraiser to say it's worth $60,000, and you deduct that from your reported income. That saves you more on taxes than the $10,000 you actually paid.

Of course all these tax loopholes and deductions are available to all citizens in theory. But then who would they help the most? Which poor families have the money or connections to play the "revalued charitable contribution game?" In any case, the largest federal tax most poor pay is social security and Medicare taxes, for which (surprise) there are no deductions allowed.

Can this be fairly called a transfer of wealth from the poor and middle class to the wealthy? In a way, yes. Imagine if the rich paid nothing (in reality they still pay most of the taxes). That would make it clear that they are receiving a net benefit from the taxes paid by others - a transfer of wealth from poor and middle class to the rich. To the extent that they are paying less than a fair share, this is still true.

There's nothing wrong with wealth, but how one obtains and maintains it matters. If we don't put a stop to the hundred ways that the wealthy take from the poor and middle class (including all the entirely unnecessary tax loopholes designed primarily for the rich), people will more and more think that it is wrong to be rich. That will make us all poorer.

Read the whole series:
The Redistribution of Wealth to the Wealthy

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Tax Loopholes