If Democrats want the wealthy to pay more into the U.S. Treasury, they’ll need to contend with one fact: The rich are very good at dodging taxes.
The top 0.1 percent have become expert in shifting and re-labeling their income in response to tax incentives. That skill is why some on the left are proposing blunter tools to tackle inequality. Massachusetts Senator Elizabeth Warren, who’s exploring a run for president, is proposing a wealth tax, a 2 percent annual levy on fortunes of more than $50 million and a 3 percent tax on the assets of billionaires.
Others, including Representative Alexandria Ocasio-Cortez from New York, have suggested hiking income tax rates.
“There’s an element, yeah, where people are going to have to start paying their fair share,” Ocasio-Cortez told Anderson Cooper on “60 Minutes” on Jan. 6. “Once you get to the tippy tops, on your 10 millionth dollar, sometimes you see tax rates as high as 60 or 70 percent.”
But new research on the U.S.’s largest fortunes shows that simply raising marginal income tax rates may not move the needle on inequality. Any proposal aimed at the wealthy will need to compete against the clever and complicated techniques that rich Americans can deploy.
“The lesson is that the details are going to matter a lot,” said Eric Zwick, an associate professor at the University of Chicago Booth School of Business, who co-authored the study with three other economists, including the Treasury Department’s Matthew Smith. “You have to enforce the rules and keep track of people and how they’re changing the nature of their income in response to the rates.”
Picture a rich person and you may imagine a big company CEO or a professional athlete collecting $40-million pay packages year after year. But these examples are salaried employees. Business owners are far more common among the super-wealthy. And being your own boss brings huge clout, including flexibility to decide exactly how and when to pay taxes.
Business owners have options. They can set up corporations, which pay their own taxes and whose employees and investors then pay taxes on their salaries and dividends. Or, they can establish pass-through businesses. These pay just one layer of taxes on their owners’ returns.
The previous round of tax reform, in 1986, gave the wealthy larger incentives to use pass-through businesses, and they’ve become very popular: About 84 percent of the top 0.1 percent of America’s earners made some pass-through income, Zwick’s research found.
Among the top 0.1 percent, pass-through owners are far more common than well-paid execs. In 2014, there were 139,000 taxpayers with a combined pass-through income of $264 billion, the study finds. That’s eight times more income than collected by the top 10,700 executives in an S&P index.
Owners and entrepreneurs also have freedom in how much salary they pay themselves. By minimizing their salaries – and boosting profits – the wealthy can save a couple of percentage points in payroll taxes. That’s what the rich have been doing since 2001, the paper says, “paying themselves less in wages and more in profits.”
Zwick and his colleagues conclude most rich owners are actively involved in their businesses, no matter what their tax forms say.