Close Close
Sign In
Newsletters
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards
Podcast Center Video Center Webcasts Resource Center Events
About ThinkAdvisor Contact Us Advertise With Us Asset & Logo Licensing Sitemap Terms of Service Privacy Policy Copyright © 2024 ALM Global, LLC. All Rights Reserved.
ThinkAdvisor
laptop with tax icon

Regulation and Compliance > Legislation

Senators Debate Tax Avoidance Methods Used by Ultra-Wealthy

By John Manganaro

X
Your article was successfully shared with the contacts you provided.

What You Need to Know

  • Democrats on the Senate Finance Committee focused on exposing oft-used pathways to not paying taxes.
  • Although committee Republicans offered a different perspective, all agreed that the tax code's complexity is a big problem.
  • They also agreed that the tax-mitigation techniques bemoaned by Democrats are legal and therefore a legislative issue.

The Senate Finance Committee held a hearing Thursday to examine and decry what committee chairman Sen. Ron Wyden, D-Ore., called “all the schemes the ultra-wealthy rely on to legally get away without paying their fair share in taxes.”

During the hearing, Wyden and several Democratic colleagues specifically called for ending the tax avoidance pathway sometimes referred to as “buy, borrow and die.”

More broadly, they also argued that the federal government should take significant and immediate steps to make the tax treatment of investment earnings, capital gains and other forms of wealth more similar to that of normal earned income.

According to the committee Democrats, such steps would simultaneously improve the average Americans’ perception of the fairness of the tax system while also raising significant amounts of new revenues that could help offset the fast-growing federal budget deficit.

While the hearing did not grow contentious or even overtly partisan, Republican committee members, led by ranking member Mike Crapo, R-Idaho, sought to paint the current tax code as being more progressive and balanced than the committee’s Democrats would admit.

To that end, they cited data showing that wealthy Americans already pay the lion’s share of federal income taxes on an absolute dollar basis, even if the average percentage of taxation on their overall earnings in any given year may be lower compared with less-wealthy Americans who depend more on work income.

The hearing also included the testimony of four expert witnesses, including Chye-Ching Huang, executive director of the Tax Law Center at NYU Law; Morris Pearl, chair of Patriotic Millionaires and a former BlackRock managing director; William McBride, vice president of federal tax policy at the Tax Foundation; and Douglas Holtz-Eakin, president of the American Action Forum.

One point the senators and witnesses agreed on is that the current tax code, which runs to more than 4 million words, practically invites abuse of its many seeming contradictions and grey areas.

They also agreed that many of the tax-mitigation techniques bemoaned by the committee’s Democrats are perfectly legal — meaning the consideration of such issues is a legislative matter and one that the current Congress will continue to debate in the years ahead.

The Democratic Case

The Senate Finance Committee’s Democrats and several witnesses offered testimony about a range of tax-mitigation strategies that they see as problematic and as unfairly favoring the wealthy, The main thrust of their argument, as noted, is that the tax code should be changed to treat earnings on wealth the same way it treats earnings from work.

Simply put, the Democrats argued, there are many potential pathways for earnings derived from investments, real estate and privately held businesses to be structured so as to avoid much, if not all, taxation.

There is no analog for this flexibly when it comes to normal working income, they argued, meaning that the average American whose wealth is derived primarily from work is at a significant disadvantage.

“The ultra-wealthy are abusing this difference to shield their vast fortunes from federal taxes,” Wyden argued. “It’s time to change the code so that we collect the fair share from those at the top, and we should use the money to help families — for example to help people get a jumpstart on child savings accounts.”

In addition to improving Americans’ perception of the fairness of the tax system, Wyden and other speakers suggested, the collection of additional taxes on investment income and the value of privately held businesses and other wealth assets could help to put key programs like Social Security and Medicare on a more solid financial footing.

Republican Counterpoints

Though careful to maintain a congenial tone during the hearing, Crapo also pushed back against many of the assertions leveled by the committee’s Democrats and their preferred witnesses.

“One thing we should do is dispel the notion that there is support on any side of the aisle for tax evasion,” Crapo said. “We all agree that tax payers should pay the tax they legally owe. For the grey areas of tax law, we should constantly assess how the code can better and more fairly target impermissible activities.”

However, in Crapo’s view, “framing this whole issue through the subjective lens of ‘fairness’ is also misguided.”

“We shouldn’t focus on rhetoric but on data,” Crapo argued. “To be clear, most of the tax burden [on an absolute dollar basis] is paid by higher earners. We should also acknowledge that tax collections have been at or near all-time highs in recent years, and the voluntary tax compliance rate is high and stable.”

Finally, Crapo argued that, depending on how they are implemented, higher taxes can be a major disincentive to work, savings and investments. He argued that a better approach is to keep taxes low enough and stable enough to foster greater and lasting economic growth, which he called the “real solution to our deficit problems.”

Expert Testimony

During her testimony, Huang emphasized that America’s highest-income earners would pay hundreds of billions of dollars per year in additional taxes if more sources of earnings were treated like working income for federal tax purposes.

“The tax breaks enjoyed by the ultra-wealthy increase deficits and increase inequality,” Huang argued. “They also spur excessive tax avoidance activity and they harm the economy by locking up capital based on tax treatment rather than innovation. Talent goes to waste dreaming up tax schemes for the ultra-wealthy rather than innovating and fostering entrepreneurship.”

Pearl offered a similar perspective, suggesting the wealthiest Americans are effectively given carte blanche to “choose when to pay taxes, how to pay and even whether to pay at all.”

“It’s all because their wealth comes from property and ownership and assets — not work,” Pearl said. “Roughly speaking, the top rate on salaries is above 40%, while the top rate on capital gains is about half of that, at 23%.”

Most capital gains are invisible to the tax system until they are realized, Pearl explained, and this usually only happens when the asset is sold. Or, the asset is held by an individual until death, at which time the asset can pass to an heir while enjoying a tax-free step-up in basis.

“So, the wealthiest filers have this significant degree of control and flexibility that can mean they pay practically no taxes even as their wealth balloons — and even though they can borrow and spend against their assets to live a lavish lifestyle,” Pearl said.

The commentary from McBride and Holtz-Eakin was more technical in nature and sought to paint a clearer picture of exactly how the amount of taxes paid varies by income group. They also sought to provide insight about how changes to the tax code could address questions about fairness while helping to reduce the federal deficit.

Both also emphasized how there is “nothing simple about he way these taxes are assessed and collected,” as McBride put it.

“Taxes are inherently complex, and various credits and preferences add to the complexity,” McBride said. “The current code is more than 4 million words long, and in 2022 alone, Americans spent 6.5 billion hours trying to comply with the tax code — and that doesn’t even include the cost of tax planning. It is time to pursue significant simplification of the system.”

(Shutterstock)

John Manganaro

NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.