Trump’s Taxes Give Biden Blueprint to Fix System Rigged for Rich
(Bloomberg Businessweek) -- Money can arrive in many forms—paychecks, invoices paid, dividends from a business you own, a gift from Dad, a loan from Mom, rising property values or stock prices. Even non-monetary perks like housing, plane rides, and haircuts have a cash value. Much of this income—and let’s call it all income, though the lawyers might quibble—never gets taxed. With your paycheck, of course, the government takes its cut immediately. Plumbers and Uber drivers who don’t set aside money for the Internal Revenue Service will regret it. But for others, different rules apply.
In a now infamous—though hardly unique—example, Donald Trump paid just $750 in federal income tax in 2016 and the same amount in 2017, his first year as president, according to a report by the New York Times, which obtained copies of his tax returns. Trump reported massive losses from his businesses, effectively wiping out all income tax owed in 10 of the previous 15 years as well. That’s despite a net worth estimated at $2.7 billion by the Bloomberg Billionaires Index.
Rich Americans and a small army of sophisticated advisers have perfected the art of tax avoidance: Wealthy families set up complex trusts, private pensions, and life insurance schemes to lower their taxes. Silicon Valley startups valued in the billions of dollars grab tax breaks meant for small businesses. Multinational corporations shift profits to overseas tax havens. Add it up and, according to one estimate, billionaires now pay lower overall tax rates than working-class Americans hovering above the poverty line.
Congress has helped, by failing to fill obvious loopholes and opening new ones. Lawmakers have also starved the agency that polices the rules. From 2010 to 2019, the number of IRS revenue agents dropped, from 13,879 to 8,526, even as the economy they must patrol kept growing in size and sophistication. In May a government watchdog, the Treasury Inspector General for Tax Administration, found 879,415 high-income Americans didn’t file returns from 2014 to 2016. The agency then barely tried to collect, with 326,579 cases never entered into its enforcement system, and 42,601 cases closed without any work done. Overall, the IRS’s audit rate has plunged to barely above zero. Of all income groups, Americans earning $10 million or more have the lowest chance of facing an IRS examination.
Americans seem OK with paying some taxes. What irks them, and has done so since the 1913 invention of the 1040 form, is the idea that someone else is getting away with something they’re not. A survey of 2,000 people commissioned by the IRS and released in March showed 87% believe it’s “not at all” acceptable to cheat on your taxes, and 95% agree “it is every American’s civic duty to pay their fair share of taxes,” a remarkable amount of agreement in a polarized nation. Last year 62% told Gallup that higher-income people pay too little taxes, while 69% said corporations don’t pay enough.
Merely raising tax rates on the wealthy and corporations wouldn’t really make the system any fairer. Some companies and rich people, especially those with little opportunity to game the system, already pay full freight. Including state and federal taxes, a salaried worker earning millions of dollars a year can pay a marginal rate of almost 46% in New York and a bit more than 50% in California. “The problem with raising rates is that it only raises it on people who are already paying,” former IRS Commissioner Charles Rossotti says. The “aggressive” and “noncompliant,” meanwhile, can keep using tricks—legal and illegal—to avoid paying their fair share.
In the six months after Trump declared the coronavirus pandemic a national emergency on March 13, the collective net worth of the 100 richest Americans—a list that doesn’t include the president—rose $563 billion, a 31% advance, according to the Bloomberg Billionaires Index. Hardly any of these windfalls will be reported to the IRS when 2020 returns are due. They’re paper gains, lawyers will rightly point out, and under current law, your rising net worth isn’t taxable until and unless you sell some assets. In the meantime, you can enjoy your new wealth by taking out loans against it, a far cheaper option than selling because borrowed money isn’t taxable income. Whenever you do sell, capital gains are taxed at a little more than half the top rate on wage income. And if you never sell? Congratulations, you beat the IRS. Your children can inherit the assets with all taxable gains wiped out. Invoking a rule known as “stepped-up basis,” the earnings of a lifetime can escape tax forever. This year Americans—mostly rich ones—will inherit $764 billion but pay an average rate of 2.1% on that money, according to a study by New York University law professor Lily Batchelder.
These tax quirks preceded Trump, but he and Republicans in Congress have taken the tax code in a direction even more generous to the rich. The 2017 tax law lowered their rates, slashing the corporate tax in particular, gave special breaks to private business owners, and made it easier than ever to avoid the estate and gift tax. Trump has suggested cutting the capital gains rate further in his second term.
Joe Biden has promised to push in the opposite direction. He’s proposed higher rates on corporations and rich individuals, limiting deductions for high earners, and almost doubling the wealthy’s rate on capital gains and dividends so it matches rates on ordinary income. Still, many progressives wonder just how much Biden would be willing to soak the rich. After all, he opposed the wealth tax favored by Democratic primary rivals Elizabeth Warren and Bernie Sanders.
How can a President Biden tax someone like Trump more judiciously? The candidate hasn’t issued a comprehensive tax plan, but here’s one clue to his priorities: For years now, he’s brought up the stepped-up basis rule as a loophole he’d like to close, often to audiences that must have been baffled by the arcane tax provision that benefits the heirs of well-to-do people. Conservatives “still argue that protecting things like stepped-up basis makes more sense than putting 3 million more kids in community college,” Biden said in 2018, a year before he announced his run for president. “I applaud investors, but do I think they are greater job creators than anyone else who works in that company? No, I don’t.”
It’s hard to address complicated loopholes in a campaign speech. But Biden’s repeated attempts to do so suggest that tightening rules, and enforcing them more fairly, appeals to him. Try this for shorthand: Biden could try to crack down on the techniques that people like Trump use to escape taxes on both themselves and their heirs.
As Trump’s tax returns show, the wealthy have a powerful incentive to use losses to report as little income as possible to the IRS. Sometimes these losses are an accounting fiction, which is one reason billionaires love buying real estate and sports teams. Because of a rule called depreciation, which assumes properties have a limited useful life, owners can write off a portion of their purchase price each year. Those paper losses can offset real income, zeroing out tax bills even as the true market value of a property keeps climbing.
That’s the legal stuff. The IRS also estimates that about 15% of taxes owed go missing annually, a “tax gap” that could amount to $7.5 trillion over the next 10 years. Again, the problem isn’t salaried workers or contractors, whose tax documents—sent to the IRS each year—make cheating difficult. It’s businesses and rich people who can easily hide money from an IRS that’s stretched thin.
The Tax Foundation estimates that ending stepped-up basis would generate $116 billion over 10 years. And it could be much more. Now, rich families typically hold onto assets for decades, generations even, to pass them on untaxed. Changing the basis rule—especially alongside higher capital gains rates and tighter inheritance rules—would turn past strategies on their heads, pushing the wealthy to sell long-held assets and trigger tax bills. It’s “an underestimated revenue raiser,” says Bill Schwartz, managing director at Wealthspire Advisors in Potomac, Md.
For the last couple years, left-leaning tax experts have been dreaming up more creative ways to tax the wealthy and big corporations. Ron Wyden, the Oregon senator who’s likely to chair the tax-writing Finance Committee if Democrats retake the chamber, has floated ways of taxing investment gains of the extremely wealthy every year, essentially taxing paper profits. Others have proposed schemes to stop multinational corporations from shifting their profits into tax havens—ideas that Biden took up in September with a plan to raise taxes on corporations’ foreign profits while rewarding companies that bring jobs and investment to the U.S.
The first step is bringing the IRS to a point where it can effectively enforce the rules. An analysis by University of Pennsylvania law professor Natasha Sarin and former Treasury Secretary Larry Summers estimates restoring the agency to its 2011 size as a share of the economy could bring in an extra $1 trillion over 10 years. In a more detailed proposal published on Sept. 14, Rossotti suggests shining a spotlight on missing income by requiring that far more data be reported to the IRS, particularly on bank accounts used by businesses. Then, he would invest billions of dollars in new staff and technology, which he estimates would pay back 25 times their cost in new revenue, or $1.6 trillion over the next decade. That doesn’t include the extra money that could be raised by closing legal loopholes, Rossotti says.
IRS agents were once celebrated; they were the ones who took down Al Capone. In World War II, the income tax, previously paid only by the wealthy, was broadened to include most Americans. Irving Berlin penned a patriotic tune on the topic: “See those bombers in the sky? Rockefeller helped to build ’em. So did I!” By the late 1970s, however, country singer Johnny Paycheck was singing “the big man plays, while the little man pays” about American taxes. It’s time for government to rewrite the score.
©2020 Bloomberg L.P.