Tax the Rich?

     

Now that the U.S. Senate and House of Representatives have passed tax reform bills, the bills will go to a joint committee of both houses to reconcile the differences before sending the final bill to President Trump for his signature. In the meantime, political commentators and cartoonists are only intensifying their efforts to brand the Republican bills as favoring the rich to the harm of everyone else.

In particular, they point to the potential reduction or removal of the estate tax as a huge benefit to the rich. Anyone who looks at the pie chart to the left will see that the estate tax makes up less than 1% of total annual revenues. Why is this so?

In the first place, I would guess that more than 95% of estates are exempt from the tax because estates under $5 Million are not subject to the tax. Indeed, in the new proposals the exemption will be raised to $11 Million. Only the very, very wealthy are subject to the tax but in most cases, they will pay very little.

When I worked as a financial advisor, it was common to refer to the estate tax as a “voluntary” tax, a tax only paid by those too lazy or stupid to take measures to avoid or minimize it. In fact, there was a host of lawyers and other so-called estate planners who specialized in advising wealthy clients in how to avoid dreaded death taxes. When Congress raised the exemption amount a few years ago, most of these parasites had to find other areas of work.

The very wealthy, both liberal and conservative, often turn to tax-exempt family “foundations” not only to promote their own pet causes but also to avoid estate taxation. We are all familiar with the Clinton, Gates, and Buffett foundations. Just this year wealthy progressive financier George Soros added $18 Billion dollars to his foundation.

Critics of tax reform also argue that lowering the corporate tax rate from 35% to 20% is also a boon for the rich. But if you look at the pie chart again, you will see that corporate taxes make up only about 10% of federal revenues. It should be obvious to all but the most die-hard progressives that any large corporation will use its high powered attorneys and accountants to use every means to reduce its tax burden.

Lowering the tax rate will make many of these tax-avoidance strategies less attractive. As President Trump has pointed out, these companies will have less incentive to relocate their operations overseas to lower tax countries, or to keep their profits overseas.

Moreover, what do companies do if they can keep more of their profits. If they are taxed at a lower rate, they might pay higher salaries or even keep prices down to the benefit of consumers, rich and poor. If they just pay out the profits to shareholders in the form of dividends, those dividends become taxable income to the recipients.

People think that only the rich benefit from corporate profits but stock ownership in this country has spread to millions. Practically everyone receiving a pension check has benefitted from the recent increase in stock prices because most pensions invest heavily in the stock market. Most holders of IRA or 401k accounts need only to check their most recent statements to see how much the upsurge in stock prices has helped them.

One element in the tax code that really helps the rich has so far received little attention from the media. Hedge fund managers have made enormous profits during the Obama administration. These funds are investment companies that in addition to earning high annual management fees also claim 20% of the profits they make for their investors. They can charge such exorbitant fees because they are largely unregulated due to the fact that they are not open to the general public. Only large investors can participate but many small fry do get involved because many state and local pension funds invest in them. A few years ago the pension fund of my own town of Fairfield lost millions because it had entrusted funds to a money manager who, for an annual fee of more than 2% (2% of millions of dollars is a lot of money), merely turned over the money to the infamous Bernie Madoff.

In any event for some reason Congress, whether run by Democrats or Republicans, has allowed these huge hedge fund fees to be taxed at a substantially lower rate than the rate on ordinary income. In 2016 both Donald Trump and Hillary Clinton campaigned against this policy, but so far I have not seen that either party is willing to change it.

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Presidential Campaign Issues: Taxes

     

Federal Tax Revenues and Expenditures

One of the big differences between the candidates in the last Presidential debate came on the issue of taxes. Republican Donald Trump argued that an across the board decrease in tax rates was necessary in order to get the economy growing again. He also stressed the need to significantly lower the corporate tax rate in order to grow American business and make it more competitive with other countries.

Democrat Hillary Clinton promised to increase taxes on the rich by which she means anyone making over $250000 per year. She argued that this tax increase would enable her to implement all the programs in the Democrat platform without adding to the Federal deficit which is now close to $20 Trillion.

Neither candidate pointed out that there is a difference between raising tax rates and raising taxes. An increase in tax rates on the rich or anyone else does not always lead to increased government revenues. Historically, almost the opposite has occurred. Over 50 years ago, President Kennedy lowered tax rates and Federal revenues grew dramatically. President Reagan did the same thing with a similar result after he took office.

Even the much-maligned Bush tax cuts did not reduce Federal revenues. In 2002 the Federal government collected 1 Trillion dollars in income taxes and 1.88 Trillion in total revenues. By 2007 after five years of Bush “tax cuts”, Federal income tax collections went up by 50% to over 1.5 Trillion dollars, and total government receipts exceeded 2.5 Trillion. In 2007 the total federal deficit was a mere 160 Billion dollars, the same it had been in 2002. Only with the recession did income tax revenues go down to 2002 levels although total government receipts stayed higher.

Today, total Federal government revenues are the highest they have ever been. Unfortunately, during the Obama administration massive government spending has far outstripped the increased revenues produced by the Bush cuts. Even if a newly elected president Clinton were to tax those making over $250000 at a rate of 100%, it would not come close to dealing with the massive debt roll accumulated during the Obama administration.

Ironically for conservatives, it would appear that reductions in tax rates lead to increased government revenues and only enable more government spending. At the same time, it would appear that raising tax rates would actually lead to less revenue for Washington? Why should this be so?

In the last election campaign Mitt Romney tried to make the same point that Donald Trump is making today. He argued that lower tax rates would actually grow the economy and produce greater revenues for the Federal government. Most people, including those who should know like politicians and newspaper editors, could not understand the concept.

But there is another factor. Increasing tax rates only increases tax avoidance strategies both legal and illegal. Increasing tax rates on the rich or anyone else will only encourage more tax avoidance since the potential reward gets greater. If someone’s income is taxed at a 50% rate rather than 25%, the potential reward for deferring, sheltering, or otherwise hiding income has doubled.

Although he has not released his tax returns, Donald Trump has admitted that he uses “depreciation” on his real estate holdings to keep his taxes down, a perfectly legal strategy that neither President Obama nor Hillary Clinton has ever challenged.

No one has ever asked candidate Clinton or her husband why they felt a need to set up the tax exempt Clinton Foundation for their charitable work in the first place. Many financial planners advise high-end clients to set up foundations for tax purposes. We all know of the Gates foundation and the Buffett foundation. Theoretically, since these foundations pay no taxes, more of their money can be used for the charities they wish to support.

 Even assuming that the Clintons had the best of motives, they must have realized that they could achieve greater results with their money than the Federal government could. Why give the government a third or more of your speaking fees when all the fees could go to the Foundation. Of course, they also could be able to maintain control over the tax exempt funds as opposed to leaving it to government bureaucrats to decide. The funds could go to pet causes. Recent email leaks have indicated a dark side in the Foundation. It appears that daughter Chelsea had to initiate an investigation of the Foundation to see if there were any conflict-of-interest issues jeopardizing its tax-exempt status.

There are other legitimate ways for people to shelter income from taxation. For example, taxable withdrawals from IRAs and other retirement plans can be deferred until age 70, and after that only minimum withdrawals need be taken over one’s lifetime. Raising tax rates only discourages taking money out of IRAs. Lowering tax rates would actually increase taxable withdrawals.

Trump is also right about lowering the Corporate tax rate. Corporations actually don’t pay taxes. The taxes are figured into the price of what their customers pay in the same way that the real estate taxes paid by landlords come out of the rent paid by tenants. Higher corporate taxes are inevitably passed on to the consumer.

Also, corporate accountants are paid to find ways to create strategies that will minimize their corporate tax liability. A higher tax rate will inevitably lead to more and more drastic measures. When states raise corporate tax rates, corporations move to more tax friendly states as General Electric did this year in Connecticut. We all know that the high federal Corporate tax rate has led many domestic companies to relocate overseas.

Inevitably, increases in tax rates never produce the expected tax revenues. Just look at the state of Connecticut. Two years after his election Democrat Governor, Dannell Malloy, and an overwhelmingly Democrat legislature pushed through the largest tax increase in State history. The expected revenues failed to materialize, and the Governor had to raise taxes again to balance his budget.

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