Thursday, June 10, 2021

"True Tax Rates" Are Real and True, and They Are Now a Thing

by Neil H. Buchanan
By now, many Dorf on Law readers will have heard about a report detailing the incredibly low rates of tax that the richest Americans pay.  ProPublica received leaked IRS records for some of the wealthiest people in the world, including name-brand billionaires like Jeff Bezos, Elon Musk, George Soros, Michael Bloomberg, and Warren Buffett.  Although there are ways in which this story would be only medium-sized even if American constitutional democracy was not being destroyed before our very eyes, in at least one way it is an especially big deal.

The headlines and pundits are essentially all focused on the obvious fact that billionaires pay incredibly low rates of tax, which I will detail below.  I say "obvious" only because I am a tax law professor and economist, and people in my fields have known for quite some time what ProPublica's report details, although obviously we did not have the records for specific taxpayers.  Based on the political and media reaction, confirming just how extreme the inequity goes is definitely big-ish news.

And as I noted, there is what counts as a major breakthrough in the way that the report was framed.  Before exploring that point, however, there are a few matters that are worth discussing, all of which will show where the public debate on taxes now stands.
As an initial matter, it is notable that the White House's reaction focused not on the real news in the report, but on the leaking of IRS information.  When a reporter asked the Press Secretary about the substance of the report and also about the leak, she insisted on talking about the leak first, saying:
Any unauthorized disclosure of confidential government information by a person with access is illegal, and we take this very seriously. 

The IRS commissioner said today that they are taking all appropriate measures, including referring the matter to investigators.  And Treasury and the IRS are referring the matter to the Office of the Inspector General — the Treasury Inspector General for Tax Administration, the FBI, and the U.S. Attorney’s Office for the District of Columbia, all of whom have independent authority to investigate. 

So, obviously we take it very seriously.  I’m not going to comment on specific unauthorized disclosures of confidential government information.
That is a lot of words to devote to arguing in favor of government secrecy.  Even so, and even though I wish that the focus could be on the meaningful questions raised by the content of the report, I do understand why the Biden people had to handle it in this way.  The IRS is constantly under attack by Republicans, and anything that would make it appear that the Service and the rest of the federal government are lackadaisical about taxpayer secrecy would create very bad optics, to say the least.

This is especially important in light of a second (relatively unremarkable) fact, which is that the substance of this leak adds to the momentum to give the IRS a bigger budget so that it can enforce the tax laws that currently exist.  Republicans used the completely over-hyped non-scandal around "social welfare organizations" -- organized under Code section 501(c)(4) -- as an excuse to strangle the Service for a decade, cutting its budget in real terms by about one-fourth and driving out upper-level talent as morale plummeted.

Now, we have an op-ed from five former Treasury Secretaries (one of whom served under George W. Bush, the other four under Clinton and Obama) strongly supporting the Biden Administration's proposal to make a "significant investment in the I.R.S., with $80 billion over a decade in primarily mandatory funding to provide multiyear resources to support necessary work force, service and information technology advancements."
As it stands, they note that we are losing at least $600 billion per year in unpaid taxes because under-funding of the IRS leads to under-enforcement of the tax laws.  This is in no way an accident, as Republicans in Congress have long viewed budget cuts to the Service as a way to achieve high-end tax cuts without actually having to vote for high-end tax cuts.  It is much better politically for Republicans to say, "The IRS is out of control" than it is to vote for a bill that cuts taxes for the Republicans' donors.

That is obviously not to say that Republicans are shy about cutting taxes on the rich.  Even regressive giveaways like the 2017 Trump/McConnell/Ryan travesty are subject to some political and legislative limitations, however, so "Screw the IRS!" is a second battle front by which Republicans can say to their moneyed backers that the on-the-ground reality is even better than it looks for rich people.

That fact, in turn, highlights another notable feature about the press's reaction to the ProPublica report.  Nearly everything that I have read and watched included someone stressing that the low tax payments by the super-wealthy are "perfectly legal."  That is, this is not a report about that $600 billion per year "tax gap" (which might be bigger, but the funding cuts for the IRS perversely make it impossible for the Service to actively monitor the gap); it is a report about why it is legal for billionaires to pay virtually no taxes.

I do think it is a bit much, however, when a pundit says that we "can't blame the rich" for paying low (or no) taxes.  The idea, of course, is that no one is obligated to pay more than the legal minimum, and if Congress has made it possible for a billionaire's legal minimum to be minimal, then of course the billionaire need not volunteer to pay more.  That was the essence of Trump's "that makes me smart" defense in 2016, when he was accused of shirking his tax obligations.

In Trump's case, of course, it is almost certain that "smart" was not merely a matter of maneuvering "up to the limits of the (admittedly generous) law, but not a millimeter beyond," crossing into pure tax fraud.  We might yet see that play out in court.  But even for those who truly have not violated the law, this "don't blame me" defense is more than a stretch.
After all, it is not as if the billionaire class has no influence over tax policymaking.  Many of these people are positively obsessed with it, funding AstroTurf anti-tax protests (see esp. Tea Party, The, 2009) and paying the budgets of anti-tax lobbying groups that masquerade as think-tanks.  When Bill Clinton was a month or so away from being inaugurated, billionaires were pouring money into fake scholarship warning against "soak the rich" tax policies, focusing in particular on stopping wealth taxation.

It is one thing if, say, a dentist making $175,000 per year says that the tax system should be more progressive even as she minimizes her taxes by carefully itemizing every expense.  She could not change the law if she tried.  Warren Buffett tries unsuccessfully to convince Congress to make the tax laws more progressive, which is at least something.  Bloomberg, notwithstanding how awful he is in so many ways -- or how wrong he is in opposing wealth taxes -- is at least a donor to some important progressive causes.
There is an age-old claim that rich people should not even try to create political pressure to make the tax code more progressive.  Conservatives argue that the wealthy who feel some combination of guilt and social obligation can do what Bloomberg does, which is to make themselves slightly less wealthy by choice, rather than making all billionaires less wealthy by force.  That is a once-clever way to wish away the group-action problem, but by this point it is one of the standard talking points on the right.

In any event, it is disingenuous at best for people to argue that rich people cannot be blamed for paying very low taxes.  Doing so is a choice for them, in every sense of the word.

All of which brings us to what I consider the most positive aspect of the way this story is being covered.  The authors of the ProPublica report made a strategic decision to focus on what they call the "true tax rate" for the subjects of their study.  What is a true tax rate, and what is the false tax rate that they are rejecting?  Again, for people who know something about taxes, there is nothing new to the substance, but the framing is still important.

The key move that the authors make is to focus on what is called the "economic definition of income" (sometimes called the Haig-Simons concept), which crucially includes increases in wealth over the course of a year, not just salary or other pedestrian types of income like interest on bank deposits.  (It also includes consumption.)  Thus, if a person does not work to earn wage income over the course of a year, but her (often inherited) net worth rises by $500 million dollars, she has received income -- sometimes denoted "unearned" income -- of $500 million.

The U.S. income tax system only includes in annual income the "realized" income derived from wealth during a year, which (with some complicated exceptions) is the result of actually selling an appreciated asset.  That means that a person who sells nothing has zero measured income.  In 2012, for example, Mitt Romney's tax returns (remember when Republican presidential candidates released their tax returns?) showed him paying a tax rate of about 25 percent, but that was measured against a denominator that excluded his unrealized income.

The ProPublica report thus notes: "To capture the financial reality of the richest Americans, ProPublica undertook an analysis that has never been done before. We compared how much in taxes the 25 richest Americans paid each year to how much Forbes estimated their wealth grew in that same time period."  For those 25 people, the "true tax rate [was] only 3.4%."  A table shows the true tax rates for Musk (3.27 percent), Bloomberg (1.30 percent), Bezos (0.98 percent), and Buffett (0.10 percent).  Those rates are now being bandied about in political and media conversations.

The most important part of this story, then, is that the public discussion of the report has taken as a given the underlying switch from "taxable income" to "changes in wealth" in measuring the income of the wealthy.  (Most people's Haig-Simons income is mostly a matter of consumption, with very little if any increase in wealth, but for the people at the top, consumption is a tiny part of the whole.)
That is a very big deal, because it means that we are finally going to start discussing income in the accurate sense that it ought to be discussed, not in the way that rich people have convinced Congress to redefine "income" for tax purposes.


hardreaders said...

The "can't blame the rich" pundit link doesn’t work?

Michael C. Dorf said...

I agree that the realization rule is a huge giveaway, but I wonder whether "true tax rates" might be misleading in the other direction. Consider a schematic example. Suppose that Richie Rich sees his stock portfolio grow by 20% each year for ten years. If he starts with a billion dollars, then after ten years he has about $ 6.2 billion (because 1.2 to the tenth power is about 6.2). If he sells his shares at that point, he will pay tax on the gain of $5.2 billion. In years 1 through 9, he pays tax on none of that gain. That is the core of the unfairness. The growth compounds tax-free. If we taxed unrealized gains, then the real rate of growth would have been substantially less than 20% annually. So Richie gets a windfall relative to people whose wealth grows through savings from salary or even from interest (which is realized when paid). No question about that. However, it's a little misleading to describe years from 1 through by reference to a denominator that includes the unrealized gain, unless one is also prepared to exclude from the denominator the years 1-9 appreciation in year 10. If one does that, then Richie is paying a tax calculated based on a gain of $5.2 billion even though his actual gain in year 10 was "only" about $1 billion.

UNLESS the idea is that Richie will NEVER pay tax on any of the appreciation because he will simply pass the asset along to his heirs, who will receive a stepped up basis -- another huge giveaway. I know that some conservative (and even some non-conservative) tax economists don't like the idea of taxing unrecognized gains for various reasons. I don't find those objections persuasive, but at least they're coherent. Except perhaps for certain forms of real property, there's no plausible justification for the stepped up basis.

Unknown said...

Professor, I am unsure I can agree with your classifying wealth growth as income. I can't directly trade, at least no reasonably, the increase in price of my Apple stock for food, transportation, or medical care, for example. I have to sell some of that stock, at which point I am assessed a tax on the net increase in market price. Meanwhile, the rest of my wealth in such a stock is only theoretical at most. Contrary to your assertion at the ned of your essay, recognition of this lack of income is not a "redefinition" of the concept.

Michael A Livingston said...

No particular disagreement, but two comments:

1. Anyone who wants to pay more tax than they have to can easily do so, I believe there is a specific line on the form for it, and I recall a Cornell Professor (Hockett?) actually organizing an effort to do so. So the argument that “I pay less tax than my secretary” (Warren Buffett) isn’t entirely convincing; you can always pay more. In fairness, this column is not making that particular argument. But it is a common one in such debates.

2. Undoubtedly more IRS agents, together with new international agreements, would reduce the extent of tax avoidance. But I’m skeptical. The reason the super rich pay lower taxes is because they tend to have assets that are easy to move from one place to another. You can restrict this phenomenon by new rules and agreements, but as soon as you close one loophole, another will open. Moreover—as even Paul Krugman admits—the confiscation of all of the 1 percent’s assets would still not suffice to pay even a fraction of the cost of a truly comprehensive welfare state. So you are basically talking about something symbolic rather than substantive. That doesn’t make it wrong: there are various good reasons to make the rich pay their fair share. But it would change things much less than people think.