Leaked records of billionaires' miniscule taxes rekindle debate on tax policy, wealth gap

Taxes were already set to be a key area of political contention this year, amid President Joe Biden’s proposal to raise levies on corporations and high-income Americans. But now that leaked personal tax records appear to show billionaires paying little to nothing in income taxes, the debate could move to center stage.

ProPublica published details of the personal tax returns of 25 of the wealthiest Americans, documents the news organization said it received from sources within the Internal Revenue Service. The nonprofit outlet did not specify who provided the documents. Merrick Garland, the U.S. attorney general, vowed to investigate the matter as a top priority.

The revelation of minute true tax rates among the richest Americans comes amid a yawning wealth gap and increased discussion of what to do about it. Even before COVID-19 arrived, more of the nation’s wealth was winding up in fewer hands. The pandemic widened that disparity. Lower-income Americans fell behind, owing to job losses and other disruptions, but the rich flourished as real estate, business interests and the stock market soared in value.

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The timing of the leak doesn’t appear coincidental. ProPublica contends that the “public interest in knowing this information at this pivotal moment” outweighs legitimate concerns over a breach of privacy. The organization, a nonprofit newsroom that investigates abuses of power, has promised further updates about the tax practices of billionaires, including their use of loopholes and audit-avoidance tactics.

What the report revealed

In some respects, the ProPublica report wasn’t all that earth-shattering.

It is widely suspected that many of the richest Americans pay relatively little in taxes, sometimes even below what middle-class households pay. This is largely because the rich derive most of their wealth from investments rather than salaries, wages or other income taxed each year. Tax rates on capital gains are below those on ordinary income, and there’s more flexibility to delay taxes on gains.

What was revealing, however, were details on actual tax returns. Many of the wealthiest people paid no income taxes in one or more years over the past decade and a half. According to the report, that list includes Jeff Bezos, Elon Musk, Michael Bloomberg, Carl Icahn and George Soros. Others, such as Warren Buffett, paid well under 1% in taxes, as a percentage of how much their wealth increased.

The 25 wealthy Americans whose returns were leaked paid a combined $13.6 billion in income taxes over the five years from 2014 to 2018, ProPublica said. Yet their collective wealth surged by $401 billion over that period, meaning they paid the equivalent of 3.4% in taxes, based on wealth increases, over the period.

You might have noticed that ProPublica mixed apples and oranges in its comparison. The news organization computed what it figured would be the tax bill if changes to the billionaires’ net worths were taxed on an ongoing basis, like income. Under current law, wealth increases aren’t taxable. Nor are gains taxable if the underlying assets aren’t sold.

How is this possible?

The ProPublica analysis examined several tax-avoidance strategies — all legal — that the wealthy rely on more than most Americans.

Some billionaires pay little or no income taxes simply because they don’t earn much income. That’s because they don’t draw much in the way of salaries or wages, preferring instead to ride their substantial portfolios higher.

But they still need living expenses, and for this many of the wealthy borrowed against their growing assets, ProPublica said. Loan proceeds aren’t taxable, and certain debt expenses are deductible. Some rich individuals also live off dividends, typically are taxed at the lower rates that apply to capital gains.

Another practice was for billionaires to donate heavily to charities or other philanthropic causes, allowing them to lower their taxable income.

But the main strategy utilized by the rich, as highlighted by ProPublica, centers around capital gains. Because long-term investment profits or gains are taxed at lower rates than ordinary income, the wealthy can shave their obligations. This enables them to pay an effective overall tax rate that might be below those of middle-class Americans.

Why are gains so crucial?

All Americans have access to low capital gains rates, but not everyone owns stocks, real estate or other assets on which to generate such gains. Millions of Americans don’t own any such assets, which also helps explain the widening wealth gap.

Not only are tax rates lower on long-term gains — the top rate of 20% compares to 37% for regular income — but owners of stocks and other investments have more control over when to pay these taxes. Wages are taxed in the year received, collected through payroll withholding or estimated payments, but capital-gain taxes aren’t triggered until an investment is sold. That could be years, if not decades later.

In fact, taxes on some gains might never be collected because of various estate planning rules. One is the automatic exemption of nearly $11.7 million in assets from taxes per person at death (or $23.4 million for a married couple).

Another involves the ability to eliminate much or most of an accumulated taxable gain at the owner’s death through what is known as the step-up in “basis.” Basis is the amount of an asset not subject to tax. Stepping up or increasing this to the asset’s value around the time of death, as allowed by the tax code, can wipe the tax slate clean for heirs. 

“The result is that large fortunes can pass largely intact from one generation to the next,” ProPublica said.

Where does the debate go from here?

Biden’s proposed reforms would change the nation’s policies in several ways that could generate more tax revenue from the wealthiest Americans (or at least top earners). These include raising the top income rate for individuals to 39.6% from 37% (on annual income above $400,000) and ending the lower rates on capital gains for these people, meaning gains would be taxed the same as income. 

Then there’s a proposed millionaire’s surtax of 10 percentage points that would apply to income as well as capital gains/dividends. The Democrat-backed measure would affect 0.2% of taxpayers — those with income above $1 million (or $2 million for couples).

As a more fundamental change, the government could tax unrealized capital gains.

Under a proposal by Sen. Ron Wyden, D-Oregon, accrued gains would be taxed each year, treating these assets as if they had been sold. This provision wouldn’t apply to more than 99% of taxpayers, and it would exempt retirement accounts, family homes and farms. It also wouldn’t apply when assets lose value. The tax revenue received, under Wyden’s proposal, would shore up Social Security.

Taxing unsold property would be easy enough on assets such as stocks, mutual funds and the like that have regularly updated prices. It would be trickier for harder-to-value property such as artwork or shares in private companies. Wyden has suggested a “look back” rule that would impose the tax when the asset is ultimately sold for these assets.

The complexities of taxing unrealized gains do pose hurdles. But if the wealth gap continues to widen, these and other proposals might get a fresh look.

Reach the reporter at russ.wiles@arizonarepublic.com.

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