Taxes.
(Image credit: KAREN BLEIER/AFP via Getty Images)

During the debate over spending bills, Democrats proposed raising taxes on the wealthy. Do the rich pay a fair share? Here's everything you need to know:

What do the wealthy pay?

Generally, a much lower percentage of their incomes than the middle class. A White House study released in September found that America's 400 wealthiest families paid an average federal income tax rate of just 8.2 percent from 2010 to 2018. The rich do pay other taxes not included in the White House analysis, such as estate taxes, but in recent decades, most kinds of taxes on the wealthy have been substantially cut. The marginal tax rate for the top tax bracket held at above 63 percent between 1932 and 1982, spiking as high as 92 percent in the 1950s. Now, after decades of cuts that started during the Reagan administration, the top marginal rate stands at 37 percent. In addition, payroll taxes to finance Social Security and Medicare are levied on laborers and CEOs at the same rate, and only up to $142,800 in income. If you include all taxes, such as sales and state taxes, the country's top 1 percent earn about 21 percent of total income and pay about 24 percent of total taxes, making our tax system progressive — but mildly so.

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Why isn't it more progressive?

In writing and amending the tax code over the decades, Congress has been heavily influenced by the political contributions of wealthy Americans and large corporations, and the armies of lobbyists they send to Washington. Investment income is taxed at a much lower rate than salaries, on the theory that this encourages business growth and stimulates the economy. The tax code is also filled with loopholes and deductions only the wealthy can take. An analysis by ProPublica earlier this year, based on a trove of leaked IRS data, showed that mega-billionaires Jeff Bezos, Elon Musk, and Warren Buffett have paid no federal income taxes at all in some years, and a very low percentage on their massive gains in wealth. Bezos, one of the world's richest men, paid $973 million in personal federal taxes on $4.2 billion in reported income between 2014 and 2018. His wealth, mostly in the form of Amazon stock, increased by $99 billion during that same time period, giving him a "true tax rate" of 0.98 percent, ProPublica said. Corporations pull similar tricks: Between 2018 and 2020, 39 S&P or Fortune 500 companies managed to pay no income tax while recording a combined $122 billion in profits.

How do they do it?

Corporations and the super-affluent can employ accountants and lawyers who know how to manipulate their capital gains, interest, and dividends. Executives paid in stock, for instance, can sell their losing investments at the end of the year to zero out their taxable growth. The wealthy also engage in asset-based lending — borrowing money against their portfolio rather than selling appreciated investments that may incur capital gains taxes. Rich Americans can keep wealth in the family by passing assets to heirs and exploiting a loophole called "step-up in basis." This means the value of an inherited asset generally adjusts to what it's worth on the date of its original owner's death — meaning years or decades of gains before that date instantly become tax-free. "As long as you're adhering to the law," says Sharif Muhammad, founder and CEO of Unlimited Financial Services, "everything's fair game."

Can wealth itself be taxed?

Oregon Sen. Ron Wyden and some other Democrats recently pushed for a "billionaire tax" that would tax the richest Americans on unrealized capital gains. But such a tax would face constitutional challenges, and billionaires quickly accused progressives of waging class warfare. "Eventually, they run out of other people's money and then they come for you," tweeted Musk, the Tesla CEO, who's worth roughly $280 billion. From a practical standpoint, taxing unrealized gains would require a major revamping of the tax system, giving an already overwhelmed IRS the tricky task of valuing assets such as private businesses.

Who does the tax code favor?

It has a strong bias for investment income over wages, and thus worsens income inequality. The top 10 percent now own 70 percent of the wealth, up from 60 percent in 1990, and any attempt to alter the status quo runs into powerful, well-financed opposition. The Biden administration's plans to raise taxes for spending bills, for example, have met a torrent of organized corporate opposition on Capitol Hill. "We're doing it in every way you can imagine," said Aric Newhouse, the senior vice president for policy at the National Association of Manufacturers. So far, those lobbying efforts have been successful; though a 15 percent corporate minimum tax and a surtax on incomes over $10 million remain on the table, proposals to increase tax rates on the wealthy and corporations have been dropped.

How the IRS was gutted

The IRS has never been America's most popular government agency, and conservatives have harbored suspicions about its usefulness since the 1990s. Their hostility escalated dramatically in 2013, with reports that "Tea Party" groups seeking tax-exempt status were receiving extra scrutiny. The IRS also targeted groups with "progressive" and "green" and other partisan labels in their names, but enraged Republicans accused the agency of bias and political persecution. They escalated their efforts to cut the IRS budget, reducing the number of auditors by one-third. In 2017, the IRS conducted 675,000 fewer audits than it did in 2010, a drop of 42 percent, and auditors are stretched so thin that they are reluctant to take on complex returns filed by the wealthiest citizens. As a result, the IRS now audits Americans who receive the earned-income tax credit — whose incomes are about $20,000 — at about the same rate as people earning $500,000 to $1 million. For this to change, Pam Reicks, a former IRS manager, told ProPublica, the IRS needs a bigger budget and more employees. "You can see all this abuse and fraud and people not paying their taxes," she said, "but can't use your hands to get it."

This article was first published in the latest issue of The Week magazine. If you want to read more like it, you can try six risk-free issues of the magazine here.

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