Please look at the light green swatch at the top of the chart above; it shows that the most wealthy 1% of Americans own one-third of the nation’s wealth. Then look at the narrow black line at the bottom that almost disappears as it reaches the lower right corner; it represents the wealth of the less wealthy one-half of Americans! Why do 1% of Americans own a third of the wealth while half of Americans have little or no wealth? I hope to convince you that our tax laws are a big part of the answer.
I focus on the top 1%, not just because they are so few in number yet have such great wealth, but also because their story illustrates most clearly how our tax laws favor the rich. A recent study by Pro Publica showed that the 25 most wealthy taxpayers paid only a tiny fraction of their wealth in taxes. Some years Jeff Bezos of Amazon paid no taxes at all.
How can these people be so rich and yet pay so little? The short answer in tax jargon would be that they have enormous wealth, but little income, and only income is taxed. “Income” is things like wages and dividends; “wealth” is houses, bank accounts—and stock holdings.
I can illustrate how our tax system distributes wealth by sharing the experience of a fictitious young executive named Sally recently hired by Amazon. Let’s imagine the company tells Sally that she can choose how she is paid. She can receive her compensation every month in the form of a $12,000 check or in Amazon stock with a market value of $12,000.
Sally will quickly discover that if she chooses a salary she will be liable for federal and state income taxes. This tax obligation alone might eat up one-third of her paycheck. On the other hand, if Sally takes her compensation in stock, she will pay no tax because shares of stock are not taxable under U.S. law until they are sold. A year later she will still have the stock and have paid no taxes. And quite possibly the value of the stock shares will have increased!
How will Sally choose? The hard truth is, unless Sally is independently wealthy, she will choose to take the salary. Being paid in stock only works if you don’t need to sell the stock to pay your rent.
Tax lawyers and accountants have created this clever tax strategy that has been given a cute name, “Buy, Borrow, and Die.” I think it gives us a good picture of how wealthy investors play the tax game.
The first step is to “buy’; Sally couldn’t afford to “buy” and therefore couldn’t play the game, but people with money can. For example, let’s look at Amazon’s Jeff Bezos’ experience. Jeff’s’ parents gave him $300,000 dollars when he started Amazon. That nest egg allowed him to start buying stock in the company.
Next we come to the “borrow” component. A clever investor like Bezos invests in stock and covers living expenses by taking out loans secured by the value of the stock he is buying. When you have billions of dollars of Amazon stock in your vault, it’s not hard to find people who will lend you money at a good rate. That allows Jeff to leave those stock shares alone to appreciate in value.
The “die” component refers to the tax consequences of death. Here is how it works. If Bezos sells shares of stock, he is liable for capital gains taxes on any appreciation in their value over the price he paid. Bezos started buying Amazon stock in 2006; by 2018 the value of his stock had appreciated $120 billion in value ($120,000,000,000!). If he had sold that stock, he would have had an enormous capital gains liability.
These billions of dollars in tax revenues would be paid to the Treasury to be used in part to finance federal programs that help the “little people” in the areas of health, education, welfare, and the environment.
But a very different tax scenario plays out should Bezos not sell his stock and then die in a space vehicle disaster. His heirs would receive the stock, but they would pay no tax on it because under American tax law his heirs would receive a “stepped up” basis; that means the heirs would not be taxed on how much the stock appreciated in value since its purchase (the standard way of taxing capital gains). Instead they would pay the difference between the stock’s “stepped-up” basis value and its value at the time of Bezos’ death.
Since the law has decided that that “stepped-up basis is determined by the stock’s value at Bezos” death, the heirs must pay the difference between its value at the time of his death and its value at the time of his death—ZERO! The giant payout that would have gone to the Treasury if he sold will now go to the heirs. What a difference a death makes!
If Jeff’s heirs follow the same strategy as their dad, the appreciation of their Amazon stock during their lifetimes will also be “stepped up” when they die; so their heirs also will also pay no tax on their inheritance. And then there’s t he next generation of Bezos. Like Leona said, “Only the little people (like Sally) pay taxes!”
The “stepped-up basis” gambit is just one of many tax loopholes that favor the rich. Experts estimate that the Treasury loses $1.4 trillion a year to various loopholes; we also lose another $1.7 trillion to people who cheat on their taxes. Those trillions start to add up over time.
Now I ask you to look again at the chart. Now notice that the top 1%’s share of the national wealth continues to grow; it is now one-third of the total national wealth. The next 9% of taxpayers own about 37% of the national wealth. Together the wealthiest 10% own 70% of the nation’s wealth. That means that the bottom 90% of Americans own only about 30% of the wealth—and the bottom half only 2%.
We must face up to the fact that this extraordinary skewing of wealth is in large part caused by our tax laws. It’s also important to realize that a good deal of this windfall to the very wealthy is later funneled into campaigns to add new tax loopholes, and to prevent the IRS from collecting the taxes legally owed.
What do you call a political system that is governed for the rich?
https://en.wikipedia.org/wiki/Jeff_Bezos#Early_career
Stan F, a devoted reader, writes:
I agree with Prof. Denvir that there is a lot of inequality baked into the Internal Revenue Code.
However, his analysis of Sally’s tax consequences should she elect cash versus stock is wrong.
That mistake pollutes the rest of his discussion. We both agree that if Sally receives cash
compensation she pays tax on the earnings. Where we disagree is with the situation in which
Sally receives stock compensation with a fair market value (fmv) equal to the cash
compensation. Prof. Denvir states that in the stock case, Sally would defer her tax until the stock
is sold. That is incorrect. If Sally receives stock compensation with a fmv equal to the cash,
then she pays tax on the earnings. She does not defer anything. If she gets a Picasso in lieu of
cash compensation, she pays tax on the fmv of the Picasso. If she later sells the stock or the
Picasso, she may have either a capital gain or a capital loss, depending on her basis in the asset.
Whether that gain or loss is long- or short-term will depend on the holding period.
Here is my somewhat simplified understanding of the tax laws as they relate to earnings by
individuals who receive stock. Receiving full rights and title to stock with a readily ascertainable
fmv as compensation is fully taxable when received and at ordinary tax rates. Section 83
provides an exception if the right to the stock is restricted or if the fmv is not readily
ascertainable. I have not reviewed this section in some time but I believe that if a section 83
election is made by the issuer of the security, then the recipient realizes ordinary income initially
and capital gain or loss, if any, is realized later on disposition. I am aware of complicated
nonqualified stock compensation plans which hold the legal and equitable ownership rights to
stock until some earn out time period expires. Whether ordinary income or capital gain rates
apply at that time is an issue. Obviously the goal of such plan is to delay tax payment and
convert ordinary (salary) income to capital gain.
There are, indeed, features of the tax laws that favor those who can take advantage of them. The
one feature that materially helps the “little people” is the earned income tax credit. Most of the
features cut the other way. It would be better to focus on those features rather than to introduce
an incorrect and misleading example