Income tax rates don’t matter

Lots of discussion lately about income tax rates, pointing out that individuals reporting high incomes once were subject to marginal federal rates in excess of 90%, whereas today that rate never exceeds 35%.  And corporate incomes face federal tax rates of 39.3%, higher than most other countries. Various ignorant or deceptive interests use these figures to make all kinds of arguments, such as that America’s rich are undertaxed, or American corporations are overtaxed.

But the secret, that all lobbyists know, is that income tax rates don’t much matter.  When wealthy Americans were subject to 90% taxes, they didn’t really have to pay them.  Instead, accountants and lawyers and various other shysters put together all kinds of partnerships, trusts, and other mostly imaginary constructs, which were used to legally hide or redefine income into something else.  It was a bother and an expense, but way cheaper than paying taxes.

As for corporations, they have all kinds of manipulations available to reduce their taxes, as I discussed two months ago.  (If individuals figured their taxable income the way that corporations do, we could deduct all our expenses for food, clothing, medical treatment, and practically everything else).  If a few corporations appear to pay taxes in excess of the federal rate, it is due to state income taxes, local real estate taxes, other nonincome taxes, or special circumstances.

What brings all this to mind is this post, which provides two nice examples to illustrate my point.  Read them if you have the patience, but the basic point is that corporations are able to entice many very intelligent, experienced people to devise ways to avoid taxes that legislators intend (or at least pretend to intend) to impose.  They are opposed by many very intelligent, somewhat less experienced (and less well-compensated) people employed by IRS and other agencies, many of whom hope in the future to be employed by the corporations.  The net result of taxing incomes, especially corporate incomes, is that many of the most intelligent and creative people, who might be providing goods or services that people need or want, are instead playing word-games with each other.

I would appreciate if someone would explain to me how a land value tax could possibly waste 1/10th of the brainpower absorbed by this useless, destructive system.

What Sam Zell knows

Several times each year I give a little talk at HGS about “What the Rich Know.”  And I always point out that the richest man in Chicago, Sam Zell, got that way not so much from smart investments in real estate and other monopolies, but more because he is extremely clever in taking advantage of income tax laws and regulations.  (And that’s why increasing tax rates on high incomes doesn’t really bother the rich much, nor does it raise much revenue, except for tax lawyers.)

We see another example today, with a Sun-Times report that tax expert Robert Willens suggests that IRS will eventually examine the (pending) “sale” of the Cubs, which has been structured to avoid $300 million in capital gains tax that would otherwise be due.

Update Sept 27 2009: Kevin Horrigan suggests that, if Zell doesn’t want to pay the tax, America’s taxpayers should be entitled to a share in the team.

For those who say government can’t run anything right, I say, compared to what? Not winning a World Series for 101 years?

Thanks to Al Katzenberger of Public Revenue Education Council/ Common Ground USA for the tip.

Maybe the rich do work harder…

…but part of what they work at seems to be under-reporting their taxable incomes.  A paper (pdf) from economists Andrew Johns and Joel Slemrod estimates that folks with “adjusted gross income” below $50,000 understate their incomes by less than 7%, whereas those “earning” $200,000 to $1,000,000 understate by 21% or 22%.  One reason is that the government monitors some types of income very strictly, whereas others are virtually unrecorded.  So they estimate that 99% of the “tax liability” on wage and salary income actually shows up on the tax forms, compared to only 88% for capital gains, 48% for rent and royalty income and 28% for farm income. The research is based on 2001 tax year data.

It’s a bizarre subject to study. Researchers cannot know what “true income” actually is, but can only estimate it by looking at what IRS agents found in a sample of returns selected for intense audit.  One intriguing assumption they make is that the IRS examiner’s ability to find hidden income is correlated with her pay grade.

Very high income taxpayers, over $2,000,000, are estimated to have a much lower propensity to underreport than their $200K to $1 million brethren.  Do they hide less?  Perhaps, but there remains “the plausible possibility that the misreporting of upper-income taxpayers is more sophisticated and thus harder to detect.”

All the estimates of under-reporting are looking at the tax laws as they actually exist, and do not consider the various special-interest loopholes to be anything other than part of the rules (pretending, of course, that someone actually understands the income tax code).

A surprising result follows from the “progressive” nature of the income tax:  Even tho low income taxpayers hide relatively little income, their underreporting actually reduces their taxes by a much greater percentage than does that of the high income folks. [This is because, if your income is low, only a small part of it is actually subject to income tax.]