The Rich Really Are Different - They Pay Lower Taxes

November 13, 2013
Posted by Jay Livingston

Two weeks ago, I posted a graph showing the income tax rates paid by the very wealthy. The official tax rate for that bracket is over 35%, but the rate actually paid was less than half that. In the recent presidential campaign, Mitt Romney insisted that he had always paid at least 13%, as though using loopholes in order to pay barely more than a third of the official rate were an honorable act deserving of great admiration.*

The loophole most at issue then was “carried interest” – a magic word that takes the huge fees paid to hedge fund managers and transforms  them into capital gains, which are taxed at a lower rate. This trick is available to a very few – the aforementioned hedge fundies and private equity operators like Romney. 

But wait, there’s more.  That is, there’s less – less taxable income – at least if you’re filthy rich. In a recent interview (here), David Cay Johnston, the premiere tax  journalist, outlines another scheme available only to the very rich.

Very, very wealthy people — Warren Buffett, hedge fund managers, Mitt Romney when he ran a private equity fund — are not required to report most of their economic gains and legally they can literally live tax-free or nearly tax-free by borrowing against their assets. You can borrow these days, if you’re very wealthy, against your assets for less than 2 percent interest and the lowest tax rate you could pay is 15 percent. So no wealthy person with any sense of good economics will pay taxes if they can borrow against their assets.

Genius. If your money is borrowed rather than earned, it’s not income. That’s even better than the preferential low tax rate on capital gains. Unfortunately, most of us can’t try this at home.

Now you and I can’t do that because our assets aren’t worth that much, but if you’re a billionaire and you borrow, let’s say, $10 million dollars a year to live on, you pay $200,000 interest, but your fortune through investing grows by $50 million. At the end of the year you pay no taxes, your wealth is up almost $40 million dollars and your cost was just the interest of $200,000.

If the $10 million were earned income taxed at the official rate, you’d pay more than $3.5 million in taxes. This way you pay only $200,000 in interest. And if Johnston’s estimate is right, your investments bring you 20 times what you paid in interest.

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* Romney made public only one or two years of his tax returns. For his claims about the other years, he asked us to take his word for it – much like W.C. Fields’s “gentleman’s game” in My Little Chickadee, as I blogged (here) at the time. Demands for actual evidence were, in the Romneyside view, ungentlemanly. What ever happened to “trust but verify”?

HT: Andrew Gelman