Many tax lawyers would agree that the average taxpayer may not find Warren Buffett’s famous remark amusing. In this long-remembered statement, Buffett said he essentially paid a lower tax rate than his secretary. Unfortunately, there is quite a bit of truth in that statement concerning average taxpayers when compared to the country’s wealthiest billionaires.
On lifetime earnings, the ordinary taxpayer is taxed at a federal rate of 17.6 percent. According to research conducted by Self, a financial technology company, that rate is five times higher than what the wealthiest 25 percent of taxpayers are likely to pay to Uncle Sam. This estimate came from a report from ProPublica. Tax policy expert Seth Hanlon told Yahoo Money that working-class Americans are taxed in a completely different way than those who enjoy great riches. Hanlon works at the Center for American Progress and maintains that there has been a long-term understanding that the tax system favors the extremely wealthy.
Sources of Wealth Play a Major Role in How Much Tax is Paid
The tax rate mentioned in the ProPublica report was arrived at after all sources of wealth were considered regarding America’s billionaires. For example, unrealized capital gains accounted for a percentage of the overall amount, but even still, the wealthiest 25 percent of taxpayers pay an overall tax rate that is 1.8 percent lower than that paid by the average taxpayer.
For most American workers, earnings come primarily from wages or salaries. This is not true for many billionaires whose income depends on other sources, which their tax planning professionals often help manage. For example, 66 percent of the income received by the richest 1 percent of taxpayers comes from capital gains and capital income, according to a 2017 study. The Congressional Budget Office has stated that for the bottom 8 percent, income from sources such as capital income and capital gains only accounted for 2.4 percent of the filer’s income.
An Unbalanced Taxation System
A data reporter from the ProPublica analysis, Jeff Ernsthausen, reminds us that working-class filers are taxed automatically from their paychecks, but for those in the 1 percent, the bulk of their income is sourced from unrealized gains and situations that occur outside the tax system and rarely make it into the spotlight of a tax audit. According to Seth Hanlon, part of the issue causing this imbalance is that there is no way to avoid or defer the payment of income taxes on salaries or wages, but wealthy individuals have the opportunity to defer capital gains taxes.
For the other 80 percent of filers, a minimum of 60 percent of their income is sourced from labor and is taxed at the state and federal level. Obviously, they cannot make use of any funds that go toward taxes, but this is not true for those who can take advantage of capital gains loopholes: such taxes can be successfully deferred, which allows holders to sell stocks or other investments when it is most profitable, and they can offset their gains with parallel losses. In certain instances, for example when assets are inherited, taxes on such gains can be altogether avoided.
Unrealized Gains Used as Collateral
Billionaires can also simultaneously use unrealized gains as loan collateral, which lets them acquire cash without paying taxes on investments such as stocks because such investments were not yet sold.
From the standpoint of most economic experts such as Hanlon, the term “income” technically refers to gains and the ability to consume. Those who are wealthy enough can convert appreciated stock to cash, which is equivalent to bolstering one’s bank account. A tax attorney can provide additional information regarding tax rates and ways for working-class Americans to possibly lower their tax burden, based on current tax laws.