How Wealthy Americans Pay No Tax

There was another article in the Financial Times today covering “How the wealthiest Americans get away with paying no tax”. The item was based on a report by ProPublica which suggested that America’s richest billionaires paid virtually no taxes on hundreds of billions of dollars of added wealth over the past decade. They only paid 3.4% of the increase in taxes. The report is based on leaked IRS data.

One reason is because the US tax system is like the UK one in that there are numerous allowances that can be claimed, and although there are taxes on capital gains these are only payable on realised gains.

The article even went so far as to suggest that unrealised gains be taxed so as to make the system more equitable (a mark to market system) or that a wealth tax be introduced. These could ensure that the tax rates on wealthy people are more similar to those paid by the normal working population.

Is it really so different in the UK I am wondering? I now know how much tax I will pay for the last financial year (an exceptionally high one in terms of capital gains tax paid) and it’s only 6.3% of overall profits (capital growth plus dividends received last year).

With a lot of the gains and dividends being in ISAs, SIPPs and VCTs, this partly explains the relatively low tax. But it is also low because of avoiding realising capital profits unless absolutely necessary in direct holdings. I sell holdings showing a loss and retain those showing profits, i.e. running the winners and selling the losers which is always a good policy to follow on stock market investment.

Is such a low tax rate unprincipled? It’s partly low because I have responded to Government policy to encourage investment in early-stage companies but it’s also because of the structure of the tax system and taking sensible steps to avoid paying tax unnecessarily. Which is no doubt what the US billionaires are doing.

Should unrealised capital gains be taxed? This is a very doubtful proposition mainly because it means taxes in cash terms could be imposed on gains which have not been realised in cash. The losers from such a system would be those who simply did not have the cash to pay the tax demands. There is also the problem with any “mark to market” system that there may be no readily available market price for many assets (property for example).

Capital gains tax rates might be raised of course, and I have no objection in principle to the rates being more aligned with income tax rates, but that might simply mean that more people postpone realising capital gains. There may not be a great increase in the net tax receipts.

It is surely better to encourage capital gain realisations so that people have the resources to invest in new business ventures and so as to ensure a vibrant economy. If any realised gains are reinvested, why should they be taxed anyway? I have suggested before that we need a new capital gains tax system to take account of roll-overs from past investments where any profits may simply arise from inflation anyway.

Taxation policies should not be driven by the politics of envy which is essentially the theme of the FT article, but by a wider view of the economy and the incentives that taxes drive.   

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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