Sunday, August 12, 2012

Income: $200 Million. Income Tax: Zero

An interesting fact is buried in a New York Times article about Mitt Romney's income taxes:

In 2009, the 400 Americans with highest income earned an average of $202 million, but six of the 400 paid zero income tax.  And more than 100 of them paid less than 15% of their income as income tax, less than many middle-class Americans.

How is it possible to earn so much income and pay so little income tax - or even no income tax at all?

First, most of their earnings come from capital gains and other investment income, taxed at a maximum rate of 15%.  These 400 people, not much more than one one-millionth of all Americans, earned 16% of all capital gains reported in 2009.

Second, they can easily get their tax rate below this 15% rate by donating appreciated stock to charity, which allows them to get the full value of the donated stock as a deduction thought they never paid taxes on the gain.  For example, if you buy stock for $10 million, its value goes up to $100 million, and then you donate it to a tax-deductible charity, you get the full $100 million deduction from your taxable income, and you never pay taxes on your $90 million capital gain.

Third, they can carry forward capital losses from earlier years.  Deductions for charitable donations can only be half your income, but you can offset your capital gains income for this year with capital losses from earlier years, making it possible for some people with extremely high incomes to get their income tax down to zero.

We can get some idea of how much $200 million yearly income is by considering that, if you save this income and invest it in ways that earn a fairly modest 5% return, you can have an income of $10 million per year for the rest of your life just from the return on this one year's income.

If you earn this $200 million from investments, it is easy to get your rate down below 15% by giving some appreciated stock to charity.  It is more difficult, but sometimes possible, to get your rate down to zero by carrying forward earlier capital losses.

How can we get the wealthiest Americans to pay their fair share of taxes?  The most obvious first step is to tax capital gains and other investment income at the same rate as earned income.

It seems only fair that, if you make money by sitting back and collecting dividends and capital gains, you should pay the same tax rate as people who earn their money by waking up early, getting to work on time, and working hard all day.

Click to see the New York Times article that is the source of these numbers.