Opinions

TAX THE MILLIONAIRES & BILLIONAIRES

 

TAX THE MILLIONAIRES & BILLIONAIRES

 

Bob Fahnestock

 

This seems to be the constant and incessant rally cry of the administration regarding the deficit and the national debt. Unfortunately it indicates either complete ignorance of the subject or deliberate deception. The amount of taxable income of an individual has nothing to do with whether or not they are a millionaire/billionaire. Millionaires and billionaires are determined by something called the fair value of net assets. This is measured by taking the fair value of everything they own (assets) and subtracting all of their debts (liabilities). If that amount equals or exceeds one million dollars, then they are considered a millionaire. It has nothing to do with how much income they earn. One can be a millionaire and have zero income and one can earn one million dollars a year or more and have negative net assets. For instance, I can own land valued at one million, have no debts, live with my parents, and have zero income. Or I could have paid one million for a house that has a $750K mortgage and a fair value in the current depressed market of only $500K. In this case my net assets are negative regardless of how much I earn. Voters would be surprised at the number of ordinary Americans who worked at the same job most of their life, saved their money, paid their bills, and are now millionaires—and living on $40,000 to $60,000 per year of retirement income. Many will need all of these assets just to cover their medical costs in old age. Politicians do not seem to realize that changes in the income tax law create a dynamic environment. When taxes are increased, taxpayers find a way to legally pay less tax, or worse yet, find ways to earn income off the books. The result is that the government collects less total tax revenue and not more. An alternative available to the very wealthy is the ability to take advantage of the tax law to reduce their taxable income. When the founder of the Dodge Motor Corporation retired his widow sold the company to Chrysler Corporation. The deal was structured such that she was paid in municipal bonds. Yes, the gain on the sale of the company was taxable but she lived the remainder of her life on nontaxable municipal bond interest income. In the case of a high income earning businessman or physician, they simply work less and earn less. Despite the current rhetoric concerning taxing those earning over $250K this group of taxpayers are largely small business people. Small business employs the overwhelming majority of Americans. I have seen numerous tax returns for small business owners where the tax liability (amount owed the government) exceeded $250,000. These are certainly not people we would consider billionaires. Taxing people in the highest income categories only serves to reduce the number of people they hire, increasing unemployment, generating less tax revenue to the government. So why deliberately mislead the populous?

ROMNEY AND OBAMA’S TAX RATES

 

ROMNEY AND OBAMA’S TAX RATES

 

Bob Fahnestock

 

The recent release of Romney’s 2011 tax return has sparked the reporting of what has been termed the “effective tax rate” for both Romney and Obama. It has been reported that Romney’s effective tax rate was right at 14% while Obama’s effective tax rate was 20%. The problem with the reported information is twofold: (1) the effective rates being reported for both are not measured in the same way for both candidates; and, (2) the computation of the “effective tax rate” is incorrect. Because the U.S. tax system uses progressive or graduated income tax rates, the rates increase as the taxable income increases. The rate in each bracket is referred to as the “marginal tax rate.” The overall tax paid will be a combination of these multiple tax rates making the effective rate less than the marginal rate. In fact, one can never have an effective tax rate equal to the tax rate in the highest bracket. The tax rates are applied to “taxable income” which is after deductions and exemptions and before tax credits. In order to correctly compute the effective tax rate the total income tax paid should be divided by the taxable income. Based on the reported information the “effective rate” was not reported correctly for either candidate. Plus, the so-called effective rates are being computed differently for each candidate. The rate that is being reported for Romney is the total tax paid divided by the gross income before any adjustments, deductions, and exemptions. The rate being reported for Obama is the taxes paid divided by the adjusted gross income (after some adjustments to gross income but before deductions and exemptions). When the so-called effective tax rate is computed on gross income it will be lower than if computed on adjusted gross income or taxable income. When computed on adjusted gross income it will be somewhere in-between the lowest and highest possible rate. Because Romney donates such a large chunk of income to charity, this erroneous computation makes the so-called “effective rate” on his tax return look lower than the rate on Obama’s return when, in-fact, they should close to the same effective tax rate. Based on the reported information about Romney’s deductions, we can estimate his taxable income. Using this number to correctly compute Romney’s effective tax rate, the rate is right at 25%. This number cannot be computed for Obama as my research has yet to uncover the amount of his deductions. But it will be higher than 20% and close to 25%. This whole story is much ado about nothing as the media continues to “make” news. Based upon my experience, the “effective tax rates” for the upper middle income and high income earners tend to range from 20% to 25%. Based on my experience, both candidates (as well as Warren Buffet) are paying a typical “effective tax rate” for taxpayers in their respective income tax bracket.

Loop Holes

 

LOOPHOLES

 

Bob Fahnestock

 

There is an old joke that a “tax loophole” is a tax benefit that your neighbor gets and you do not. That is pretty much how the term is used today. Any tax benefit utilized by an individual or business that others do not like is referred to as a loophole. Technically a loophole is something that the law is silent on. The tax law is silent when it does not specifically permit a deduction, exclusion, or credit to the taxpayer; nor, does the law specifically disallow a deduction, exclusion, or credit to the taxpayer. The general rule used by tax professionals is that if the law is silent, take advantage of it. The Internal Revenue Code (IRC) is enormous and loopholes are few and far between. When someone does find a loophole that involves significant money, it is immediately challenged by the IRS. If the government does not prevail in the case, then Congress quickly amends the IRC to disallow the use of that loophole in the future. Public corporations that pay zero in income taxes make the news but are quite rare. Businesses and individuals that appear to pay disproportionately low income taxes are simply following the letter of the law. GE paid no income taxes last year but did so quite legitimately. Congress created this situation, not corporate management. GE avoided the income tax by purchasing credits from a foreign subsidiary that had no need for the credits and using those credits to reduce their U.S. tax liability. Money flowed out of the country so that GE could avoid remitting funds to the U.S. government. Congress enacts the tax law and can fix these questionable items at any time. In fact, they make changes to the law frequently. Several years ago they added a special tax break known as the “Starbucks Footnote.” It doesn’t mention Starbucks by name, but by description and provides them with a tax benefit that most other coffee houses cannot take. In the 1980s the head of the House Ways and Means Committee (where tax laws originate) wrote in a provision making season football tickets at LSU a charitable contribution. When the bill got to the Senate Finance Committee the Chair wrote in the same thing for the University of Texas. Again, they described the schools instead of mentioning them by name and this provision applied only to those two schools and to no other schools. This provision has since been eliminated but it does illustrate that the tax law is not written for you and me. The current tax code is immensely complex and easily lends itself to this type of abuse. What really needs to happen is for the corporate income tax to be abolished. The fact is that businesses simply pass the income tax and payroll taxes incurred onto the consumer in the form of higher prices for goods and services. Consumers really pay these taxes. Some investors actually look for the corporations that pay the least in income taxes or have the highest deferred tax amounts on their balance sheets. The theory is that if the business incurs lower taxes, then management must have a prudent tax planning scheme. Additionally the products/services of businesses that pay the least in income taxes can be sold for less than those of the competition giving them an advantage in the marketplace. The fact is that it is time for the IRC to be rewritten from scratch. We need to move to a single flat tax rate with no deductions, three tax rates with no deductions, or to a national sales tax to replace (not in addition to) the current income tax structure. I vote for the latter alternative.

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