The New York Times reports that with inequality at its highest levels in nearly a century the very richest Americans have financed a sophisticated and effective apparatus for shielding their fortunes, consisting of expensive lawyers, estate planners, lobbyists and anti-tax activists who exploit and defend an array of tax-avoidance maneuvers, virtually none of them available to taxpayers of more modest means. The ultra-wealthy “literally pay millions of dollars for these services,” said Jeffrey A. Winters, a political scientist at Northwestern University who studies economic elites, “and save in the tens or hundreds of millions in taxes.” Whatever tax rates Congress sets, the actual rates paid by the ultra-wealthy tend to fall over time as they exploit their numerous advantages. The major industry group representing private equity funds spends hundreds of thousands of dollars each year lobbying on such issues as “carried interest,” the granddaddy of Wall Street tax loopholes, which makes it possible for fund managers to pay the capital gains rate rather than the higher standard tax rate on a substantial share of their income for running the fund.
Operating largely out of public view — in tax court, through arcane legislative provisions and in private negotiations with the Internal Revenue Service — the wealthy have used their influence to steadily whittle away at the government’s ability to tax them. The effect has been to create a kind of private tax system, catering to only several thousand Americans.
“There’s this notion that the wealthy use their money to buy politicians; more accurately, it’s that they can buy policy, and specifically, tax policy,” said Jared Bernstein, a senior fellow at the left-leaning Center on Budget and Policy Priorities who served as chief economic adviser to Vice President Joseph R. Biden Jr. “That’s why these egregious loopholes exist, and why it’s so hard to close them.”
“We do have two different tax systems, one for normal wage-earners and another for those who can afford sophisticated tax advice,” said Victor Fleischer, a law professor at the University of San Diego who studies the intersection of tax policy and inequality. “At the very top of the income distribution, the effective rate of tax goes down, contrary to the principles of a progressive income tax system.”
Two decades ago, when Bill Clinton was elected president, the 400 highest-earning taxpayers in America paid nearly 27 percent of their income in federal taxes, according to I.R.S. data. By 2012, when President Obama was re-elected, that figure had fallen to less than 17 percent, which is just slightly more than the typical family making $100,000 annually, when payroll taxes are included for both groups. From Obama’s inauguration through the end of 2012, federal income tax rates on individuals did not change (excluding payroll taxes). But the highest-earning one-thousandth of Americans went from paying an average of 20.9 percent to 17.6 percent. By contrast, the top 1 percent, excluding the very wealthy, went from paying just under 24 percent on average to just over that level.
Each of the top 400 earners took home, on average, about $336 million in 2012, the latest year for which data is available. If the bulk of that money had been paid out as salary or wages, as it is for the typical American, the tax obligations of those wealthy taxpayers could have more than doubled. Instead, much of their income came from convoluted partnerships and high-end investment funds. Other earnings accrued in opaque family trusts and foreign shell corporations, beyond the reach of the tax authorities. The well-paid technicians who devise these arrangements toil away at white-shoe law firms and elite investment banks, as well as a variety of obscure boutiques. But at the fulcrum of the strategizing over how to minimize taxes are so-called family offices, the customized wealth management departments of Americans with hundreds of millions or billions of dollars in assets. Family offices have existed since the late 19th century, when the Rockefellers pioneered the institution, and gained popularity in the 1980s. But they have proliferated rapidly over the last decade, as the ranks of the super-rich, and the size of their fortunes, swelled to record proportions. Family offices, many of which are dedicated to managing and protecting the wealth of a single family, oversee everything from investment strategy to philanthropy. But tax planning is a core function. While the specific techniques these advisers employ to minimize taxes can be mind-numbingly complex, they generally follow a few simple principles, like converting one type of income into another type that’s taxed at a lower rate.
Organizing one’s business as a partnership can be lucrative in its own right. Some of the partnerships from which the wealthy derive their income are allowed to sell shares to the public, making it easy to cash out a chunk of the business while retaining control. But unlike publicly traded corporations, they pay no corporate income tax; the partners pay taxes as individuals. And the income taxes are often reduced by large deductions, such as for depreciation. The IRS is not allowed to collect underpaid taxes directly from these partnerships, even those with several hundred partners. Instead, it must collect from each individual partner, requiring the agency to commit significant time and manpower. The budget deal that Congress approved in October allows the I.R.S. to collect underpaid taxes from large partnerships at the firm level for the first time — which is far easier for the agency — thanks to a provision that lawmakers slipped into the deal at the last minute, before many lobbyists could mobilize. But the new rules are relatively weak — firms can still choose to have partners pay the taxes — and don’t take effect until 2018, giving the wealthy plenty of time to weaken them further.
The wealthy can also avail themselves of a range of customized tax deductions that go far beyond writing off a home office or dinner with a client. One strategy is to place income in a type of charitable trust, generating a deduction that offsets the income tax. The trust then purchases what’s known as a private placement life insurance policy, which invests the money on a tax-free basis, frequently in a number of hedge funds. The person’s heirs can inherit, also tax-free, whatever money is left after the trust pays out a percentage each year to charity, often a considerable sum.
The inheritance tax has been a primary target. In the early 1990s, a California family office executive named Patricia Soldano began lobbying on behalf of wealthy families to repeal the tax, which would not only save them money, but also make it easier to preserve their business empires from one generation to the next. The idea struck many hardened operatives as unrealistic at the time, given that the tax affected only the wealthiest Americans. But Ms. Soldano’s efforts — funded in part by the Mars and Koch families — laid the groundwork for a one-year elimination in 2010. The tax has been restored, but currently applies only to couples leaving roughly $11 million or more to their heirs, up from those leaving more than $1.2 million when Ms. Soldano started her campaign. It affected fewer than 5,200 families last year.
For the ultra-wealthy, “our tax code is like a leaky barrel,” said J. Todd Metcalf, the Democrats’ chief tax counsel on the Senate Finance Committee.