How the Rich Avoid Paying Taxes and What to Do About It

 

In the US, tax evasion is a significant issue, particularly among the richest 1% of citizens. The richest 1% fail to pay as much as $163 billion in taxes each year, or nearly 28% of the overall tax gap, according to a new Treasury Department report3. This means that although the rest of the population is required to pay for public services and programs, the wealthy do not pay their fair amount of taxes.

How do the rich evade taxes? There are many ways, but some of the most common ones are:

Rich people frequently utilize intricate networks of fictitious businesses, trusts, and foundations to hide their wealth and income from the IRS. They also benefit from tax havens that provide little or no taxes and strong secrecy, such as Switzerland, Bermuda, and the Cayman Islands. Research by economists Gabriel Zucman and Emmanuel Saez estimates that around 7% of the financial wealth of American families is kept abroad.

Using tax incentives and loopholes to cut taxable income: The wealthy can take advantage of several tax breaks that lower their effective tax rates. For instance, they are allowed to deduct company expenditures, state and local taxes, mortgage interest, and charitable donations from their income. By keeping their capital gains and income in retirement accounts or giving them to charity, people can postpone paying taxes on them. They can also employ techniques like carried interest, like-kind swaps, and stepped-up basis to avoid or reduce taxes on their investment income.

Underreporting income and overstating expenses: The wealthy frequently underreport their income from sources such as self-employment, business partnerships, rentals, royalties, and gratuities that are not subject to withholding or reporting. Additionally, they inflate deductions, pass off personal spending as business expenses, or make up imaginary bills to misrepresent their costs. To produce fictitious losses or income shifting, they may also utilize complex schemes involving offshore businesses, trusts, or insurance contracts.

What can be done to combat tax evasion by the rich? The Treasury Department has proposed a series of measures that aim to increase tax compliance and fairness. Some of these measures are:

In recent years, the IRS has seen major budget cuts and staff reductions, which have made it more difficult for it to audit and collect taxes from high-income people. According to Treasury Department projections, spending an additional $80 billion on the IRS over ten years would result in an increase in revenue of roughly $700 billion3. Additionally, the proposal asks for increasing information reporting on financial accounts, cryptocurrency exchanges, and other revenue sources that are now not being disclosed.

Changing the tax system to get rid of advantages and loopholes The tax system has also been subject to several revisions from the Treasury Department that would make it more progressive and egalitarian. Some of these changes include increasing the top marginal income tax rate from 37 to 39.6 percent, taxing capital gains and dividends at ordinary income rates for those making more than $1 million annually, capping the number of deductions available to high-income taxpayers, closing the carried interest loophole, taxing unrealized capital gains at death, and imposing a minimum tax on businesses that report low or no profits.

Increasing international collaboration and transparency: To combat tax evasion and avoidance by multinational firms and individuals, the Treasury Department has also called for increased coordination and information sharing across nations. The strategy backs the Organisation for Economic Cooperation and Development's (OECD) global minimum tax effort, which seeks to guarantee that businesses pay a fair amount of taxes in each nation in which they conduct business. In addition, the proposal backs the creation of a worldwide network for the automated sharing of data on financial accounts as well as stricter transparency rules for trusts and offshore corporations.

 

Rich people avoiding paying their fair share of taxes is bad for the economy and for society as a whole. It denies the government of funds that could be used to pay for universally beneficial public goods and services. Additionally, it erodes social cohesiveness and the public's confidence in the tax system. The United States can make great progress toward narrowing the tax gap and ensuring that everyone pays their fair share of taxes by putting the Treasury Department's recommendations into practice.