Taxing the Rich

For the United States the year 2021 is proving to be economically unsettling. Never before did this nation’s hierarchy ever manage to spend money at the rate it is now doing, nor succeed in generating the sort of federal budget deficit we are experiencing. The national debt in June of this year reached approximately $28.4 trillion … more than $3.5 trillion larger than a year earlier when it totaled $24.9 trillion.

It takes no imagination to see that, at the rate we are spending money we do not possess, we will, as an economic entity, soon find ourselves in serious trouble.

There are ways in which overspending of this sort can be resolved. The most rational method, of course, is a reduction in spending. Unfortunately this is often not possible for various political reasons. The alternative is normally extracting more funds from the most logical source: the taxpayers. As you possibly guessed, this is exactly what our government is in the process of pulling off – if they can swing it.

In the customary fashion, our legislative leaders are hoping to tap into those persons with substantial income while mostly ignoring the mass of low-income citizens from whom little or nothing can be collected. President Biden vows any new taxes will hit only those whose earnings are greater than $400,000 per year, or $450,000 for couples. Among other things, the bill proposes a 3% surtax on the wealthier Americans. In addition, the possibility of collecting additional taxes from corporations earning more than $5 million per year is under consideration, with the current 21% tax rate escalating to 26.5%.

At the same time the president’s plans are under review and re-review. With an expectation of increasing annual revenues by approximately $1.75 trillion, a more far-reaching program involving real estate is being generated by the Democratic members of the House of Representatives. Aimed at massively boosting government revenue at the expense of those individuals and entities which own rental properties, the plans include an increase in the taxation of real estate operating profit from 29.6% to 46.4% and an increase of capital gains upon sale from 20% to 31.8%. In addition, new limitations will phase in on the deductibility of mortgage-interest

In addition, President Biden favors a radical change in the way real estate assets are treated when an owner dies. He proposes to fully tax the step-up basis upon death. You might note that, when added to the federal estate tax, as well as the inheritance taxes numerous states employ, there is a likelihood many families which counted upon their real estate holdings as a means of retirement income for the successors may find themselves forced to sell their inherited property simply to pay the taxes.

As involved and comprehensive as is the resolve to extract additional funds from the mass of Americans at all income levels, there is another wrinkle in the taxation fabric quite new to us. It is a program just recently revealed by the president to institute a tax on billionaires … but it is not to be an ordinary tax on income, but rather what he refers to as a tax on wealth.

Although during his campaign for the presidency last year he never suggested an intention to support such a scheme, it’s obvious the runaway costs of the social-spending and climate programs he helped enact requires a source of revenue far surpassing what can be generated by the more traditional income tax increases possible.

This new tax will be assessed only on persons whose net worth is no less than $1 billion, or whose annual income is at least $100 million for three years in a row. By these standards 745 Americans currently qualify. It is proposed each shall pay a certain percentage – an amount not yet stipulated – of any increase in the value of their assets, whether or not sold during the year. As you see, although it is described as a wealth tax, it is really a form of income tax, where the income is not actually being realized to incur the levy.

As to whether this particular measure becomes law, I will concede very few people will view it with personal alarm, as it affects only a minute portion of the populous. Most surely, practically no one will ever be affected by such a statute … or will they?

Please join me in a trip back in time. The year is 1969. The U.S. Treasury just concluded a study where they discovered 155 wealthy individuals, whose 1966 reported adjusted gross income exceeded $200,000, paid no income tax. To give you an idea of the targeting, $200,000 was equivalent to $1,254,775 in today’s dollars.

Apparently, those high-income persons side-stepped income tax by combining enough perfectly legitimate tax breaks and deductions, thereby reducing their tax liability to zero. Without a doubt, according to the tax collectors, such a flagrant miscarriage of justice required correction – and correction it received; let me tell you how.

The story begins with the Vietnam War. The government needed to secure additional funds to finance a war which peaked in 1968 and 1969. President Lyndon Johnson named Secretary of the Treasury Joseph Barr to come up with some method to increase taxes. Several possibilities were considered, including a proposal by Chairman of the House Ways and Means Committee Wilbur Mills. He suggested creating a minimum tax on persons with large incomes who eliminate their taxes because their income is from sources receiving preferred tax treatment.

In early 1969 a House tax reform committee focused on a so-called minimum tax, to result in placing a ceiling on the amount of an individual’s income eligible for tax-exempt status. The result: The Tax Reform Act of 1969, by which final legislation somewhat increased revenues while closing loopholes and tax preferences. This constituted a start – but only a start. It took another nine years, following the Nixon and Ford eras, until passage of the 1978 Tax Reforms during the Carter years formally transformed the minimum tax into the Alternative Minimum Tax (AMT) and increased the percentage in taxes individuals would be required to pay.

 Several years later it was revealed the AMT raised $4 billion in 1983 and $8 billion in 1984, the result of a rule where wealthy individuals became responsible to add back all deductions, take a $50,000 exemption and then pay a tax set at 15% of the remaining income.

After years of increased budget deficits, and a prediction by Richard Darman, director of the Office of Management and Budget, that the 1990 deficit might reach the intolerable sum of $231 billion, both President George H.W. Bush and the Congress acknowledged a tax increase became a necessity. One of the many increases: the AMT became raised from 21% to 23%.

The final major tax legislation of the 20th Century, at the behest of the Clinton administration, and titled the Revenue Reconciliation Act of 1993, included yet another increase in the AMT. This time it increased to 26% for people earning between $100,000 and $175,000 and $28% for those who earned above $175,000. It remained at those rates ever since.

You may find it interesting to learn this increase was enacted Aug. 5, 1993, on a straight party-line vote, in which not one Republican voted for the measure. It passed when Vice President Al Gore, in his position as President of the Senate, cast the deciding vote.

A final comment on the AMT: Because the rates were never adjusted for inflation, it targeted not only the rich, but also the middle class … and there seemed to be no end to the misery it caused. According to a report by the New York Times it hit 30 million taxpayers as far back as 2010, and among them a staggering 94% of married filers – persons for whom the law was never intended – made $75,000 to $100,000.

However, during the Trump administration the Tax Cuts and Jobs Act of 2018 substantially altered the law. In 2018 only 200,000 households paid AMT – more in line with rationality. We shall soon find out whether, under the Biden administration, the law will revert to the monstrosity it once resembled.

Please permit me to now philosophize. The reason I’ve just annoyed some of you with the evolution of a law dating back more than a half century, is because the way it became contorted from its original presumed intent is pretty much the way we may expect to see this billionaires’ law, designed to tax only the wealthiest on their wealth, metastasize in a similar fashion.

Most assuredly, as the dollar continues to decline in value – and our government’s proliferate spending guarantees this – a greater percentage of our population will qualify as among the wealthiest to be taxed. However, it is the determination to levy taxes on unrealized income which will open the floodgates to unlimited taxation. When this occurs, no one’s assets will be safe.

A final comment: The wealth tax is not an untried novelty. Sweden abolished it in 2007 as capital and business fled. France ended theirs in 2018 after 10,000 citizens left – taking their 35 billion euros with them. And Germany abandoned its program when it saw their wealthy escaping. The simple fact is the very rich will find ways to avoid confiscatory taxes. As J.P. Morgan once said: “Congress should know how to levy and collect taxes and if it doesn’t a man is a fool to pay them.”

Al Jacobs, a professional investor for nearly a half-century, issues weekly financial articles in which he shares his financial knowledge and experience. Al may be contacted at al@abjacobs.com