Fun With Math: Our Obsession With the Rich

By now you have probably read, skimmed, or at least seen the headlines about ProPublica’s ProPublica’s huge expose regarding how the wealthiest Americans are not paying their fair share of income tax. (see: The Secret IRS Files: Trove of never-before-seen records reveal how wealthiest avoid income tax.) I am going to argue that, while ProPublica’s premise is correct, their logic and math are flawed and misdirected. 

I am really swimming against the tide here.  In a recent New York Times piece Warren Buffett and the Myth of the ‘Good Billionaire’ Anand Giridharadas, the author of “India Calling” and “Winners Take All: The Elite Charade of Changing the World” argues “ there is no way to be a billionaire in America without taking advantage of a system predicated on cruelty, a system whose tax code and labor laws and regulatory apparatus prioritize your needs above most peoples.”  Anand is being a bit harsh on America.  In terms of the Gini Index, which measures comparative income inequality among nations, America is the 53rd most wealth-concentrated nation of 159.  There are many countries whose systems and economies benefit the wealthy far more than America’s.

Regardless of his strident approach, on its face, I agree with Anand (who I knew as a child, and a very precocious one at that).  The system is at fault. 

The ProPublica answer, taxing wealth like income, is not the solution.   Neither is demonizing the rich.  I think there are few, if any, reasonable arguments against the position that the mega-wealthy should be paying “more” of a fair share.  That is a societal decision, and since we are not talking about tax evasion (illegal) but tax avoidance (stretching the legal limit to the maximum), it is abundantly clear that this is a legislative problem to fix, even if a moral one to discuss. I found Ezra Klein’s NY Times op-ed What the Rich Don’t Want to Admit About the Poor to be more on point but still predicated on the assumption that all “rich” folks are actively conspiring to keep people poor.  Again, I do not believe this.  I do believe our system is tilted towards the privileged and wealthy and I believe that should be corrected.

But how? The devil is, of course, in the details. Structure the solution correctly, and we can generate more tax revenue without damaging the incentives around the benefits of entrepreneurship, or growth, or investment for growth, or engines for job creation.  Structured incorrectly, as I will argue the ProPublica approach is, will damage growth, destroy incentives, and punish investment.

My biggest bone of contention with ProPublica’s approach is their comparison of taxes paid to wealth gain.  As with most things in this world, the Pareto effect is in operation.  That is, knowing nothing else, I would expect that, at a minimum, 80% of the wealth would be held by the wealthiest top 20% of the population and 80% of all taxes would be paid by the top 20% of income earners. 

The argument that the income to wealth ratio is a good measure of inequality is suspect – mostly because a) the two are not necessarily connected at all and b) the wealthiest, by definition, have more wealth compared to income.  The fact that income inequality exists is not up for debate here because it is true. The argument is how to fairly measure this inequality and what to do about it, fairly. 

ProPublica’s comparison of wealth gain to taxes paid – and the implication that that wealth gain should be taxed whether realized or not, is not well thought through.  For example, what happens when the unrealized wealth change is negative rather than positive?  In 2008-2010, the stock market declined by 50%.  Would the wealthiest people get a tax refund because the unrealized change in their wealth declined?  The reality is that even if Jeff Bezos’s wealth were cut in half, his wealth to tax ratio would still be an exceedingly small number compared to a middle-class income earner. For example, in 2014-2018 Jeff Bezos’ wealth grew by $99 billion and his income was $4.22 billion, and he paid $973 million in Taxes (23.1% of income).  ProPublica says Bezos ONLY paid 0.98% of his total wealth.  OK, and if Amazon someday loses value like Sears, will we refund him $50 billion?  I think not.

Now, think about what a tax on unrealized wealth means for insurance companies and pension funds.  How about IRA and 401K accounts?  It would not be fair to tax individual wealth without taxing corporate wealth, right?  Because remember, according to the Citizens United decision, corporations are people. How about the excess of a company’s cash plus receivables less payables – shouldn’t that be taxed? That’s also unrealized wealth gain, right? Moreover, the ProPublica thought is a realization of the Marxist labor theory of value; treating labor the same as capital is a hallmark of Marxism.  We have seen how successful that was.  I am sorry, but no matter how much labor put into making mudpies, it does not make them valuable. 

Income, for most of us, comes from our work.  For the more well-off, some income will come from return on savings and investments.  For the uber-rich, most of their income comes from return on investments and the sale of assets.

However, no matter what happened when I was working, when I retire, the ballgame changes.  For those with no retirement funds, Social Security is the safety net.  For everyone else, it is the growth of their investments in retirement plans that will fund their golden years.

The Social Security Administration says their payments, on average, should be no more than 40% of retirement income.  The Motley Fool says that 35% of retirees rely on Social Security for 100% of their retirement income.  If my math is right, then the rest of retirees only have an average a little less than 10% of their retirement income from Social Security (you can trust my math or you figure out Z when (0.4 = (0.35 x 1) + (.65 x Z)).  Throw out the highest income earners and say that most middle-to-upper-middle class retirees get 20% of their retirement income from social security and the rest – 80% – comes from their investments.

For the middle-class family who budgets $100,000 a year in pre-tax retirement income (in 2020, the median household income in the US was $78,500), they need $80,000 to come from investment returns, which requires “wealth” of $2,000,000.  The family who wants double that needs $4,000,000 in investments. The families will be taxed on all those investment returns: interest, dividends, and any gains from selling assets.  They will also pay tax on Social Security.  Now I ask just how much of their unrealized wealth gain does ProPublica propose to tax as well? Assuming an average annual gain of 9% or $180,000, is ProPublica really proposing that the family with annual income of $100,000 be taxed every year on that $180,000 gain? (Clearly, this tax would make the principal decline faster or reduce the income, neither a good result).  And, as most people would consider having $2-to-$4 million to be rich, I cannot imagine why ProPublica thinks this is appropriate and good policy. By the way, the 2021 threshold to be in the top 1% of wealth in the US is $4.4 million. And yet, a $100,000 to $200,000 annual retirement income does not seem high enough to me to warrant draconian measures, attitudes, or taxes.

Thus, I submit that the idea that we tax unrealized “wealth” without some indicator of how to measure wealth and at what levels to tax is dubious at best, idiotic at worst. What exactly are we trying to accomplish?  Mitigating generational wealth transfers?  Reducing income inequality?  Preventing massive wealth concentration?  Level the playing field?  Taking all the rich people’s money?

It is not clear to me what the objective is of taxing unrealized wealth gains, other than punishing the rich for having achieved (or inherited) a lot of wealth.  In order of priority, let me make a few suggestions for objectives.

  1. Ensuring that there is no poverty, no unemployment, and our minimum wage is a living wage.
  2. If you understand the Pareto principle you recognize that 80% of the wealth is likely to be held by 20% of the population. In today’s reality the top 1% of the US population holds 31% of all wealth and the next 9% have 40% and the next 10% have 16%. In other words, 20% of the US population holds 86% of the nation’s wealth. Not as far off the theoretical Pareto principle as you thought it would be, huh? As an aside, the Pareto principle may not be considered fair, just a reality.
  3. Above a certain level of “income,” it is not hard for me to consider taxing capital gains at rates like income. For the people above that level, most of their income is derived from capital, not wages and thus it seems fair to increase their capital gains taxes on the amount of gain over the level set. The argument is going to be at what level. I suggest something north of $1 Million in capital gains. It could be more, but I do not think less.
  4. At some point, our democracy is threatened by generational wealth accumulation. Our system of legislative lobbying and privately funded political campaigns is not in line what most of us have considered to be the basis of our democracy. Today, as always, money means power. I suggest two things. First, reverse Citizens United and remove unrestricted PAC money from the equation. Second, cap the amount of spending on political campaigns at every Federal level of elections – President, Senate, and House. States should do the same. If I were to have my wish, campaigns would be State and Federally funded with no private funding. Participate and volunteer your time all you want. But no cash. Not from individuals or corporations. Freedom of speech does not mean allowing the perversion of our democracy.
  5. Simplify the tax code to eliminate the discrimination in favor of the wealthy. Cap interest deductions above a certain amount of either interest or gross income. Eliminate carried interest – if corporations are people, so are private equity firms. Align the US with the rest of the world and establish a minimum corporate tax. Eliminate local municipalities’ ability to approve tax abatements for private investment. Eliminate all subsidies for fossil fuels. Cap agricultural subsidies based on the amount of land under control.
  6. Fix the estate tax so that at whatever level we decide it should kick in, it remains permanent, increasing (or decreasing) only with inflation. Changing this every time the control of Congress changes is just plan nuts. Stagger the tax rates above that level by size of estate and make it very progressive above the exclusion. If Jeff Bezos passes on with an estate of $100 billion, even an 80% tax rate will leave the heirs plenty of spending money. This provides some defense for generational wealth and certainly improves tax revenues. PS, there are only some 60 people in the US with a net worth above $10 billion. As of 2020, there are 614 Americans with net worth of $1 billion or more. I would wager most of that wealth comes from the stock in the company they own, run, or manage.
  7. Introduce the concept of a Universal Base Income set at well above the poverty level.

Now, having said that all out loud, I admit that I want to reduce ridiculous amounts of CEO income and stock option appreciation and at the same time I want to see less income inequality and more livable wages, as well as having all families able to live in a comfortable retirement.  It is about “fairness”.  I do not believe that a livable minimum wage or universal basic income or phasing out benefits at higher levels of income or a modest wealth tax above a ‘reasonable” level (to be determined) will damage our incentives to create, to growth, and to innovate. 

I am concerned that the demonization of the wealthy, with its implied demonization of capitalism, is dangerous. Does the system need guide rails? Yes.  Am I in favor of unfettered capitalism without any regulation? No.  Do I believe in social Darwinism? Hell no.  I do not believe that we have proved that self-interest is also self-correcting for society.  Capitalism needs oversight.

I also think (given what we know about the Pareto principle) that trying to rid the world of rich people is a fool’s errand that disguises the priority for fixing the system.  It also gives all the defenders of the rich the opportunity to demonize the demonizers for being radicals and therefore dismiss them.  Designing a tax structure for 330 million people by focusing on 674 billionaires is simply ridiculous. Play with the math. If 674 billionaires average $5 billion each, that total wealth is $3.4 trillion. That’s about 70% of the US Federal budget for one year. And then it does not exist anymore. And as for impact, if we taxed total “wealth” of billionaires at 3% per annum as Elizabeth Warren and Bernie Sanders have called for, that is about $100 billion a year. The equivalent of almost 8 Nimitz-class aircraft carriers or about 8% of the annual Social Security budget in 2021. An impact, but not radical.

Let us keep the eye on the prize. Reduce poverty, create a fair and equitable tax structure, support the middle-class, ensure livable wages as the minimum, create quality jobs and job security for everyone, and make sure everyone has a crack at better opportunities.  If we can achieve that, who gives a shit about the rich. For they will always be with us.

Note/Disclosure: Please check my math if you wish. If I am in error, let me know please and I will correct my misteaks.

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