Earlier this spring, a news organization called ProPublica got a hold of private confidential tax data from the IRS on several wealthy individuals, including Jeff Bezos, Elon Musk, and Warren Buffet. It analysed the data and published a report titled ‘The Secret IRS Files: Trove of Never-Before-Seen Records Reveal How the Wealthiest Avoid Income Tax.’ The report made headlines across the world and left people feeling shocked and angry.
The CBC headline was ‘Many of the U.S. uber-rich pay next to no income tax, ProPublica reports,’while The New York Times went with ‘Wealthiest Executives Paid Little to Nothing in Federal Income Taxes, Report Says.’
I read the entire report and this is a case of apples and oranges. Make that tax apples and tax oranges.
• Apples: Income Tax In Canada and in the U.S., we have income tax, which is tax on income we earn. The rates vary depending on how much we earn. The higher the income, the higher the tax rate. A person who earns $50,000/year in Canada effectively pays approximately 20 per cent in tax, a $100,000/year earner 28 per cent in tax, and someone earning $1 million approximately 50 per cent in tax.
• Oranges: ProPublica’s ‘True Tax’ The folks of ProPublica made up their own tax, ‘the true tax’ they call it, but I will refer to it as ‘ProPublica Tax.’ They take the increase in your wealth, compare it to the income tax you pay, and then come up with their own ‘ProPublica Tax’ rate.
For example, they say Elon Musk’s wealth increased by $13.9 billion from 2014 to 2018, yet he only paid $455 million in income taxes over that period. As such, Musk’s ‘ProPublica Tax’ rate was 3.27 per cent, a shockingly low number compared to the 20 per cent to 30 per cent in income tax we are all used to paying. The message seems to be that if someone’s wealth grows not proportionally to their income tax liability, we should tax their wealth.
I was confused. If we look at increases in wealth that are disproportionate to income tax, an average homeowner in Toronto earning an average income would also qualify as being too wealthy by ProPublica ‘true tax rate’ standards. For example, take my friend Olga who lives not far from me. Olga is in her 60s. Her modest, after-war bungalow increased in value by over $600,000 the last four years. Olga earns $40,000/year in dividends from her company (average income for the area). So, her ‘ProPublica true tax rate would be one per cent.
• Apples: Taxable Income Income in tax law is a net concept. It is earnings/revenues minus expenses we incur for the purpose of earning income. Such expenses could be interest expenses, professional fees, salaries we pay, office supplies, etc. If a business expense does not fall into a specific category, it can be recorded as ‘other expense’ on a tax return.
If we incurred losses in a year or in prior years, tax law allows using the losses to offset one’s income. Thus, the tax policy encourages entrepreneurship, even when risky.
There is nothing sneaky or illegal about these deductions. Virtually all taxpayers who earn income from business or property, big and small, regardless of their tax sophistication, use these deductions.
• Oranges: Gross Revenues The ProPublica report, however, presents the very same deductions taken by the wealthy as evidence of “striking tax avoidance” and billionaires taking advantage of secret “loopholes” in tax law:
“[…] Bezos […] reported a paltry (for him) $46 million in income, largely from interest and dividend payments on outside investments. He was able to offset every penny he earned with losses from side investments and various deductions, like interest expenses on debts and the vague catchall category of “other expenses.”
Any tax professional will tell you that reducing one’s income by claiming losses, interest, and “other expenses” is neither tax avoidance nor “loopholes.” It’s basic Tax Law and Accounting 101, and you learn it during your first week of tax classes. Your accountants would be negligent if they don’t do this for you.
The ProPublica report includes colourful charts on the total or gross income the billionaires reported (before claiming legitimate business expenses) and the tax on net taxable income they paid. For example, for the year 2018 Warren Buffet’s gross reporting income was $24.8 billion and he paid $5.36 million (or 21 per cent) in taxes. The tax rate, again, looks low, but this is because it’s calculated based on gross income, not net income. Again, the ProPublica report multiplies apples by oranges.
“Instead of taxing Extreme personal Wealth, I would take A closer look at its Obvious source – Extreme corporate Wealth.”
• Confidential Private Information vs. “Secret IRS Files” The phrase “Secret IRS Files” in the title sounds like some evil powers within the IRS were protecting the wealthiest by hiding these files from the public eye. Right? Except the tax returns represent highly private and confidential information for all taxpayers, including you, me, and even Elon Musk. The IRS must by law keep this information “secret.” The source of the illegal leak is unknown and the FBI is investigating possible corruption links within the IRS. The title should really refer to the files as “Illegally obtained private confidential files.” Again, apples and oranges.
So what do we do with wealth?
One thing the ProPublica report does well is raise awareness about the income disparity problem in North America. It is a serious issue and must be addressed. So, what do we do with growing wealth? Tax it? Maybe.
How do we calculate someone’s wealth for tax purposes? At what point in time? Based on the market price on December 31? What if the market crashes on that day? What if it shoots up and then falls again? If you follow Elon Musk on Tweeter, you know what his tweet can do to stock prices!
How do we define who is too wealthy? The problem with wealth tax is often liquidity. Some need to sell their wealth in order to afford to pay tax on wealth. In my example above, Olga can only afford to pay the “wealth” tax if she sells her home. Do we force her to do that?
Of course, the uber-wealthy can afford to pay the wealth tax. I’ll leave it to economists to define the best tax policy or the right threshold for the tax (over $50 million or over $100 million), but a number of economics studies have shown that raising personal taxes has the opposite effect of what we are trying to achieve; it reduces government revenues instead of increasing them.
As a practicing tax lawyer, I note that, since the pandemic began, I have seen a significant increase in high-net-worth clients seeking to leave Canada solely because of its high personal tax rates. These Canadians realized that they no longer need to be physically present in Canada to have access to the best business opportunities, or even to provide good education to their children. Meanwhile, some countries offer a 10-year tax holiday and a two-days-per-year residency requirement. For some who are paying over 53 per cent in tax in Canada, the offer is too good to refuse. Sure, we can tax wealth, but keep in mind that in the post-pandemic world the wealthy are a lot more mobile than they used to be.
Instead of taxing extreme personal wealth, I would take a closer look at its obvious source – extreme corporate wealth, the wealth of the Amazons and Googles of the world. It’s hard to overstate these businesses’ contribution to the world’s economy. At the same time, it’s also no secret that some corporate giants do exploit gaps and mismatches (the true loopholes) in international and domestic tax law in order to minimize and sometimes completely avoid paying any tax at all. The OECD/G20 Inclusive Framework on BEPS (Base Erosion and Profit Sharing) is doing very important work in this area, and is very careful about not mixing tax apples and tax oranges.
Anna Malazhavaya is a tax lawyer and founder of Advotax Law. www.advotaxlaw.ca