About a year ago, investigative outlet ProPublica somehow managed to access a trove of confidential tax returns of the wealthiest Americans. Since then, it has published a series of reports on this data — most of which are, from a policy analysis perspective, seriously flawed. Almost a year later, ProPublica is still publishing stories on this previously confidential data, using questionable analysis to falsely claim that the wealthy are getting away with paying income taxes at inappropriately low rates.
Though we here at NTUF do not have the benefit of illegally leaked data, we can look at the plentiful data the IRS has published on the income tax obligations of individuals and companies. That data shows us that the tax rates paid by the wealthy are actually very high: in 2019, for example (the most recent year for which data is available), the top one percent paid about 39 percent of all income taxes, despite earning 20 percent of all adjusted gross income.
ProPublica instead devised an entirely new metric for their reporting — the “true tax rate.” Rather than just dividing income tax paid by taxable income, ProPublica also added nontaxable income to the denominator. This alternative measure produced much lower reported “true tax rates” for some wealthy taxpayers, creating the appearance of a bombshell for people new to this fanciful math.
Our tax system specifically does not tax unrealized “income,” but that’s not an oversight or a loophole, it’s just how reasonable tax policy works. That’s because until you actually sell an asset — be it a stock you hold, real estate, or your collection of antiques, any appreciation in value takes place entirely on paper. In order to benefit from that appreciation, you have to sell the asset, at which point you do face tax obligations.
Aside from questions of fairness, there are practical reasons not to tax unrealized gains. While some assets like publicly-traded stock shares are fairly easy to value on a year-to-year basis, others are far more difficult. It’s hard enough for assets like privately-held business shares, but gets even more complicated when you consider intangible assets like the value of a celebrity’s endorsement.
We’ve seen how mind-numbingly complex and wasteful this can be with the estate tax. When Michael Jackson died in 2009, the value of his image was claimed at $2,105 by his estate on his estate tax return. The IRS challenged this valuation, claiming that his image was worth $434 million. It took twelve years of litigation before a court set the value at $4 million.
Imagine the IRS having to go through that each year for public figures above a certain income threshold. The only people who would win from that would be the lawyers.
To justify its inclusion of nontaxable income into tax rate calculations, ProPublica references a practice called “buy, borrow, die,” by which taxpayers borrow against their assets’ values so that they can earn income without owing tax. To the extent that this is an investment practice, it’s not foolproof — corporate stock holdings are still taxed through the corporate tax code, and borrowing incurs interest. But the greater point is that the proposed cures would be far worse than the disease.
Each time a form of wealth tax has been put forward by progressives (and there have been many times), it has suffered from the same fatal flaws that have caused most European countries that once tried the idea to abandon it — they would be monstrously complex to administer, the difficulty in valuing assets would make avoidance easy, would hurt the economy by taxing normal investment returns, would curtail private philanthropy, would harm market competitiveness by forcing entrepreneurs to sell off their controlling shares to pay their tax bills, and would be of dubious constitutionality.
It’s past time for the IRS and Congress to get to the bottom of how private taxpayer data ended up in the hands of a news organization. It’s also past time for ProPublica to stop using this data to advance “alternative” measures of private taxpayers’ income tax obligations. Including nontaxable gains in any discussion of “tax rates” is at best policy analysis malpractice, and at worst deliberately dishonest.