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The tax blockbusters you may have missed

Commentary
June 23, 2021By Juan Carlos Ordóñez

In the tax policy world, the summer blockbusters arrived a bit early. News articles and studies revealing the tax shenanigans of the rich have been coming in fast and furious over the past month.

In case you’ve missed them, here is a recap.

ProPublica names the superrich paying little or no federal income taxes

One of the biggest tax stories in decades broke earlier this month, when ProPublica aired the tax secrets of the nation’s wealthiest people. The investigative news site hit the motherlode: IRS data on the federal tax returns of Jeff Bezos, Warren Buffett, Elon Musk, and others. The information showed many of these billionaires paid no federal income taxes in some years, and very little others, at a time when their fortunes have grown by billions.

The superrich can make their tax bill disappear using perfectly legal means, availing themselves of “tax-avoidance strategies beyond the reach of ordinary people,” ProPublica explained. One of the biggest loopholes is the fact that gains on assets such as stocks and bonds are only taxable when they are sold. Thus, even as Amazon’s stock price goes through the roof and Jeff Bezos’ wealth multiplies, he pays no income taxes on those gains unless he sells stocks. But billionaires don’t do that. Instead, they use their stock as collateral to take out loans to support their lavish style. This allows them not only to avoid paying income taxes, but maybe even to get a tax break for deducting interest paid on some of those loans.

That the superrich pay little or nothing in taxes did not come as a big surprise to tax experts, who have warned for years that giant tax loopholes lead to predictable endings. But it’s one thing to assume massive tax avoidance at the top, and another to see it on the big screen. Want a supervillain? How about Bezos, who at a time when his net worth stood at about $18 billion, claimed and received a $4,000 tax credit for his children?

The ProPublica story has significant implications for Oregon. For one, the Senior Senator from Oregon, Ron Wyden, chairs the Senate Finance Committee. In recent years, Sen. Wyden has put forth excellent proposals to reform structural flaws in the tax code, including some of the tax loopholes exposed by the ProPublica story.

Second, it’s clear the Oregon legislature also needs to contend with the issue of tax avoidance at the top. If the superrich are paying little or no federal income taxes, you can bet they are paying little or no income taxes in Oregon.

The New York Times shows how private equity has captured the tax system

Days after ProPublica released its investigative piece, The New York Times explored another genre of tax avoidance, the kind practiced by the private equity industry. Private equity typically refers to firms that buy other companies with borrowed money, debt placed on the books of the purchased company. Private equity firms then look to slash costs and, in a few years’ time, unload the company for a tidy profit. Critics point out that this business model is little more than asset-stripping, as the purchasers risk little of their own money, placing the risk on the employees of the acquired companies, investors, and lenders. Indeed, along the trail cut by private equity lie the carcasses of many bankrupted companies.

Tax avoidance is also part of the private equity business model. Private equity firms enjoy a special tax loophole, the “carried interest” rule. It allows owners of private equity firms to treat profits not as regular income, but as capital gains income subject to much lower tax rates. This slashes the tax bills of some of the nation’s richest people. Private equity, said Senator Wyden in a cameo appearance, “is always saying that Western civilization is going to end if they have to pay taxes annually at ordinary income rate.” Many elected leaders, including former President Trump have railed against carried interest, but the loophole remains.

Now, as the New York Times revealed, private equity firms have found a way to stretch the carried-interest loophole — a practice so dubious that people inside the industry have blown the whistle. Carried interest is supposed to apply to private equity’s cut of the profits from the sale of the acquired company. But now, private equity firms have applied the loophole to management fees, basically by rebranding them as part of the carried interest.

This story has no Hollywood ending; the villain triumphs. As The New York Times explained, starved of resources, the IRS has practically given up policing private equity. This powerful industry also protects itself through vast campaign contributions and industry insiders placed within regulatory agencies. “Private equity’s ability to vanquish the I.R.S., Treasury and Congress,” The New York Times said, “goes a long way toward explaining the deep inequities in the U.S. tax system.

The IRS admits partnerships are almost never audited

Last month, the IRS released a report describing the Biden Administration’s efforts to close the “tax gap,” the difference between taxes owed to the government and taxes actually paid. The tax gap stood at about $600 billion in 2019 and is expected to grow to about $7 trillion over the next decade. Most of the gap, about 80 percent of it, is the result of “underreporting,” meaning people understating how much income they earned or overreaching on tax deductions or credits on their tax returns .

Underreporting “tends to rise with income,” the IRS said. This is because the rich use accountants and tax advisers who “stake out aggressive tax positions that can help shield true tax liability.” Ultimately, this makes the tax system less progressive , less fair.

The rich get away with it because the IRS lacks the resources to go after them. The report is mostly a tale of an agency hampered by declining resources, outdated technology, and lack of experienced auditors who can investigate increasingly complex business structures. One of the most memorable lines from the report is this: “More than 4.2 million partnership returns were filed in calendar year 2018 . . . the IRS audited only 140 of these returns.”

The report sets out four recommendations for shrinking the tax gap: (1) provide the IRS more resources, (2) require more reporting to the IRS from third parties (e.g., financial institutions) to make tax avoidance harder, (3) overhaul the agency’s outdated technology, and (4) regulate paid tax preparers and increase penalties for those who commit or abet evasion .

Will all of these blockbuster revelations finally move Congress to enact common sense, equitable reforms of our tax system?

Stay tuned for the sequel.