Expert explains why you pay more taxes than corporations -- and the people who own them

Now that we have a seasoned Washington hand in the White House working with a team of competent appointees and a plan to distribute coronavirus vaccines we can begin to rebuild our economy.

But there is a major problem that the Biden administration doesn't appear to be planning to tackle—our hidden welfare system for people who neither need nor deserve a handout, yet Congress lets them scoop up welfare money by the boatloads.

Raising tax rates on incomes above $400,000 and on corporate profits, as Biden pledged, will bring in revenue. It will make our tax system less unfair. That's all well and good. But it also misses the big money. It misses our hidden system of upward redistribution which I've spent decades documenting from the public record.

The core problem: Not all income is verified equally nor taxed equally, if at all. The current tax system is has big holes that can be easily closed by tweaking our existing law. In terms of drafting new law—that's easy. Getting the American people to demand it and overcome the influence of those who currently benefit is another matter entirely.

Earn Now, Pay Taxes Later

The first hole allows corporations and partnerships to earn now but pay their income taxes by-and-by. The second hole is income from legal sources that the IRS never knows about, especially in real estate and art. We'll examine this second hole in a future DCReport article.

Unlike you and me, corporations and certain partnerships large enough to afford sophisticated advice–and super-rich individuals who own and control big businesses–get to earn now and pay much later.

This happens because Congress literally requires them to keep two sets of books. If that sounds like the kind of organized crime schemes made famous by Eliot Ness in pursuing Al Capone, you got it right. What should be a crime is now legal thanks to Congress.

The number for income tax that a big company like Amazon puts on its financial statement line does not indicate taxes actually paid. It's not like your W-2 wage statement of taxes withheld from your paycheck and promptly turned over to our Treasury. That line (see Item 6) just shows the tax that the company may, someday, pay.

Hidden in Plain Sight

The actual taxes paid in any given year may be less than zero as a company collects refunds on past taxes. Many big companies including Amazon have enjoyed a negative income tax in recent years. Matthew Gardner of the Institute on Taxation and Economic Policy explains more here.

Taxes actually paid are disclosed, sort of, in a footnote to the financial statements. But even that is misleading because our government's disclosure rules lack transparency and integrity.

And the taxes that should be paid are known only if the very best IRS tax auditors conduct an examination. But under rules that Congress enacted two decades ago, the IRS must notify companies in advance of what they are looking for. The IRS auditors are not allowed to pursue anything else they find, no matter how much money is at stake, unless they have clear evidence of fraud. That's official corruption.

Contrast this with Congress requiring your employer, pension plan, mutual fund, bank and stock brokerage to report how much money you collected. Petty merchants have the total of their credit card payments reported to prevent understating revenue. And it's all automated so the cost of ensuring that gross incomes are fully reported is low. The system for making regular people pay their taxes is almost perfect in its effectiveness.

Taxes as Profits

Complaints about the burden of taxes on the wealthiest among us and corporations make the front pages in the evening network news frequently. But you will almost never hear that many of these complainers profit off our tax system. That's because through the modern alchemy of accounting and tax rules they can convert the burden of taxes into a profit center.

The trick is to get a loan from Uncle Sam at 0% interest. Better yet, take out a new loan every year and the amount of capital the taxpayers are giving you to invest snowballs.

How do you apply for and qualify for these 0% interest loans? That's one of the best parts. You don't. Congress hands them out automatically under our accounting and tax rules. For simplicity, we will ignore inflation in explaining this stealth welfare for the rich program.

Don't Pay for 30 Years

Now please imagine our government sent you a letter today saying you can keep all the taxes withheld from your 2020 paychecks for the next 30 years, but you must pay up at the end of 2050.

Now invest that money in a stock that pays no dividend and increases in value at a modest four percent annual rate of return through 2050.

For each dollar of deferred tax, you will have $3.24 in 2050. After paying the $1 tax you are left with $2.24. You'll owe a 20% long term capital gains tax on that money. That leaves you with $1.79. You are richer than if withholding took the tax in 2020.

If the investment you made grew at a 10% annual rate, which wealthy individuals with sophisticated advisers should be able to achieve, the riches that flow from tax deferral balloon. Each dollar of deferred tax becomes $17.45. After paying both the deferred tax and the 20% levy on the capital gain you walk away with $13.16.

See how tax deferral can make you rich? See how it enables dynastic wealth?

How to Become a Billionaire

Now multiply that $13 by millions and billions. And now further imagine you do that year after year, as many corporations controlled by a single individual do. But for his propensity to squander money and cheat, Donald Trump's solely owned Trump Organization really would be worth more than $10 billion today thanks in good part to legal tax deferral.

Wage-earners, small and medium-sized businesses are not allowed this deferral, except in retirement plans. But you don't get the same tax deal.

When you collect from your pension, IRA or 401(k) you won't enjoy the low rates Congress levies on capital gains even though most of the money in your retirement plan comes from such gains. Congress says you must pay at the higher rate for labor, up to 37%. Except for those so poor they are exempt from all income taxes you will be burdened more than the owner of a company that deferred.

More for Their Heirs, Too

Also, while business owners can exempt more than $11 million from the estate tax whatever is left in your retirement plan when your time runs out will be fully taxed before your heirs collect a dollar. And it will be taxed at the highest rate your heirs pay Indeed, under new rules if you leave $4 million or more your heirs will be taxed at the highest income tax rate while heirs of a business owner leaving the same would pay nothing.

Paying higher tax rates and losing out on the estate tax exemption are not the only way Congress puts workers at a disadvantage to the wealthiest business owners.

Those 0% interest loans are not free. Someone had to extend the loan money. That someone is you. A dollar of tax not paid is no different from a dollar given out by our government. And in this area, we are talking in billions, perhaps trillions, of dollars of interest-free loans.

Here's how you pay. Congress spends each deferred $1 today. To cover that expense, it borrows money equal to what is deferred.

At the current blended average federal borrowing rate of about 2%, the value of the tax-deferred for three decades will cost you 81 cents in interest paid on government debt. But wait, it gets worse.

After taking those interest payments into account our government will net 19-cents on each dollar of tax-deferred for 30 years.

Warren Buffet Gets a Free Loan

One of Warren Buffett's companies has a loan that, the last time I found it in his disclosure filings, was worth $660 million. Half of it would still be unpaid 38 years later. With apologies to Mel Brooks, it's nice to be Warren.

Thanks to dynasty trusts that help generations of rich families build their wealth even as the number of descendants expands, and to the eternal nature of corporate persons, deferring a tax today is one of the most lucrative opportunities out there.

These are riches made first in the marketplace, where riches should be made, but then grow thanks to a stealth welfare program.

How to Do Something About It

The solution? Require one set of corporate books and a definition of profits set by the government instead of the cumbersome system of reconciling General Accepted Accounting Principles to tax rules. And then require that income taxes be paid under the same rules as your pay – when you make your money.

Congress could also end all existing deferrals, as it did in 2017 for profits siphoned out of America untaxed and nominally held overseas. The Republicans established that principle in the Trump/Radical Republican Tax Law in 2017.

To prevent a shock to the system Congress could require companies to declare how much is deferred, send the IRS a detailed report documenting this and then allow companies to spread tax payments across four years with an annual interest charge on the unpaid. A rate equaling our government's blended average borrowing rate would be a boon to these companies. That rate plus 1 percentage point (so about 3%) would encourage prompt payment.

Failure by the Biden administration and the majorities in Congress to address this stealth welfare for the rich would be a betrayal of the voters. It would run contrary to the promise in the preamble to our Constitution to promote the general welfare.

But unless you spread the word so people know how they are paying taxes to make zero-interest loans this burden on working Americans will continue.