Give Our Young People and All Americans a Chance- Fix the Rigged Tax System

June 06, 2024

We received lots of comments on our blog “War on the Young” which was issued on May 2, 2024. Most of the comments we received asked the question, “What can be done to correct this?” Today we look at possible changes that could help not only the young but America overall. It’s fair to say that today’s differences between “earners and owners” could be compared to the Gilded Age of 1870 to 1900. Back then, monopolies were created in the steel, petroleum and transportation industries. Colorful and energetic entrepreneurs were known as “captains of industry” and "robber barons.” Ultimately, reforms came to address income inequality.

There were no income taxes in the Gilded Age. Today, an income tax system favoring owners over earners has added greatly to the inequality. Here is a summary, in part courtesy of Professor Scott Galloway, about the current tax system and suggestions for major revisions.

Earners vs. Owners.  Most Americans are earners not owners. Whether you get a W-2 or a 1099, it’s a paycheck. As an earner, you use your paycheck to pay your bills, usually with little left over. Owners may also get a paycheck, but they often get most of their money from other sources including profits from investing, rent from properties and other streams of income for ownership of assets, including their business. As opposed to an earner who is paid for the 8 hours they work in a day, an owner’s money is working 24/7, in theory appreciating all the time.

The income of the bottom 80% of American household incomes is almost all derived from work. The top .01% of American households derive about 7% of their income from W-2s and 93% from their returns on what they own.

Income TaxesThe super-earners today pay a significant amount of income taxes. A married household making more than $500,000 is in the top 5% of households. Those earning $1 million are paying about 40% for federal taxes and, depending on where they live, another 5% to 14% for state and local taxes, unless they live in FL, TX, TN or other tax-free states. So, super-earners can be paying 50% of their earnings.

Owners’ taxes are much less and are much more complex than taxes on earners. In 2020 the 26,000 households with an income above $10 million paid 25% on “reported income” to the IRS. Many “reside” in tax-free states and have an overall rate of tax of 25% or lower.  Effectively, the high-income owners, at 25%, pay half as much tax on their income as the super earners at 50%.

The key difference is that much of the cash the owners receive isn’t taxable income and much of their increase in wealth may never be taxed at all. The White House recently calculated that the top 400 families in American pay an effective tax rate of 8%. Pro Publica found the 25 wealthiest households pay just 3% tax.

How has this happened? According to Professor Galloway, the system is rigged in favor of the owners in three ways- calculation, timing and collection.

CalculationMost people just talk about their “tax bracket.” Rather, they should look at taxable income and rates of tax on that income. Earners pay ordinary tax rates on almost everything except some pre-tax retirement or medical plan contributions. Owners may receive cash from sources such as dividends, rents, proceeds from asset sales and others that result in lower taxes. In most cases, the taxable income of owners is less than the cash received and/or is taxed at a rate lower than the ordinary income rate.

For example, entrepreneurs get a big break when they sell all or part of a business. Section 1202 excludes the first $10 million received in the sale, under certain circumstances. Ownership of real estate allows annual depreciation deductions, which reduce taxable income, even though the property is actually appreciating, and they get a 20% qualified business income deduction on the net rental income. Federal capital gains rates max out at 23.8% as compared to 40% on ordinary income. Managers of private equity and venture funds make most of their money from the increase in value in their funds. This compensation is called “carried interest” which is taxed as capital gains, not ordinary income. (This was a $14 billion loophole in 2022.) Further, no tax is paid on appreciating assets until sold. Owners can borrow against assets and receive cash without paying tax.

Also under current rules, when an owner dies with appreciated property, the capital gains of the assets, i.e. the increase in value, are not taxed at all. The “cost basis” is “stepped up” so the beneficiaries of the owner get the value as of the date of death -they can then sell it without a capital gain or start depreciating the asset using a higher number. Of course, under current IRS regulations an estate of more than $13.6 million ($27.2 million for a couple) will have to pay estate taxes, but the capital gain taxes are never assessed or paid.

In short, the share of owners’ income taxed at preferential rates has been 54%. For those earners making $1 million or less, their share of income taxes taxed at preferential rates is 8%.

Timing.  The wealthiest families know the best time to pay taxes is never, using the tax strategy of “Buy, Borrow and Die.” Owners live on loans collateralized by company stock or real estate, which causes no current taxes. When the owner dies, stock goes to the heirs, with a “stepped up basis,” who pay off the loans and start the cycle over. “Wash, Rinse, and Repeat,” creates dynasties.

CollectionThe tax programs and strategies above are all legal and part of our tax code. In 1913 when the federal income tax started, there were four pages of instructions. Now we have a 7,000 page tax code, and another 68,000 pages of federal tax regulations and official guidance, making 75,000 pages in total. The complexity of the code makes it difficult for the IRS to audit returns. The Treasury department estimates $600 billion in taxes is not paid each year. That amount is equivalent to the income taxes actually paid by the lowest-earning 90% of taxpayers.

Congress has limited the funding of the IRS, and the agency audits fewer and fewer returns each year.

However, analysis shows that for every $1 invested in tax enforcement targeting wealthy returns, $12 is recovered. 

Suggestions to make it better for the young and for more equality in America:

  1. Give the IRS more money to upgrade its collection processes, do more audits and collect more taxes.
  2. Eliminate capital gains.
  3. Eliminate the step-up basis on inheritance.
  4. Remove the income cap on social security tax (currently wages above $168k are not charged social security taxes). This would help keep the social security trust fund solvent for longer.
  5. Consider a transaction tax on securities trades.
  6. Consider a compute tax on AI and cloud services. Most of the wealth being created here is going to the wealthiest Americans.
  7. Simplify the tax code.
  8. Using the hundreds of billions per year gained by the above, consider the following:
    • Expand the child tax credit
    • Lower rates on the highest earners

Conclusion:  I have loved being a CPA for the last 55 years and a financial adviser and coach for most of that time. I have loved saving clients/friends perhaps $100 million in income taxes- all done according to the tax code. I also love fairness and equal opportunity. If the wealthiest Americans paid their fair share, our country would be a much more equal and happier place. I am fortunate to have been born in the U.S.- the best place in the world to be able to become a successful earner and owner. I’d like to do my part to help create opportunities for more people, particularly young ones, to be able to have the success and happiness many in my generation have had. Let’s revise the tax system!! Let’s give the young a better chance! Let’s make America a better and happier nation for all!!

Detterbeck Wealth Management is a fee-only financial planning / wealth management company with offices located in Palatine, IL (Chicago area) and Mt. Pleasant, SC (Charleston area) serving clients locally and across the country. To contact us about setting up an appointment, please see our contact us page within