In the United States over the past few decades, the most well-to-do people—the “1%”—have garnered an increasingly disproportionately large share of the nation’s assets, concentrating greater and greater wealth in the hands of fewer and fewer people. The 2013 Federal Reserve Board Survey of Consumer Finances shows that the richest 3% of U.S. households own 54.4% of the nation’s wealth, which is more than double the total wealth of the poorest 90% of families. The top 10% hold nearly 85% of the nation’s wealth, whereas the bottom 50% only own 0.8%.
A graphic in the The Boston Globe’s 2015 Divided Nation Series illustrates the trend favoring the ultrawealthy. It shows that in 1978, the top 0.1% of the U.S. population held 7.1% of the wealth, but that swelled to 22% of the wealth in 2012 as economic gains flowed to investors and financial service providers. In 2012, the top 0.1% of the population represented about 160,000 families with net wealth above $20.6 million (see http://bit.ly/1XIPhGN). The share of U.S. wealth of the top 10% declined from 81.9% to 79.2%, but the portion held by the lower 99% of that group fell from 74.8% to 55.2%. During this same period, the share of the least wealthy 90% dropped from approximately 28.1% to 22.8%, reflecting stagnation in wage growth.
Such a concentration of wealth has more potential adverse effects than envy and social unrest. According to the Institute for Policy Studies (IPS), recent research reveals that extreme wealth inequality may be having a negative effect on the health and longevity of Americans (see http://bit.ly/1SWkXtk).
HOW DID THIS HAPPEN?
A December 29, 2015, article in The New York Times titled “For the Wealthiest, A Private Tax System That Saves Them Billions” stated that “the wealthy have used their influence to steadily whittle away at the government’s ability to tax them.” The result has been much lower tax payments by the ultra-rich. The newspaper reported that 20 years ago “the 400 highest-earning taxpayers in America paid nearly 27 percent of their income in federal taxes, according to IRS data. By 2012…that figure had fallen to less than 17 percent, which is just slightly more than [that paid by] the typical family making $100,000 annually, when payroll taxes are included for both groups.”
WHAT MUST WE DO?
To start reversing this dangerous trend, we must stop six key unethical practices.
- Eliminate the “carried interest” tax provisions. “Carried interest” is a term used to describe the bonus-incentive performance fee paid to managers of hedge and private equity funds to reward them for superior performance. The U.S. Internal Revenue Code (IRC) specifically taxes this income at the long-term capital gains rate (a maximum of 15%) rather than the ordinary income rate (a maximum of 39.6%). In addition, fund managers usually receive a flat-rate management fee, normally 2% of assets under management, which is taxed as ordinary income.
- Effectively cap tax deductibility of excessive executive compensation. The IRC prohibits corporations from deducting executive salaries exceeding $1 million. This has resulted in compensation for senior executives being based largely on short-term and noneconomic measures of “performance” that may be detrimental to the company. Use of unaudited, self-determined performance goals for bonuses instead of financial results reported to shareowners can ensure payment of bonuses to executives regardless of whether the outcome really is favorable for shareowners or whether the executive contributed to achieving the outcome.
- Raise the holding period for gains considered long term. Currently, a capital asset needs to be held for one year before the gains on its sale can be preferentially taxed at the long-term capital gains rates of 0%, 15%, or 20% rather than at the short-term gains rates of 10%-39.6%. No informed individual considers a year to be a long term for an investment, but the nearly two-thirds saving in taxes has strongly motivated corporate executives to be paid in stock rather than cash.
Companies may use cash to repurchase shares from the public to increase earnings per share outstanding rather than investing in a long-term strategy. Focusing on short-term results that support share prices or “quarterly capitalism” can lead to management of earnings to meet short-term expectations. Lifting the holding period for preferential tax treatment of gains by at least two or three years would direct management to focus more on the longer-term sustainability of the enterprise.
- Restrict transfers of wealth to tax havens. Research by University of California-Berkeley economist Gabriel Zucman reveals that as much as $7.6 trillion—or 8% of the world’s total financial wealth—is believed to be hidden from view worldwide and isn’t being taxed. The annual effect on government revenues is significant. Zucman believes tax evasion by individuals costs governments $200 billion a year, and tax-saving strategies by U.S. multinational companies cost the U.S. government $130 billion annually.
In an interview with Jesse Drucker for a September 21, 2015, Bloomberg.com article, Zucman said that the need to stop the wave of tax avoidance and evasion goes beyond the revenue lost to the particular dodges. “If a significant fraction of rich people can evade taxes and if the rest of the population feels taxes are not fairly enforced, then the willingness to pay taxes will disappear,” Zucman asserted.
- Reduce tax subsidies for home ownership. Increasing home ownership has been a worthwhile objective for many years, yet wealthy individuals receive subsidies in the form of tax deductibility for second homes only they can afford. Further, a cap should be placed on the tax deductibility of mortgages now subsidizing the ownership of residences of extremely high value.
- Eliminate unlimited retirement contributions for the wealthy only. “A Tale of Two Retirements,” copublished on October 28, 2015, by IPS and the Center for Effective Government (CEG), reported that CEOs of Fortune 500 companies have been able to set aside before-tax funds of $3.2 billion in special tax-deferred compensation accounts that are exempt from the annual contribution limits imposed on ordinary individuals’ 401(k)s. The CEOs don’t have to pay any income tax until they withdraw from the accounts after retirement. In 2014 alone, these CEOs saved $78 million on their tax bills by putting $197 million more in these tax-deferred accounts than they could have if they were subject to the same rules as other workers. Almost half of total retirement assets for Fortune 500 CEOs are in the form of deferred compensation.
Stopping these practices will require strong Congressional leadership, but implementing them will help society avoid a growing, serious problem.
IMA ETHICS HELPLINE
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