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Just What Do The Rich Have That's Taxable?

Dec 10, 2011
Originally published on December 11, 2011 6:42 am

In a lot of ways, Nick Hanauer is just like many Americans. He lives in Seattle with his wife and two children, and he grew up working in the family business, manufacturing pillows and comforters.

But recently, Hanauer wrote an opinion piece for Bloomberg News that was a plea to the government: "Please tax me more."

These days, Hanauer is a venture capitalist who was one of the first big investors in Amazon. He's not quite a billionaire, but not that far off, either, and he insists his plea is all about self-interest.

"I reject the idea that I am advocating higher taxes for myself and other wealthy people because I'm a good person or because I love you," Hanauer tells weekends on All Things Considered host Guy Raz. "Let me just be very clear: I do not love you. I value you as a potential customer, and we have rigged the economic system in a way to destroy my customer base."

The top income tax rate in America is 35 percent. If you earn $380,000 or more a year, that is, in theory, what you pay in federal income taxes. Many taxpayers in this category do, in fact, pay that rate, but some do not.

The richest of us, billionaires, derive the bulk of their wealth from stock appreciation. Their income strategies often reap hundreds of millions of dollars from those valuable shares in ways the IRS doesn't always classify as taxable income.

No Income, No Income Tax

Bloomberg reporter Jesse Drucker recently found out that, for the most part, the richest people in America pay nothing close to 35 percent.

"Larry Paige or [Sergey] Brin at Google, these are men who are extremely wealthy," Drucker says. "They get salaries of a dollar a year."

That's because the wealthiest Americans make their money from money; from stocks and investments. And from a tax perspective there are huge advantages to that.

A wage is taxed automatically, but capital gains from stocks are only taxed when you cash them in. So Drucker found that many of the so-called super rich don't sell their investments at all. To buy cars and houses and groceries and clothes, they borrow money — often at very low rates.

Since 2003, the richest investors have been able to do even more, thanks to a rule change from the IRS. To avoid paying taxes, wealthy clients can make deals with investment banks for something called a variable prepaid forward contract.

"It basically [says]: 'I agree to give you my stock at a certain point in the future in exchange for cash now,'" Drucker says.

Drucker says the IRS doesn't necessarily consider that a sale of stocks, even though the bank may pay that investor hundreds of millions of dollars to temporarily own his shares. It allows the investor to avoid paying capital gains taxes, which right now are 15 percent.

So it's not exactly a bending of the rules, but more a bending of the spirit of the rules. In recent years, however, the IRS has been less likely to let people bend the spirit of its rules.

A couple of years ago, a billionaire investor named Billy Joe "Red" McCombs made one of these deals. It made him $259 million, but because it wasn't officially a sale, he didn't report that $259 million as income and it never showed up on a tax return, Drucker says.

"Very wealthy people are pretty regularly figuring out ways to cash out appreciated shares and appreciated real estate in ways that do not show up on tax returns," he says. "And the result of that is that the 17 percent rate that we hear often cited by Warren Buffett ... is probably much too high. In reality there are many folks paying effective tax rates that are much lower."

Venture capitalist Nick Hanauer, who makes about an eight-figure income annually, says his tax rate this year was about 11 percent. Most Americans think that the tax rate on the very wealthy is 35 percent, but Hanauer says this is absolutely not true.

"If you're a small business person earning $350,000 a year, your tax rate is 35 percent," he says, "but if you're a hedge fund guy or an incredibly rich person ... all of your income is from capital gains or dividends or tax-free municipal bonds – these things are taxed at much lower rates."

Paying A Fair Share

Hanauer invests in companies that hire people, so he is someone who might be called a job creator. Some economists and most Republican lawmakers argue that if you increase taxes on these people the result would be devastating for the economy.

But Hanauer says the economy is like an ecosystem and that its lifeblood is the spending power of the middle class, not people like him. He says business people spend their time fundamentally on two things: creating sales and cost containment. Or, as he puts it, "how to not create jobs."

"The fewer jobs you can create, for the revenue you create, the more profit you make," Hanauer says. "The only time that businesses create jobs is when middle-class consumers essentially put a gun to our heads, in the form of orders for products that we can't make ourselves, and then we hire people and create jobs."

His basic argument is to make the wealthiest Americans pay their fair share in order to give the middle class some tax relief. So what's a fair share?

Douglas Holtz-Eakin, a conservative economist and former director of the Congressional Budget Office under President George W. Bush, says that fairness is in the eye of the beholder.

"The wealthy now pay the dominant fraction of income taxes and they fund the dominant fraction of our government, but they pay a lower fraction of their income in taxes," Holtz-Eakin tells Raz. "So [if] fairness is either measured by how much of your income goes away or how much of the government you pay, you get a different answer."

The top 5 percent of income earners pay roughly 60 percent of income taxes, Holtz-Eakin says. In the end, he says, taxing is not a way to make any economy stronger — it's a necessary cost of having government services.

"We have to distribute the tax burden in some fair way to pay for it," he says. "So I think it's misleading to say we're going to use the tax policy to somehow make the economy grow better. It's actually a price, not a benefit."

Letting the Bush-era tax cuts expire across the board, as some have suggested, would have a strong negative impact, Holtz-Eakin says. Even the Obama administration's suggestion, of letting tax cuts expire only on the higher end of the income scale, wouldn't solve the problem. He says that if we want to raise money from the wealthy, we have to ask how we're going to raise it.

"The least effective way to raise it is to raise marginal tax rates," he says. "Let's do tax reform; that's what the Bowles-Simpson commission said [and] that's what all the fiscal commissions have said. If you want more revenue, you have to talk tax reform, because how you get it from the rich matters."

Defining Income

Perhaps what matters most is how you define income. Your wage is easy, everything else is more complicated. And Bloomberg's Drucker says that complication creates an inaccurate picture of income equality.

"The top 1 percent controls something like 34, 35 percent of the net worth or net wealth in this country, but topped out at about 20 percent of the income," he says. "So that shows you right there that the income inequality that we're talking based on tax return data from the IRS isn't really giving a full indication of the real level of inequality."

Hanauer, who's also written a book about taxes and income distribution called The Gardens of Democracy, says the system, as it is set up now, is actually bad for the economy. It's simply widening the gap between the richest and the middle class, he says.

"If Jeff Bezos and I had started Amazon in a poverty-stricken corner of Africa, there would have been no job creation, because there would be no people to buy the stuff from Amazon," he says. "The difference here is the American middle class, which is by every measure the most extraordinary economic achievement in the history of the world — and there is only one of those."

It is that American middle class that Hanauer calls "incredibly precious," not just for the American economy, but for the world's economy.

Copyright 2018 NPR. To see more, visit http://www.npr.org/.

GUY RAZ, HOST:

From NPR News, it's WEEKENDS on ALL THINGS CONSIDERED. I'm Guy Raz.

NICK HANAUER: Peter Piper picked a peck...

RAZ: In a lot of ways, Nick Hanauer is just like you and me. He spoke to us from Seattle this past week, which is where he lives.

HANAUER: You know, it's not bad. It's cold but clear, which in Seattle at this time of year is a miracle.

(SOUNDBITE OF LAUGHTER)

RAZ: And he grew up working for the family business.

HANAUER: It's a manufacturing business, a business that makes bed pillows and down comforters.

RAZ: What kind of pillows?

HANAUER: All kinds.

RAZ: He has a wife, two kids, a boy and a girl ages 11 and nine.

HANAUER: You know, we go out to eat occasionally as most American families do. I buy a few pair of pants a year as most American men do. My wife and I, we own three cars. The only really expensive thing in our family budget, frankly, is private air travel.

RAZ: Private air travel, as in Nick Hanauer's private jet.

Do you use that for family travel too? Or do you just fly commercial for vacations?

HANAUER: No. I haven't been on a commercial airplane in a very long time.

(SOUNDBITE OF MUSIC)

RAZ: Nick Hanauer is a venture capitalist. A couple years ago, he was one of the first big investors in a little start-up you may have heard of, Amazon.com. Roughly, how much do you think you're worth today?

HANAUER: Not a billion, but a lot more than a dollar.

(SOUNDBITE OF LAUGHTER)

RAZ: Now recently, Nick wrote an opinion column for Bloomberg News, and this was his plea to the government: Please tax me more. And he insists it's all about self-interest.

HANAUER: I reject the idea that I am advocating higher taxes for myself and other wealthy people because I'm a good person or because I love you. Let me just be very clear: I do not love you. I value you as a potential customer, and we have rigged the economic system in a way to destroy my customer base.

RAZ: Which he says is the middle class. Now for the top income earners, official tax rate in America is now 35 percent. If you earn $380,000 or more a year, that is, in theory, what you pay in federal income taxes. And, in fact, many taxpayers in this category do pay that rate. But many do not.

That's our cover story today: taxing the rich, who pays, who doesn't, and what's a fair share anyway? In a moment, more from Nick Hanauer. And later, former Congressional Budget Office director Douglas Holtz-Eakin on why he thinks soaking the rich is bad economics.

But first to investigative reporter Jesse Drucker. He writes for Bloomberg, and he recently published a story about how, for the most part, the richest people in America pay nothing close to 35 percent.

JESSE DRUCKER: You know, Steve Jobs at Apple or Larry Page or Eric Schmidt or Sergey Brin at Google, these are men who are extremely wealthy. You know, Brin and Page have net worths in the billions of dollars. They get salaries of a dollar a year.

RAZ: A dollar a year. That's because the wealthiest Americans make their money from money - from stocks and investments. And those are only taxed at a rate of 15 percent and only when you sell them. And since 2003 - thanks to a rule change from the IRS - the richest investors have been able to do even more.

BOB WILLENS: Yeah. I was in Lehman at that time. People said, wow, this is perfect.

RAZ: That's Bob Willens. He runs his own tax and accounting firm. But for years, he was a partner at Lehman Brothers, where one of his jobs was to cut deals with the firm's wealthiest clients that had a side benefit. It was a way to avoid paying taxes. It's called a variable prepaid forward contract.

(SOUNDBITE OF LAUGHTER)

WILLENS: It's not as scary as it sounds. It's an agreement that an owner of stock enters into typically with an investment bank...

DRUCKER: Basically, I agree to give you my stock at a certain point in the future for getting cash now.

RAZ: That's Jesse Drucker with Bloomberg again. He says the IRS doesn't necessarily consider that a sale of stocks, even though the bank may pay that investor hundreds of millions of dollars to temporarily own his shares. And it allows the investor to avoid paying capital gains taxes, which, right now, as I mentioned, are 15 percent.

Again, here's tax lawyer Bob Willens.

WILLENS: So I wouldn't say it's a bending of the rules. It's probably a bending of the spirit of the rules. You know, a lot of times, I found the rules themselves that could be questioned.

RAZ: In recent years, the IRS has been less likely to let people bend the spirit of the rules as easily. A couple of years ago, a billionaire investor named Billy Joe Red McCombs made one of those deals. He earned $259 million out of it. But because it wasn't officially a sale of stock, he didn't report that 259 million as income.

DRUCKER: The thing that's interesting about Mr. McCombs, and, you know, not to single him out because this is something a lot of very wealthy people do, is that in a year when Red McCombs got $259 million in cash from an investment bank to spend however he wanted, that $259 million did not show up anywhere on his tax return that year.

In other words, very wealthy people are pretty regularly figuring out ways to cash out appreciated shares and appreciated real estate in ways that do not show up on tax returns. And the result of that is that the 17 percent rate that we hear often cited by Warren Buffett that he and other folks in his class pay is probably much too high. In reality, there are many folks paying effective tax rates that are much lower.

(SOUNDBITE OF MUSIC)

RAZ: Which brings us back to Nick Hanauer.

HANAUER: I make an eight-figure income annually.

RAZ: The multimillionaire venture capitalist we heard from earlier.

HANAUER: And my tax rate this year was about 11 percent.

RAZ: How is that?

HANAUER: The reason for that is this: Most Americans think that the tax rate on the wealthy is 35 percent. But this is absolutely not true. If you're a small business person earning $350,000 a year, your tax rate is 35 percent.

RAZ: Right.

HANAUER: But if you're a hedge fund guy or an incredibly rich person like me, all of your income is from capital gains or dividends or tax-free municipal bonds or what have you. And these things are taxed at much lower rates.

RAZ: Now Nick Hanauer is someone who might be called a job creator. He invests in companies that hire people. And some economists and most Republican lawmakers argue that if you increase taxes on these people, the result would be devastating for the economy. Here's Speaker of the House John Boehner.

REPRESENTATIVE JOHN BOEHNER: Tax hikes continue to hold back job creators around our country.

RAZ: But Nick Hanauer says the economy is like an ecosystem and that its lifeblood is the spending power of the middle class, not people like him. In fact, he says he's not even a job creator.

HANAUER: Business people do two things with their time fundamentally. The first is that they try to create sales, right? Revenue, key to business. But the other thing they devote their time to equally is cost containment. That is to say, how to not create jobs. Because the fewer jobs you can create for the revenue you create, the more profit you make. The only time that businesses create jobs is when middle-class consumers essentially put a gun to our heads in the form of orders for products that we cannot make ourselves, and then we hire people and create jobs.

RAZ: And his basic argument is this: Make the wealthiest Americans pay their fair share in order to give the middle class some tax relief. The question is, what's a fair share? Here's conservative economist Douglas Holtz-Eakin.

DOUGLAS HOLTZ-EAKIN: Fairness is in the eye of the beholder. The wealthy now pay the dominant fraction of income taxes and they fund the dominant fraction of our government, but they pay a lower fraction of their income in taxes. And so fairness is either measured by how much of your income goes away or how much of the government you pay, you get a different answer.

RAZ: Right, because, what, the top 1 percent of income earners in America pay roughly...

HOLTZ-EAKIN: The top 5 percent pay 60 percent of income taxes. In the end, taxing is not a way to make any economy stronger. It's a necessary cost of having government services. We value those services. We want national defense. We want basic infrastructure. So I think it's misleading to say, hey, we're going to use the tax policy to somehow make the economy grow better. It's actually a price, not a benefit.

RAZ: Say, in a year's time from now, the Bush-era tax cuts are not extended and the rate goes up to about 39 percent for the wealthiest Americans, what is that going to do to the economy? In your view, what would actually happen?

HOLTZ-EAKIN: If we let the entire Bush tax cuts sunset, where the bulk of the money is actually to the middle and lower classes, that's going to be a big shock to the economy, $130 billion a year, $1.3 trillion pretty quickly. I think that's a strong negative impact. If we somehow do what the administration is suggesting, only do the high end...

RAZ: High end, right.

HOLTZ-EAKIN: ...it's a smaller hit, but that's never really been the argument. In my view, the argument should be if we want to raise money from the wealthy, let's ask how we're going to raise it. The least effective way to raise it is to raise marginal tax rates because, as you know, you can get financial instruments to defer that tax, you can rearrange your affairs and avoid it legally. Let's do tax reform, that's what the Bowles-Simpson commission said. That's what, you know, all the fiscal commissions have said is if you want more revenue, you have to talk tax reform because how you get it from the rich matters.

RAZ: And perhaps what matters most is how you define income. Your wages are easy, everything else is more complicated. Again, here's Bloomberg investigative reporter Jesse Drucker.

DRUCKER: You know, the top 1 percent controls something like 34, 35 percent of the net worth or the net wealth in this country, but topped out at about 20 percent of the income. And so that shows you right there that the income inequality that we're talking about based on tax return data from the IRS isn't really giving a full indication of the real level of inequality.

RAZ: Nick Hanauer, the venture capitalist who wants to pay more taxes, says the system, as it is set up now, is actually bad for the economy. It's simply widening the gap between the richest and the middle class. And he points out that if the average American family still had the same share of income they earned in 1980, they would have 13,000 more dollars to spend a year.

HANAUER: If Jeff Bezos and I had started Amazon.com in a poverty-stricken corner of Africa, there would have been no job creation because there would be no people to buy the stuff from Amazon.com. The difference here is the American middle class, which is by every measure the most extraordinary economic achievement in the history of the world. And there is only one of those, and it is the font of both innovation and of demand, not just for the American economy, but for the world's economy. And in that sense, it's incredibly precious.

RAZ: That's Nick Hanauer. He's written about taxes and income distribution in the book "The Gardens of Democracy." Transcript provided by NPR, Copyright NPR.