Richest Americans Hide 20% Of Income, Costing You $175 Billion Annually

In “The Wealth Tax And Our Shared Insanity,” I offered a deliberately humorous take on the wealthy and their relationship with taxes.

“If you’re worth $50 million or more (let alone $1 billion or more) and you haven’t figured out how to avoid paying most taxes, then you’ve failed as a rich person,” I wrote.

While aimed at eliciting a chuckle, that assessment doubled as a pseudo-lament.

At a time when countless families across the developed world are struggling to survive economically in the wake of the pandemic, the world’s wealthiest people have enjoyed a veritable windfall. The figure (below) is familiar to regular readers. It depicts the wealth gains which accrued (on paper anyway) to the richest of the rich during what was, by many accounts, the worst year for humanity in at least eight decades.

The dynamic illustrated in that simple chart is fuel on the fire for politicians seeking to implement more redistributive policies, especially in the US where it’s fair to say that capitalism is out of control (and that’s coming from someone who’s benefited from capitalism).

Note that the mention of the developed world (i.e., advanced economies) above isn’t meant to downplay the plight of emerging markets, frontier markets or failed states. At the extremes, the problem with attempting to give due consideration to, for example, a family caught in the crossfire in Yemen, or a widow trying to pick up the pieces in whatever’s left of Aleppo, is that there’s no way to contextualize that kind of deprivation vis-à-vis any kind of policy discussion.

That is: The figures in the chart (above) are meaningless to a person for whom a “good day” is one in which a close friend or family member isn’t killed. If your days are spent dodging bullets and barrel bombs and trying not to starve, discussions about a more progressive tax code are totally irrelevant. When I couch this discussion primarily in terms of developed economies, it’s not because the multitudes of people for whom life is synonymous with acute suffering “don’t count.” Rather, it’s just that the discussion makes no sense in that context.

With Democrats in control of Washington, calls for higher taxes on the wealthy are obviously at the top of the agenda. Joe Biden will do as Joe Biden does — he’ll attempt to describe his approach as relatively centrist when he’s talking to Republican critics and he’ll try to pass off that same approach as left of center when he’s talking to Progressive critics. Neither side will believe him. And he won’t care because, to speak frankly, his job is to make critical decisions aimed at saving the country from oblivion and to make them expeditiously, before his mental acuity declines. As much as Biden wants to be a consensus builder (and he does), time is short. As he sees it, that means policy can’t (and won’t) be held hostage by Mitch McConnell or Bernie Sanders. Stuff has to get done, and thanks to the Georgia runoffs, the only person capable of throwing a spanner in the works is Joe Manchin. That’s an oversimplification, but you get the point.

So, some kind of tax reform is coming, and while it seems exceedingly unlikely that Elizabeth Warren or Bernie Sanders will get everything they want in a wealth tax or in a corporate crackdown, they’ll get as much as possible in the context of legislation that has some hope of becoming law.

I like to bury the lede, which means all of the above was a roundabout way of highlighting a new NBER paper called “Tax Evasion at the Top of the Income Distribution: Theory and Evidence.” Here’s the abstract:

This paper studies tax evasion at the top of the U.S. income distribution using IRS micro-data from (i) random audits, (ii) targeted enforcement activities, and (iii) operational audits. Drawing on this unique combination of data, we demonstrate empirically that random audits underestimate tax evasion at the top of the income distribution. Specifically, random audits do not capture most tax evasion through offshore accounts and pass-through businesses, both of which are quantitatively important at the top. We provide a theoretical explanation for this phenomenon, and we construct new estimates of the size and distribution of tax noncompliance in the United States. In our model, individuals can adopt a technology that would better conceal evasion at some fixed cost. Risk preferences and relatively high audit rates at the top drive the adoption of such sophisticated evasion technologies by high-income individuals. Consequently, random audits, which do not detect most sophisticated evasion, underestimate top tax evasion. After correcting for this bias, we find that unreported income as a fraction of true income rises from 7% in the bottom 50% to more than 20% in the top 1%, of which 6 percentage points correspond to undetected sophisticated evasion. Accounting for tax evasion increases the top 1% fiscal income share significantly.

On the off chance you can’t rapidly internalize the message, the key takeaway is this: The top 1% hides a fifth of their income from the IRS. Or, if you want to leave the rich blameless in this equation, you can restate the takeaway as follows: The IRS fails to track down 20% of the income earned by the rich.

There are two main culprits: Offshore accounts and pass-through businesses. That shouldn’t surprise anyone. Indeed, that’s precisely what I meant on March 2, when I not-so-gently suggested that anyone who’s rich and still paying a lot in taxes has “failed as a rich person.”

“In our preferred estimate (blue line), we find that income under-reporting rises sharply with income until roughly the 99.95th percentile of the distribution of true income,” the study’s authors wrote. “Specifically, unreported income is around 7% of true income in the bottom half of the distribution, rises slowly to close to 10% from the median to the 90th percentile, and then rises sharply after the 95th percentile. It hovers between 20 and 25% in most of the top 1%, and then declines from 20% to just below 15% in the top two income bins we consider (P99.95 to P99.99 and top 0.01%).”

It gets better. Or worse, depending on how you want to look at things.

“In our benchmark scenario… we estimate that 36.2% of all federal income taxes unpaid are attributable to the top 1%,” the study went on to say, before noting that “fully collecting the unpaid income taxes of the top 1% would increase income tax revenue by an amount equivalent to 10.1% of the aggregate amount actually collected.”

In 2019, for example, the authors estimate that fully collecting unpaid income taxes from the richest 1% would have increased tax revenue by $173 billion.

So, if you’re a US lawmaker and you’re looking for ways to “pay for” the stimulus checks that just went out to lower-income Americans, that unpaid tax revenue would cover around 45% of the cost. The authors went on to say that,

From a policy perspective, our results highlight that there is substantial evasion at the top which requires administrative resources to detect and deter. We estimate that 36% of federal income taxes unpaid are owed by the top 1% and that collecting all unpaid federal income tax from this group would increase federal revenues by about $175 billion annually.

What does this mean for inequality? Well, I assume that’s obvious, but just in case, the answer is in the table (below).

As the authors explained, “the top 1% earns 21.8% of true income, 1.5 points more than when disregarding noncompliance.”

Full paper