Rethinking Tax Structures: The Evolution and Efficacy of Income and Inheritance Taxes

In the early 20th century, a significant shift in tax philosophy emerged. The prevailing notion became that taxes ought to be based on individuals’ means, placing heavier burdens on those with greater financial capabilities.

This “tax the rich” approach played a crucial role in shaping two fundamental tax systems of today: the income tax, introduced in 1913, and the inheritance tax, which followed in 1916. Income tax rates were designed to be “progressive,” meaning that individuals with higher taxable incomes would pay more, thereby exempting many low-income earners. Conversely, the inheritance tax aimed to impose a financial charge on the wealthiest Americans when transferring wealth to successors.

Initially, these taxes primarily targeted the very wealthy, sparing over 95% of Americans. Yet even as the income tax system expanded during World War II, the focus on taxing the affluent persisted.

Today, the structure of our income and inheritance taxes remains largely unaltered, still featuring progressive rates and taxes applicable mainly to the wealthiest citizens. However, recent evidence suggests these taxes are failing to achieve their intended purpose.

Wealthy individuals often find ways to sidestep income taxes altogether, taking advantage of methods to avoid taxable income. While experts in taxation have been aware of such practices, the private nature of tax returns has historically concealed specific cases. This dynamic shifted with the 2021 publication by ProPublica, which disclosed actual tax returns. Notably, it revealed how high-profile figures like Jeff Bezos, Elon Musk, and Michael Bloomberg manage to avoid paying income taxes entirely by not registering taxable income.

The inheritance and gift tax structure was established to curb extensive intergenerational wealth transfers, aiming to maintain a level playing field in American society for decades. Yet, much like income tax, it appears to have lost its original effectiveness.

Current economic indicators suggest that wealth concentration has surged to unprecedented levels since the modern tax system was established, negating the impact of inheritance taxes, which now raise only a fraction of total federal revenues. The methods to avoid inheritance taxes are not only recognized but are thriving, enabling wealth to be passed down through generations.

The way wealthy Americans manage their taxes varies significantly from person to person. Still, overarching trends indicate a reliance on tax avoidance strategies and the building of dynastic wealth.

How the Wealthy Avoid Income Tax

The majority of Americans depend on incomes from jobs—often heavily taxed—to support their families. In contrast, many among America’s richest evade taxes by opting out of traditional salaries. For example, figures like Larry Ellison and Mark Zuckerberg may draw minimal salaries, while others like Elon Musk reportedly earn nothing at all, leading to legal challenges regarding minimum wage compliance. This has resulted in some billionaires paying no income taxes, despite their immense wealth.

Avoiding payroll altogether not only sidesteps income taxes but also removes the burden of payroll taxes, which fund programs like Social Security and Medicare, the nation’s largest expenditures.

Even though these wealthy individuals forgo salaries, they don’t completely miss out on financial benefits. Instead, they focus on growing the value of their holdings, which enables them to accumulate wealth without immediate tax implications. Gains are typically taxed only upon sale, and if they hold their assets until death, heirs inherit them as if they had bought them at the current market value—thus avoiding any tax on earlier profits. Additionally, by leveraging these assets for loans, the wealthy can enjoy the benefits of their investments without incurring tax liabilities.

The implications of failing to tax the wealthy are profound. It allows their fortunes to increase rapidly, resulting in heightened wealth concentration.

Tax avoidance is not limited to the ultra-rich; even many affluent individuals utilize borrowing as a tax-free growth strategy rather than traditional salary measures. This trend has emerged relatively recently, as until 1982, companies typically distributed profits through salaries and dividends—both heavily taxed. However, regulatory changes allowed firms to redirect profits from dividends to stock buybacks. This resulted in a significant loss of tax revenue and provided wealthy investors with a straightforward means to accumulate wealth tax-free.

Among taxpayers, working affluent Americans shoulder the highest tax burden. They earn substantial incomes and, consequently, pay significant income and payroll taxes. Unlike them, the wealthiest can access tax avoidance mechanisms that shield them from taxation.

Supporters of the current tax framework often argue that income taxes already impose a heavy load on the wealthy. It’s true the top 1% of earners contribute roughly 40% of all income taxes, while a significant portion of the population pays nothing. But this perspective doesn’t account for how many of these wealth holders can escape taxation altogether, as evident in the notorious tax returns that demonstrate this disparity.

The Erosion of the Inheritance Tax

Though the inheritance tax remains legally in place, its effectiveness has waned, largely due to 1990s public relations campaigns that branded it as a “death tax” and portrayed it as an unjust double taxation that impacts family businesses. While these initiatives did not eliminate the tax altogether, they altered public perception, making lawmakers hesitant to tighten regulations on loopholes.

Since 1990, Congress has failed to address loopholes in the inheritance tax, allowing wealthy individuals to navigate these complexities through an array of strategies and schemes.

The U.S. income tax system was originally structured with the assumption that estate and gift taxes would operate effectively, keeping recipients of such wealth exempt from income tax, regardless of how substantial the amounts are.

While the wealthy often receive commendations for their charitable contributions, these acts can lead to significant tax revenue losses for the federal government, with benefits for the public remaining uncertain. A large percentage of Americans see no tax breaks from charitable donations, while those with financial savvy exploit their philanthropic efforts to secure tax advantages. This can result in taxpayers effectively subsidizing the billionaires’ philanthropic endeavors.

While some donations may offer societal benefits, there’s no guarantee maintaining that standard. Frequently, the wealthiest contribute to private family foundations or donor-advised funds rather than directly to vital resources like food banks. This gives them immediate tax breaks without obliging them to allocate funds to charitable purposes swiftly.

The choices made today regarding taxation on the wealthy will significantly influence the future of the country and its economy.

Allowing the wealthy to escape taxation reinforces the rapid accumulation of wealth in their hands, intensifying concerns about wealth concentration and its ramifications for American democracy. The preeminent issue persists: how to achieve a consensus between elites and ordinary citizens within a democratic society—a challenge that transcends party lines.