“We don’t pay taxes,” the hotel magnate and 1980s “queen of mean” Leona Helmsley famously said. “Only the little people pay taxes.” That Helmsley would go on to spend 21 months in the slammer for tax evasion should not distract us from the basic truth of her statement.
Rich people routinely get away with underpaying their taxes because the Internal Revenue Service doesn’t relish dedicating its ever-declining resources to multiyear court battles with the nation’s cleverest tax attorneys. Far better, the IRS figures, to audit low-income filers claiming the Earned Income Tax Credit. The poor lack the means to put up much fight when they’re guilty—or even, for that matter, when they’re innocent.
Even the IRS knows this is a bad way to do business, because the result is that it loses more than $380 billion each year in revenue. That’s more than half the Pentagon budget. What’s more, a new study led by two top IRS economists finds that this evasion is skewed even more toward the highest incomes than was previously understood. The researchers concluded that “unreported income as a fraction of true income rises from 7 percent in the bottom 50 percent” in the national income distribution “to more than 20 percent in the top 1 percent.”
Remember the one percent? These are the roughly one million taxpayers in the U.S. with incomes above, roughly, $500,000. They represent only 0.3 percent of the U.S. population, yet they receive nearly one-quarter of the nation’s collective capital and labor income. During the first nine years of the recovery from the Great Recession of 2007–09, they captured 45 percent of all income growth. It’s good to be the one percent.
But in the game of hiding income from the IRS, most one percenters are amateurs. From the vantage point of a high-rolling hedge fund manager, anybody earning less than $10 million resides strictly within the petit bourgeoisie. They might as well be shopkeepers. Oh sure, some cheat here or there, but don’t expect them—or, more to the point, their accountants—to possess intimate familiarity with offshore tax havens.
The cohort that’s truly serious about hiding its money from the IRS is the top 0.01 percent. This is a much more exclusive club of about 23,000 taxpayers for which the minimum price of entry is an income of about $10 million. The 0.01 percenters represent about 0.007 percent of the U.S. population, yet they receive more than 5 percent of the nation’s collective capital and labor income. In tax law, they are America’s criminal class.
“Detected evasion,” the authors of the new study write, “declines sharply at the very top of the income distribution, with only a trivial amount of evasion detected in the top 0.01 percent.” That’s not because the 0.01 percenters are more honest than everybody else. No, it’s because they’re so efficiently dishonest that the IRS really hasn’t a clue where they’re hiding their cash. “Offshore tax evasion,” the authors write, “goes almost entirely undetected in random audits.”
The study’s authors analyzed a sample of taxpayers who got caught doing something illegal, or at least were suspected of doing something illegal, during the first three years of the Obama administration and as a result had to disclose hidden offshore assets. A subset of these taxpayers had previously been subjected to random IRS audits. Fewer than 10 percent of these audits had turned up the offshore assets.
It’s no mystery why tax evasion is hardly ever detected among this income group. Tax compliance does not operate well on an honor system. For most of us—even for most one percenters—cheating on your taxes is fairly difficult because so much of your income is documented and reported to the government. Labor income is the hardest stream of revenue to cheat on because of all those W-2s and 1099s, but even investment income can be difficult to hide because a lot of that stuff gets reported, as well.
But as capital grows, it finds its way into all sorts of dark crevices: complex partnerships and abstruse financial structures that third parties such as banks don’t report properly to the government, and offshore accounts that don’t get documented at all. And not surprisingly, when there’s no third-party reporting, people cheat. Less than half such income gets reported to the IRS.
It’s also no mystery why this situation persists. Conservative political candidates, when pitching a massive tax cut or a massive increase in defense spending, are often asked how they’ll pay for it. Typically, their answer is that they’ll eliminate unnamed budgetary waste, fraud, and abuse—or that they’ll crack down on tax cheats. But although these conservative politicians may indeed later propose outlandish cuts in necessary government functions, especially if doing so might impede regulation of business, they almost never get around to proposals to crack down on those tax cheats. Indeed, the one budget cut that conservative officeholders almost always support is the plan to slash the budget of the IRS, where appropriations fell 20 percent between 2010 and 2018.
The new report has some technical suggestions for how to track under-reporting by the top 0.01 percent in the future, and there’s a laundry list of reforms that would allow the government to crack down on tax evasion, most of them involving enhanced reporting requirements. But what really needs to happen is for Congress to want to find this money. The 0.01 percent prefers it doesn’t happen, and it has the financial means to persuade legislators to leave well enough alone. So until Congress is prepared to tell these scofflaws to go to hell, nothing is going to change.