Tax Preferences of the Rich
Tuesday, October 05, 2010 at 11:46 am
It seems paradoxical: The wealthy pay higher income taxes than low- and middle-income Americans. But they also often pay lower effective tax rates than their much poorer counterparts. The archetypal case is Warren Buffett’s: The billionaire investor has complained that he pays proportionately less tax than his secretary, who makes a fraction of what he does.
Why? The rich tend to make more money from capital gains — rising stock prices and real estate values, for instance — than from salary and wages, and the country taxes capital gains at much lower rates than income. And they have dozens and dozens of tax loopholes to exploit. The Wall Street Journal plumbs one today. The very wealthy often use tax-free life insurance policies to pass funds onto their children without paying the estate tax.
Of the two main life-insurance tax preferences, the one that has faced the most scrutiny from Congress over the years is the provision that lets investment gains accumulate tax free within permanent-life policies.
The Congressional Budget Office last year estimated that eliminating the tax preferences for investment gains inside permanent-life insurance and annuities would raise an additional $265 billion in taxes over a decade.
Some tax-policy specialists contend the provision artificially favors income in insurance policies over things like interest on bank certificates of deposit. Some also say that because the break enables people who can afford large life policies to accumulate earnings free of taxes, it gives the affluent tax advantages far beyond those available to middle-income people through a 401(k) or IRA.
In 2005, a bipartisan panel appointed by President George W. Bush recommended changes that would have severely crimped tax-free investment gains in life insurance, as part of a broader tax overhaul. The panel said life insurance allows some people to get “nearly unlimited tax-free savings” and that a change would “level the playing field.” The proposal went nowhere.
According to Federal Reserve survey data, 22 percent of assets accumulated tax-free in whole-life and universal-life policies were held by the wealthiest 1 percent of U.S. families in 2007 — those with more than $8.4 million in net worth. More broadly, 55 percent of the assets in such policies were held by the wealthiest 10 percent of families. The bottom half by net worth held 6.5 percent of these assets.
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