Warren Buffet famously said he's paying a lower tax rate than his secretary. That may be the case for most regular Americans versus the richest billionaires.
The average American pays a 17.6% federal tax rate on their lifetime earnings, according to a study by the financial technology company Self. That’s five times higher than the 3.4% tax rate a recent ProPublica report estimated that the wealthiest 25 Americans pay in federal taxes.
“It's long been understood that the tax system is very favorable to the extremely wealthy,” Seth Hanlon, a tax policy expert at the Center for American Progress, told Yahoo Money. “People who work for a living are taxed in a fundamentally different way than people who enjoy great wealth.”
To arrive at its tax rate, ProPublica considered overall wealth as income and calculated how much tax those billionaires would have paid on sources that aren’t typically taxed — such as unrealized capital gains. Stripping that out, though, the richest 25 Americans still get a break, paying a federal income tax rate of 15.8% between 2014 and 2018, according to ProPublica, which is 1.8 percentage points lower than the rate the average American pays.
‘No way to defer or avoid paying income taxes on wages or salaries’
For the typical American, their earnings largely come from salaries or wages. That’s not true for billionaires who rely on other sources.
For instance in 2017, capital income and capital gains accounted for two-thirds of the income that the top 0.01% of Americans received. But that income made up just 2.4% of the income received by the bottom 80%, according to data from the Congressional Budget Office.
“Wage-earning Americans' taxes come out automatically every month from your paycheck,” Jeff Ernsthausen, one of the reporters from the ProPublica analysis, told Yahoo Finance Live. “For the people at the very top, the bulk of their economic life takes place in unrealized gains and things that happen outside of the tax system.”
The average American has lifetime earnings of $1,500,530, of which $525,037 or more than a third (34.4%) goes to income, sales, property, and auto taxes on the state and federal level, according to the Self study. The study is based on the Bureau of Labor Statistics’ Consumer Expenditure Report (2019) and calculates taxes from the age of 18 to 79.
On average $339,173 — or 22.6% of the average American’s lifetime earnings — goes to federal and state income taxes. Around $264,146, or 17.6 % of their lifetime earnings, goes just to federal taxes.
“There's no way to defer or avoid paying income taxes on wages or salaries,” Hanlon said. “There's much more optionality that allows wealthy people to defer paying taxes on capital gains.”
‘The same thing for them as having money in the bank’
For the bottom 80% of Americans, at least 60% of their income comes from labor income, which is mostly all taxed at the federal and state level, according to CBO data. Workers pay taxes on their wages monthly, quarterly, or annually and can’t make use of the money that goes toward taxes. That’s not true of capital gains.
Capital gains are taxed only when “realized” — meaning when investments such as stocks get sold. Capital gains taxes can be deferred, allowing holders to sell at the most tax-advantageous time with losses offsetting gains. In some cases, taxes on the gains can be avoided altogether if the asset is inherited.
At the same time, billionaires can use unrealized gains — such as stocks they hold — as collateral for loans, allowing these rich Americans to obtain cash without selling their investments or paying taxes on them.
“Economically, income is gains and the ability to consume,” Hanlon said. “If you're wealthy enough, you can convert appreciated stock to cash… it’s the same thing for them as having money in the bank.”