EPRG: Tax Avoidance and What To Do About It

The St Andrews Economic Policy Research Group has been working on a series of extended reports this year and the first we would like to announce is a study on the American tax code.

In recent years, tax avoidance by the rich has become a major source of contention under the present US tax system. This is attributed to a shortfall in capital gains tax rates relative to labour income which has incentivised wealthy individuals to game the system by earning income through corporations or assets.

A comprehensive analysis on these tax loopholes unearths three primary ways in which the rich have exploited the system: offshore tax shelters, sheltering income in corporate entities and pass-through deductions. These loopholes have been promoted recently through Donald Trump’s Tax Cuts and Jobs Act of 2017 (TCJA) which has decreased the corporate tax rate. Tax havens are probably the most well-known, and operate as American firms held as subsidiaries of shell companies in countries without income tax, so people only get taxed when they bring that money into America. Apple, for example, pays almost no taxes, swindling the US government out of billions of dollars. The Tax Cuts and Jobs Act of 2017 were meant to incentivize companies not to store cash overseas indefinitely and it would boost the US economy and lead to domestic investments, but it has not had its intended effects.

Capital gains tax is levied on income from investments held over a year and is only taxed 15% from $40,001 – $441,450 whereas the top range of this would be in the 37% federal income tax bracket of labour income. This reduces people’s taxes and enabled the oft-cited trope that billionaire investor Warren Buffet pays a lower tax rate than his secretary. Becoming a self-employed contractor for pass-through deductions, rather than a salaried employee, allows people to get around taxes seemingly without reason; your “company” gets paid, and pays you individually, a dividend, thus incurring a lower tax rate than you would otherwise.

Our paper argues that a fundamental tax overhaul is required to balance the deficit between capital gains and labour income. Therefore, the current US administration must consider policies which not only equalise the tax rates on domestic and offshore earnings of US multinational companies but target and tax corporate income immediately to avoid pass through treatment. The characteristics of the tax code are seemingly arbitrary and illogical, thus significantly reducing the amount of taxes the government should be earning each year.

To read about our solutions, check out our report.

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