Tuesday, October 29, 2013

Gary Shilling: The Wealthiest Are in the Taxmans Crosshairs

After the recent recession, the personal-taxes-to-personal-income ratio dropped well below the 12.3 percent long-run average, a casualty of the tax cuts, depressed household incomes and the weak recovery. In combination with depressed corporate tax collections and increased federal spending -- especially in 2009, when outlays equaled 6 percent of gross domestic product -- these forces pushed the federal deficit to more than $1 trillion a year.

At the time, the widespread conviction in and out of Washington was that “fat cat” Wall Street bankers, as President Barack Obama labeled them in 2009, were responsible for the financial collapse, prolonged recession and slow recovery. Americans at the top have regained all they lost and then some; many lower on the income scale, however, remain mired in high unemployment and declining real wages.

Long-term unemployment leapt to record levels. The number of those who prefer full-time jobs but are offered only part-time work skyrocketed to an all-time high. And job openings began to grow much faster than new hires as cautious employers became choosy. As of August 2013, payroll employment was 1.9 million below its January 2008 peak, even though the working-age population grew by 13.1 million in that period. Payroll growth slowed in September, with 148,000 workers added, following a revised 193,000 gain in August, according to Labor Department data released yesterday.

Furthermore, the wealthy, with their large stock holdings, have benefited most from the bull market that began in March 2009. Americans who aren’t in the highest income brackets tend to have most of their wealth concentrated in their homes; in 2010, the value of the residences of the top 10 percent was only five times that of the bottom 20 percent. The stock holdings of the richest 10 percent were 50 times greater. And even with the recent rebound, the median prices of single-family houses are still 24 percent below the April 2006 peak.

Given all this, it seemed inevitable that taxes would go up. At the beginning of this year, the Social Security tax paid by employees returned to 6.2 percent from 4.2 percent on income less than $113,700. But other changes affected only high-income earners: The rate returned to 39.6 percent from 35 percent on couples’ incomes of more than $450,000; capital-gains and dividend rates rose to 20 percent from 15 percent. For joint filers with more than $300,000 in adjusted gross incomes, personal exemptions were phased out and as much as 80 percent of itemized deductions were eliminated.

As is often the case when the personal-taxes-to-personal-income is low, the Internal Revenue Service has accelerated audits of rich taxpayers. It has even created a separate division, the Global High Wealth Industry Group, to enforce compliance. In the 2012 fiscal year, the IRS audited 5.4 percent of tax returns of Americans who earned between $500,000 and $1 million, up from 3.4 percent in 2011. Audits of those in the $1 million to $5 million category increased to 12 percent from 6.7 percent; 21 percent of people reporting $5 million to $10 million in income were audited, compared with 12 percent for 2011.

More recently, the IRS sent 20,000 letters to small-business owners, seeking to establish whether they were underreporting their business income. The tax-collection agency is taking advantage of a 2008 law that gives it broader access to merchants’ credit- and debit-card records, which it can compare with tax returns. Unusually large credit-card transactions suggest underreporting of cash sales. Underreported income constitutes the bulk of the so-called tax gap, the difference between what taxpayers owe and what they pay, according to the IRS. In 2006, the latest data available, the total gap was $450 billion.

The IRS is also pursuing Americans with undeclared investment accounts in Switzerland and other tax havens. The Swiss government protected the country’s banks from disclosing information on tax dodgers to U.S. authorities. Threats to cut off those banks from business in the U.S. and cooperation from a former employee of UBS AG (UBSN) forced a change of policy.

In July 2008, a U.S. Senate investigation found that the Treasury loses about $100 billion a year to offshore tax evasion; UBS was found to have hidden about $20 billion belonging to 20,000 Americans. UBS subsequently agreed to hand over the names of 4,450 U.S. account-holders and pay a $780 million fine. In 2011, Credit Suisse Group AG (CSGN) also agreed to disclose the names of clients suspected of dodging U.S. taxes.

Switzerland is the biggest offshore banking haven, with $1.8 trillion in foreign assets under management. Five percent of the total is owned by Americans. Swiss banks are now rushing to cooperate with the IRS and tax authorities in other countries. The government recently agreed to share data for tax purposes with almost 60 countries by signing the Organization for Economic Cooperation and Development’s tax information agreement. Switzerland also has agreed to follow U.S. law requiring foreign banks to provide data on U.S. accounts.

Banks in other tax havens such as Andorra, Liechtenstein, Singapore, the island of Jersey, the British Virgin Islands, the Cayman Islands and Monaco are also opening to U.S. tax authorities. And the IRS is pursuing money hidden in Caribbean, Israeli and Indian banks. Other countries such as Austria and Luxembourg have relaxed bank secrecy laws.

In 2008, the IRS established an amnesty program that allowed Americans with undeclared offshore accounts to avoid criminal prosecution by paying all taxes owed, plus interest for the past six years and a penalty of 20 percent of the accounts’ highest values. About 15,000 tax dodgers entered the program and 23,000 more signed up for a more punitive effort in 2011. The U.S. has collected $2.2 billion from the 2009 amnesty cases that were closed as of September 2011, with average revenue per case of $80,000. For 2009-2012, the IRS collected $5.5 billion in unpaid taxes and penalties, and it expects to collect $5 billion more.

Yes, the recent tax increases have been aimed at the “fat cats.” It is also true the IRS has stepped up audits of the wealthy and small-business owners and hotly pursued tax dodgers with foreign investment accounts.

Yet the invisible hand that underpins shifts in taxation has also probably been at work in pushing up the personal-taxes-to-personal-income ratio because the increase in Social Security taxes on employees hit lower-income people hardest in relation to their pay. Of course, the $1 trillion federal deficits were also an inducement for higher government revenue.

The invisible hand overcame the declines in real weekly wages and real median incomes. It also prevailed over the still-depressed prices of houses, the biggest asset for all but the richest. About two-thirds of homeowners have mortgages, and those with middle and low incomes account for the greatest share. The home equity of mortgage holders has risen along with house prices recently. Still, on average, it’s only 23 percent, less than half what it was in 1983.

Households are still overburdened with debt. The total has fallen to 104.7 percent of after-tax personal income in the second quarter, from 130 percent, but it still is well above the 65 percent norm in the early 1980s. Furthermore, the decline so far is almost entirely due to falling home-mortgage debt, largely a result of write-offs of bad mortgage loans. Much smaller credit-card and home-equity revolving debts have declined, though student loans have ballooned.

Household net worth has risen in relation to after-tax income, but remains below the peaks of the late 1990s and the mid-2000s. Moreover, 43 percent of the increase in the ratio since the recessionary low in the first quarter of 2009 is due to higher equity prices and, as discussed earlier, individual stockholders are predominantly high-income people. Only 8 percent of the increase is the result of the appreciation of wider ownership of real estate.