Tax Avoidance

I’ve made comments on the blogs of others critical of raising taxes where my point was that higher tax rates may mean less revenue. Left of center critics of this assertion respond by saying that I’m suggesting that rich people will cheat on their taxes if taxes go up. That’s not what I’m saying. There are two strategies to pay less taxes. One is tax evasion, and the other is tax avoidance. The former is illegal, and the latter is perfectly legal. I’m not going to cheat on my taxes, and even if I were to do so, I won’t tell you. Let’s say my employer offers to pay me $200 to work Saturday, or I can spend Saturday looking over my tax returns for the last 3 years to see if I missed any deductions. If I think that I’m going to find missed deductions worth more than what will be left after I pay the taxes on the extra $200 my employer pays me, I’m digging out the tax returns instead of working.

A classic fictional example of tax avoidance is the detective Nero Wolfe. Part way through the year, Wolfe makes enough money to put him in the 90% tax bracket. After this point, he is very reluctant to take cases. To make an additional $1000 after taxes, he’d have to charge a client $10,000. If he turns down an offer of $5000 to handle a case, he is legally avoiding taxes of $4500. This high tax rate isn’t really making Wolfe pay his fair share, it’s making people who need the services he provides pay more.

Let’s consider the effect of raising the capital gains tax. If you managed to buy Ford stock at its 2009 low, you would have purchased a stock now worth more than $10 for less than $2. You’d be sitting on a capital gain of over $8 per share. You don’t have to pay the capital gains tax until you sell. Any increase in the capital gains tax makes it less likely that you will sell.

We have something called the Alternative Minimum Tax because 200 people in the late 1960’s figured out how to legally make more than $200,000 a year and legally pay no income tax. That is tax avoidance.

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