Wealth versus a paycheck: different in kind, not just in degree – for whatever reason, this fundamental idea is both hard to grasp and difficult to apply for us humans. Yet, understanding it is key to understanding a lot of what goes on in politics and economic. So, here goes:
If you’ve ever earned a regular paycheck, you have no doubt noticed that the bottom line – take home pay – is less, sometimes a lot less, than your gross earning. There’s income tax withholding (fed and state), Social Security and maybe a retirement account. All us wage earners understand that the government gets its cut BEFORE we even get to buy any groceries or pay any rent,
Not so wealth, not so!
Let’s say I’m worth $100M (in my dreams!). What does that mean? Usually, it means I own a business or businesses, stock, land, and other investments. I might draw a paycheck, but, with few exceptions (famous athletes, actors, rock stars) the paycheck isn’t really material to my lifestyle – I’d live just as well if I didn’t get paid in the usual manner.
This living well without any (material) taxable income works in a number of ways. Chief among these are tax-free investments (municipal bonds, for example) and none-taxable benefits from the companies I own or trust funds I or my ancestors set up. In this example, let’s say my family has, over the years, built up a portfolio of municipal bonds worth $10M – they probably paid some taxes along the way to building this nest egg up, but that was long ago. Now, this investment yields, say, 3% – $300K per year. Also, my house(s) are paid for, my health care is taken care of from a trust fund, same with college costs, my business supply me with a car, I can discretely use the corporate jet for travel – in other words, that $300K is buying groceries and a good time. Everything else is covered.
In short, the wealthy person above is able to live like a king on just the tax-exempt interest on some municipal bonds. AND – pays no income tax.
Is this what really happens? Something a lot like this happens all the time. Sure, if I wanted to buy a new house or personal airplane, I might have to dip into the other $90M, and I might, if my tax people are incompetent, pay some capital gains tax. But, fundamentally, I don’t have to do anything or pay any taxes if I don’t want to.
About that other $90M – if things go well, it gets to stay invested and appreciates in value – again, in a tax-free way. Bill Gates, for example, didn’t pay any income tax on his investment in Microsoft as it went from a few thousand dollars in value up to $50B. Effectively, he ‘earned’ $50B tax-free. ONLY if he were so foolish as to take that $50B as income would he ever pay taxes on it. Same goes for other holders of appreciating investments. So, almost universally, the wealthy structure their money so that they have enough to live (very well) on without touching their capital investments – that way, they get richer and richer.
Finally, this arrangement is hardly accidental. From the Founding Fathers on down, our lawmakers were dominated by guys with large capital holding who wanted to make sure it stayed that way, and so the law favors holders of assets over earners of wages. This is not entirely a bad thing – making it better for people to start and run business and to think long-term about finances is good for the stability and prosperity of a society.
BUT – here’s the main point – taxing high wage earners, even people who pull down a million a year, is not touching the lives of the truly wealthy. They are playing a different game all together.