THE BLOG

Budget Deals, Service Cuts, Tax Returns, and Pure Frustration

04/18/2011 02:57 pm ET | Updated Jun 18, 2011

This year's tax filing season coincides with the recent budget deal and President Obama's proposal to reduce the deficit by $4 trillion. We learn about cuts to public services as we write checks to pay for them. The confluence of these events frustrates most of us. Yet, further thought deepens the level of frustration.

As you prepare your tax return (or provide information to a return preparer), you probably sift through your old receipts to maximize your deductions. Perhaps you have deductible moving expenses. Maybe you can deduct a charitable contribution you made. If you own a house, you can deduct the property tax and interest you paid on your mortgage. The few thousand dollars of deductions you have saves you a few hundred dollars of taxes. You might be relieved because you save a few hundred dollars (one or two thousand if you have more children) of taxes because of the child tax credit. In the end, however, you're still frustrated because you have to pay taxes.

The real frustration comes when you realize that the tax savings you obtained through your deductions and credits are a pittance compared to what the wealthiest portion of the population saved.

As a former colleague quipped, "I'm a tax attorney but I can't afford to hire myself." His observation suggests that a small percentage of the population -- the wealthiest -- reduce their taxes in ways that the middle class can't.

In fact, real tax savings come long before a person files a tax return. For example, large corporations hire tax attorneys to establish fake entities in tax havens and pretend to move their income offshore. Property owners hire tax attorneys to help them create complicated like-kind exchanges so they can pay no taxes when they sell property. Business owners sell their businesses and hire tax attorneys to help them structure the sale to be tax-free. The wealthiest save hundreds of thousands (often millions or billions) of tax dollars, compared to the hundreds of dollars those in the middle class save.

Many of the tax-avoidance techniques that are available to the wealthy are legal because the wealthy promote laws that create loopholes. By supporting those laws and then paying attorneys to exploit the laws, the wealthy reduce the amount of tax they pay. If the IRS audits a wealthy person, that person can hire expensive tax attorneys to challenge the IRS's efforts. Even wealthy tax cheats may fare better with expensive tax counsel.

Middle class Americans can't hire tax attorneys or influence legislation because they don't have enough money. Assume a tax attorney makes $250,000 and is in the top 2% of the population (but still in the middle class). That attorney may charge tens of thousands of dollars to provide tax advice. The tax savings a tax attorney helps create must be greater than the fee the attorney charges. (For example, no one would pay an attorney $100 to save $50 of tax.)

To save tens of thousands of dollars of tax, a person must have hundreds of thousands of dollars of income. And such income often comes from transactions. Even tax attorneys who make $250,000 a year generally don't own businesses or property worth hundreds of thousands of dollars (other than a home, furniture, cars, and assets in retirement savings), so they don't have transactions that are large enough to justify the costs of tax planning. Consequently, they get hundreds of dollars of tax savings, while they save their clients millions.

This behavior of the wealthy hurts everyone. The middle class must pay more taxes or the country must forfeit services because the wealthy pay lower taxes. To illustrate, the most recent budget deal cuts spending for education, health and human services, and transportation. Those cuts affect the middle class and especially the poor; they stymie growth, hurting the future of the country.

To help end the frustration most of us feel, I offer a bold proposition to both sides of the budget wrangling: do nothing else until you take goodies away from the wealthy, including corporations, and raise taxes on the wealthy.

President Obama once again promised that he would not renew tax cuts for the wealthy and promised to eliminate some of the tax breaks they receive. This time he must stick with those promises, and go further (despite the efforts of those who will come to the aid of the wealthy). Some people make millions of dollars a year. Those people should pay tax at an even higher rate than a person making $250,000.

Take away the preferences for the wealthy, tax them fairly, and then worry about the other expenses. That would help reduce the frustration we feel this time of year.

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