Over half America’s financial wealth is generating income not subject to current federal income taxation.
The fourth in an Inequality.Org series on the giant pools of assets in America that produce income not currently subject to taxation.
By Bob Lord
Back in the mid 1980s, as a young tax lawyer, I had the good fortune to work with one the nation’s foremost tax law experts. I remember this expert warning back then that America might become one big tax-exempt bond pool. We would get to the point, he feared, where almost all income flowing from wealth would be exempt from tax.
Turns out, that would be an amazing prediction.
In the first three parts of this series, we explored three giant pools of wealth — Roth IRAs, permanent life insurance and annuity policies, and municipal bond portfolios — not subject to current income tax. These pools of wealth together total over $5 trillion in value.
Americans, all together, held $50.2 trillion in 2011 financial assets, according to the Investment Company Institute.
So roughly 10 percent of our nation’s household financial wealth is now sitting in those three tax-favored pools. That’s a lot of income escaping tax, with most of that income flowing to America’s wealthy.[pullquote]Congress has been making the retirement savings rules more friendly to wealthy taxpayers.[/pullquote]
But these three pools of wealth make up just a fraction of the total tax-exempt pool.
Besides the roughly $800 billion in Roth IRAs, we have an additional $17 trillion in other retirement plan assets, including over $4 trillion in traditional IRAs. That’s roughly one-third of our financial wealth held in retirement plans other than Roth IRAs.
In theory, the amount of wealth held in retirement plans should level off at some point, as we reach an equilibrium where retirees are withdrawing retirement fund assets at about the same rate working Americans are growing these funds through their contributions.
But Congress has effectively postponed this equilibrium by continually making the retirement savings rules more friendly to wealthy taxpayers eager to defer their income from tax as long as possible.
One example: A retirement plan inherited by someone other than the spouse of the beneficiary used to face taxes relatively soon after the beneficiary’s death. After all, the sole justification for giving retirement savings an income tax deferral — to provide for the beneficiary’s retirement — no longer applies once the beneficiary has died.
Congress a dozen years ago changed the rules to allow a deceased beneficiary’s heirs to continue the income tax deferral for their entire lifetimes. Some retirement plan assets can now generate tax-exempt income for a century before they must be distributed.[pullquote]Some retirement plan assets can now generate tax-exempt income for a century before they must be distributed.[/pullquote]
To make matters worse, the retirement plan assets of the wealthy often go untaxed at death. Why? The wealthy use these assets to fund their tax-exempt private foundations.
Lastly, we also need to consider the wealth that super rich Americans have parked offshore in tax havens. This wealth, estimated as high as $10 trillion, doesn’t show up in our $50 trillion figure for America’s total financial wealth.
This tax haven wealth belongs exclusively to the super rich, and very little of it ever faces current income tax. This tax haven wealth brings America’s real aggregate financial wealth total to as high as $60 trillion, as of 2011.
And how large a share of this $60 trillion in financial wealth sits in America’s giant tax-exempt pool? About $34 trillion. Over half the nation’s financial wealth is generating income not subject to current taxation.
How much is our giant tax-exempt pool costing us? Hundreds of billions. So the next time you hear from the “Fix the Debt” crowd about how we can’t afford new roads or rail or cops or teachers — or that we need to cut the benefits of Social Security recipients — remember our giant tax-exempt pool.
Read the first article in this series: Retirement Vehicle or Giveaway to the Rich?
The second article in this series: Looting the Treasury to Benefit Big Insurance
The second article in this series: Tax-Free Municipals: An Unnecessary Giveaway
Bob Lord, a veteran tax lawyer and former congressional candidate, practices and blogs in Phoenix, Arizona.