In her day, billionaire hotelier Leona Helmsley was as famous as Kim Kardashian, and once said “only little people pay taxes.”
Helmsley’s notorious remark came to mind earlier this month when ProPublica released a report that the 25 richest Americans collectively paid a “true tax rate” of only 3.4% for the four years ended 2018. As the US tax system is broadly comparable to New Zealand’s, it’s likely the same findings would apply to the wealthiest Kiwi’s too.
One famous US billionaire, Warren Buffett, stood out because his true taxation rate was reportedly just 0.10%! That’s even odder as Buffett has spoken out saying wealthy Americans should pay higher taxes.
Yet, he was far from alone. ProPublica also reported a tax rate of 0.98% for Jeff Bezos, 1.30% for Michael Bloomberg, and 3.27% for Elon Musk.
Tax minimisation versus tax evasion
After seeing those rates, the next question on your mind is likely “how the heck is that legal?”
The simple truth is the reason for the richest Americans’ tax rates being so low is mostly a rather unimaginative (and perfectly legal) tax minimisation strategy available to everyone, including everyday New Zealanders.
ProPublica’s fake news “true tax rate”
It takes a little concentration to understand what happened here…
The ProPublica report made great headlines across the internet but note how they used the term “true tax rate.”
ProPublica used something called the ‘Haig-Simons’ definition of income, which includes any increase in net worth. So, while Buffett’s net worth grew US$24.3 billion during the four years covered in the report, that growth was nearly all on unrealised capital gains. That is, the value of his investments grew on paper, but he didn’t sell much of significant value to actually get a huge income from those sales. (Buffet also leads a famously frugal lifestyle, including living in the same suburban home he purchased in 1958 for US$31,500. He enjoys simple pleasures like McDonald’s burgers and Cherry Coca Cola, favouring them over the luxury items you might expect of a multi-billionaire.)
Thus, Buffett’s payment of US$23.7 million in taxes (off an income of US$125 million) was reported by ProPublica as a “true rate” of 0.1%.
- Income is already well-defined, (and is quite different to the capital gain on an asset such as a house, farm, or shareholding in a business).
- The Haig-Simons interpretation isn’t used as the basis for tax in any country we’re aware of.
- Assets can have significant fluctuations in value, which could have all sorts of implications if the Haig-Simons method were used to calculate tax. (Imagine paying high annual taxes based on the capital gain of a house, farm, or an investment portfolio going up in value over the course of a year, even if you had no cash available to pay the tax!).
Instead, most governments, including in the US and NZ, tax people based on realised income like wages, interest, dividends, and capital gains after the sale of assets (in the case of the bright line test).
So, while loopholes and tax avoidance strategies do exist for billionaires like Buffett, ProPublica’s report mostly demonstrates that the simplest tax strategy is so easy anyone could do it.
In Buffett’s case, he rarely sells his personal holdings of his corporation, Berkshire Hathaway, and the company continues to reinvest profits into the business rather than pay dividends to shareholders.
Tax evasion is bad
If Leona Helmsley’s quote at the top of this page annoyed you, then rest easy knowing she later was convicted and jailed for tax evasion!
The bottom line – pay tax like a billionaire
As dull as it may sound, the simplest way to minimise taxes is to buy investments then hold them for a long, long, time. Buffett is famous for saying that “our favorite holding period is forever.” Here at Milestone Direct, we agree.
The best road to long-term wealth is to invest wisely and hold those investments for as long as possible. Not only is this a great investing strategy, it’s also the best way to avoid the tax collector.