Tax Avoidance is Good for You

There have been lots of talk of recent targeted at concept of tax avoidance.

You probably know by now, but it bears reiteration for avoidance of any ambiguity that tax avoidance is legal. It is tax evasion that is illegal, illegality that in the United States can put rich and famous persons in prison. If there exists any one area of life in the United States within which justice has no respect for reputation, power, or intelligence of defense lawyers, it is in area of tax evasion. Uncle Sam has strong detest for tax fraud. Uncle Sam hates tax fraud so much, the government gets paid first whenever a firm is liquidated in context of bankruptcy.

In light of its legality, any angst must be targeted at reforming of legislation which legalizes tax avoidance not recouping of any monies from the super rich.

When most persons who are not super rich think tax evasion, they see their governments favoring the super rich over the not-so-rich. They see the super rich getting away with tax rates lower than tax rates which accrue to the Middle or Upper Middle Class. They see injustice, inequity, inequality before the law, politicians gratifying super rich persons who helped them to power. They see all that seems to be wrong with seeming democracies: Government of the people, by the people, for the super rich.

Tax avoidance, which is legal comes across as Government of the people, by the people, for the super rich.

I am not super rich. It is not easy to become super rich in context of profession of academia.

I tell you, however, tax avoidance is not necessarily government of the people, by the people, for the super rich.

Let me explain.

Suppose a super rich person could safely leave their money in Government Treasury Bills, which say generate a safe return of 4 percent. If such people put their money in a diversified or market index mutual fund, which also is a relatively safe investment, they perhaps can generate a return of between 10% and 12 percent. While these investments are good for an economy, they are not the investments most necessary for economic or technological development — it is difficult to drive economic development on back of relatively safe investments.

If we assume capital of US$100 million, Treasury Bills yield a profit of US$4 million; and investments in stock markets yield profits of between US$10 and US$12 million. If we apply a flat tax rate of 35% to estimated profits, we have a tax bill of US$1.4 million from the Treasury Bill investment, and a tax bill of between US$3.5 million and US$4.20 million from investments in stocks.

Now suppose a super rich person decides to invest in really risky projects, which successful generate a return of 30 percent. Starting with US$100 million, the profit amounts to US$30 million. Suppose tax avoidance laws allow shielding of US$15 million from taxes. Taxable profit amounts to US$15 million and the tax bill is US$5.25 million, a tax bill larger than the tax bill from investments in mutual funds by US$1.05 million. Even with shielding of taxes, the super rich guy is paying 25% more in taxes relative to a portfolio consisting of investments in diversified or market index mutual funds. Relative to investments in Treasury Bills, the super rich guy is paying 275% more in taxes.

We see here that while the super rich guy has shielded US$15 million from taxes, his or her willingness to invest in risky projects has contributed to higher growth within an economy (higher return of 30%), helped foster economic development, and created new jobs.

Tax avoidance laws encourage the super rich to put money in risky investments or projects — risky investments that are critical for economic development and job creation. In absence of such incentives, investments in risky projects can decrease significantly, resulting in significant declines in rates of job creation and economic development. Since the super rich still likely are paying tax bills commensurate with investments in relatively safe assets such as diversified or market index equity mutual funds, the capacity to shield some of profits from taxes is a small price to pay for willingness it induces in the super rich to commit large sums of wealth to investments in risky projects or assets.

Job creation for the middle and upper middle class are to a large extent facilitated by tax avoidance laws which encourage the super rich to invest loads of capital in risky assets or projects.

There exists another complementary good reason for tax avoidance laws. In light of the fact that risky projects are not always successful, capacity to shield taxes in contexts within which risky projects are successful helps mitigate losses that occur in contexts within which the super rich lose money on risky projects gone bad. Legislated rightly, tax avoidance laws generate flows of capital to risky projects, ensuring risky projects always can raise capital needed for facilitation of much needed investments.

So before you begin crying foul and biting hands that help facilitate middle and upper middle income lifestyles, remember tax avoidance laws ultimately are for the benefit of the not so rich.

Tax avoidance laws are instituted mostly for the benefit of the not so rich.

I cannot assure you tax avoidance laws never are abused. I kid you not, however, when I say, legislated rightly, tax avoidance laws benefit both the super rich and the not-so-rich.