How do rich Americans get away with paying so little tax?

Earlier this week, Barack Obama released his tax return. He filed jointly with his wife (the US tax system is very different to ours) and between them they had a gross income of $608,611. That’s not bad given they probably don’t have much in the way of expenses.

But it is even better than it might look to the eyes of the average middle earner. Why? Because their effective tax rate on the income was under 20% – less than the lowest rate payable in the UK. You can amuse yourself looking at the first family’s tax return here, but the takeaway here is that rich Americans – much like rich British people – have many routes available to them if they want to keep their tax bill down.

A recent piece in The New York Times written by economist Joseph Stiglitz noted that the richest 400 Americans (with an average income of $200m) pay less than 20% of their income in taxes and that the average millionaire pays around 25%. You might think that no one should have to pay more than that anyway (and I’d be tempted to agree), but the fact remains that in the US, the top marginal tax rate is actually 39.6%. So, how do the rich in America get away with paying so little?

It is partly down to the fact that the top rate kicks in at a much higher level than in most countries. In the UK, you get to pay 40% on what the average US millionaire would consider a microscopic income, but in the US, the 39.6% doesn’t kick in until you are making $400,000 ($450,000 if you are being taxed as a couple). But much more than that, it is about special allowances, breaks and loopholes.

There is the fact that all income on municipal bonds comes tax free (I’ve written on this before here). This is a tax break for the rich that allowed some 20,000-odd US citizens with an income of over $200,000 to pay no tax at all in 2011. Then there are endless special provisions, says Stiglitz – for holiday homes, for race tracks, returns from working in private equity (carried interest), charitable giving and so on and so on.

If you are shaking your head sadly as you read this, don’t forget that the UK has a similar system of complicated – or broken – taxation. Poor George Osborne never got very far with his admirable attempt to prevent gift aid being used as a tax reduction/tax hypothecation system by our rich (see my previous blog posts on this) and we give tax breaks for all sorts of things the rich benefit from too: no capital gains tax on primary homes (the bigger and better your house, the higher your tax-free gains in a rising market) being a prime example.

Those on very high incomes only pay less tax (in relative rather than absolute terms of course) than the rest of us because they can. And that’s a shame because, as Stiglitz rightly says, society needs a sense of “shared purpose”, and that in part rests on a fair tax system.

On the face of it, both the US and the UK tax systems are fair (income tax rates are progressive and so on), but the loopholes and reliefs all too often make their outcomes rather less than fair.

Obama wants to introduce a minimum tax rate of 30% for millionaires, but might it not be better just to keep rates where they are and make sure they pay the rates already advertised? Just look at how much the Obamas saved on their bill by giving to the charities of their choice rather than paying into the government programmes they surely believe are essential to their country’s future.