Four Things Smart People Don’t Know about America’s Tax Code (and How It’s Driving Inequality)

“Nothing is certain except death and taxes,” Benjamin Franklin said. For the very wealthy, however, taxes are less certain than ever. In a new book, The Second Estate: How the Tax Code Made an American Aristocracy, Boston College Law Professor Ray Madoff compares modern-day America to prerevolutionary France, arguing that the most wealthy among us enjoy all the privileges of society, while avoiding the obligation to fund it. In the case of the US, that’s thanks to the tax code, more than six thousand pages of regulations detailing how and when citizens are required to pay the government. For most working people, the code is hopelessly opaque—which according to Madoff is why the independently wealthy, aided by lobbyists and politicians, have been able to game the system in their favor. In her book, Madoff demystifies the tax code to show how that’s happened. Here are four of her biggest takeaways. 

1. It’s Salaried Workers, and Not the Independently Wealthy, Who Foot Most of the Bill in America 

Most Americans work for their income. “And when they are compensated for their work, they pay the heaviest taxes in our system,” Madoff said. That’s because they pay income taxes as well as what are known as payroll taxes—such as Social Security and Medicare—with each paycheck. Madoff writes in The Second Estate that in 2024, income and payroll taxes together accounted for 84 percent of all revenue collected by the federal government. Employers pay additional payroll taxes for their employees, but many economists believe that even that cost is actually borne indirectly by employees, who might otherwise be paid a higher salary. 

2. Independently Wealthy People Avoid Taxes by Avoiding Taxable Income

The richest Americans largely avoid paying taxes, Madoff said, because they get most of their income from investments and inheritance, rather than salaries that are subject to an income tax. Not only are investments such as stocks taxed at a lower rate, but they are only taxed at all when they are sold. For that reason, wealthy people simply avoid selling them, Madoff said. Instead, she explained, “They use their stock as collateral and borrow against it at low interest rates—then pass the stock along to the next generation.” Moreover, investments aren’t taxed when they are passed to family members, which means they can change hands untaxed in perpetuity. 

3. The Estate Tax Is Effectively Dead

The estate tax, which is a tax on wealth that is paid upon a person’s death, was introduced shortly after the income tax in 1916. The tax, which has been as high as 77 percent, was broadly accepted by the public for many decades, but according to Madoff, a highly effective campaign funded by some of the richest Americans targeted the estate tax in the early 1990s, referring to it as a “death tax” and claiming that it punished people for achieving success in life. Since then, Madoff said, Congress has not closed any of the loopholes devised by creative estate planners, who help their clients avoid the estate tax by making the value of estates appear to shrink on paper. As a result, the tax is effectively nonexistent today—generating less than 0.05 percent of federal revenues. 

4. Philanthropy Is a Rich Person’s Game, and the Public Often Loses

Even when the extremely wealthy find themselves in the position where they would otherwise owe taxes, they can easily offset them by deducting charitable donations. “The wealthy are able to deduct an unlimited number of donations to eliminate any capital gains or estate taxes they have to pay,” Madoff said. Conversely, “90 percent of Americans don’t get any benefit from their charitable giving because they don’t itemize their deductions.” The reason for this is that most working Americans can’t afford to donate amounts large enough to exceed the standard deduction. Adding to the problem, Madoff said, is that the rest of us are getting fewer and fewer benefits from the tax-advantaged donations of the super-rich. The wealthy have been increasingly giving through intermediaries called Donor Advised Funds (DAFs), which don’t have any obligation to actually pass the money on to charity. This allows the rich to structure their donations in a way that maximizes deductions, and the financial institutions holding the DAFs to accumulate more assets, all while limiting the actual good the donated money accomplishes. ◽