Politics & Policy

Looking for Taxes in All the Wrong Places

Instead of going after the little guy, Congress should take aim at foundations and endowments.

The recent congressional frenzy to increase taxes on the wealthy will backfire if such changes reduce economic output. If the Laffer curve works, as it always does, politicians will discover that tax revenues will fall — not rise — when an economy slowed by tax hikes produces lower tax revenues. In all of this, the little guy — not the rich guy — is the one who’s going to get hurt.

Even in the face of global tax-rate-reduction programs, Beltway politicians parade their latest tax schemes to “bail out” the middle class. Windfall profits taxes, higher capital gains taxes, higher maximum personal-income-tax rates, a national sales tax — each and every one of these tax increases will ultimately hurt the little guy whose lifestyle and livelihood are inextricably attached to the economy. Meanwhile, wealthy individuals like Bill Gates and Warren Buffet will use the best lawyers to keep their fortunes from the tax man, while giving billions to charity as a way of lowering their potential tax bills.

Want to see accumulated wealth grow like a snowball rolling down a steep mountainside?

Not too long ago, the multimillionaire Warren Buffet gave part of his fortune (just $30 billion) to the Gates Foundation, which could make this money grow faster than the legally required distributions from his portfolio. So Buffet gets a big-time tax deduction while the Gates Foundation only has to commit to distributing 5 percent of the $30 billion to charitable entities every year.

Why don’t billionaires like Buffet just give their money to the needy now, or step up to the plate and pay their estate taxes today if they are so charity-minded? Apparently they speak out of both sides of their mouths: They avoid tax payments by donating to tax-exempt foundations, and then endorse higher tax rates on the little guy. (Buffet and Gates, if you haven’t heard, are both pro-estate tax.)

If our big-mouth billionaires were truly committed to helping the needy they could give away more than the minimum distribution required by law — a measly 5 percent of total portfolio value. In a good year, when a portfolio’s value jumps by 10 percent or more, endowment managers might consider giving away half of the excess gain. Yet so far the big-name foundations have preferred to self-perpetuate themselves and build wealth rather than distribute it.

Maybe the IRS should revisit the tax-exempt status of these growing wealth behemoths — a broad universe which also includes the school endowment funds.

According to a recent study prepared by Bloomberg, the value of the top-25 school endowments alone is a whopping $180 billion. So let’s do some math. The growth rate of these endowments over the past twelve months was 16.2 percent, with the managers of these funds retaining about 11.2 percent of that gain (based on a 5 percent payout). So if we assume these funds grow at a 12 percent rate over the next twenty years and distribute that 5 percent each year, their total value would be about $697 billion from growth alone. (Ongoing donations would make this total even bigger.)

Now, if the federal government imposed a 30 percent foundation tax on the investment gains of these endowment portfolios, the following would happen: The future value of the top-25 foundations would be “only” $469 billion twenty years from now — much less than $697 billion, but certainly enough to take care of each school’s related needs. However, the total revenues generated by taxing these endowments would be about $1.9 trillion over this time, enough to keep the tax man off the back of hard working Americans.

Maybe the IRS should define excess profits as endowment earnings above and beyond the amount of money distributed from an endowment fund. There is precedent for this. Many years ago New York University received a gift of the Mueller spaghetti company. The trustees of the university decided it would be a cool idea to keep the company and exempt its profits from taxes, since NYU was a tax-exempt entity. But the IRS thought otherwise, and implemented taxes on unrelated business income.

Let there be no doubt about it: Even with the imposition of a corporate tax rate on only the excess growth rates of foundations or endowments, these wealthy entities will remain wealthy, the government will increase tax collections with no effect on incentives in the economy, and the average American will benefit from a lower tax burden.

When it comes to taxing endowments and foundations that have accumulated enormous wealth, there really are no losers. And there’s no reason why billion-dollar endowment funds should be able to amass fortunes with no end in sight while politicians tax the little guy to pay for their earmarks.

 

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