Our taxes are investments that help keep our kids educated, our bodies healthy, and our roads safe. We pay federal, state, and local taxes every year to ensure we all can thrive in the economy. But according to a new book from Boston College Law Professor Ray Madoff, not everyone is paying their fair share of federal taxes.
Her timely book, The Second Estate: How the Tax Code Made an American Aristocracy, walks readers through federal tax policy history and the modern-day legal maneuvers the wealthy use to pay little to no taxes. Released in October, the book delves into these loopholes, arguing that the acceleration in the accumulation of wealth starts with the tax code. Everyday Americans pay taxes all the time, but by hiring lawyers and accountants who can game the tax code, the wealthy frequently avoid paying their share.
The Trump tax law from last summer is a prime example. The administration extended previous tax changes from 2017 that were a massive giveaway to the wealthy at the expense of public programs like health care and nutrition assistance. From making fewer people subject to the estate tax (further constraining its revenue-raising ability) to increasing the pass-through business deduction, the new law furthered the wealthy’s financial advantages. Professor Madoff’s book identifies much to be changed in the federal tax code, but she remains hopeful.
Professor Madoff answered a few of my questions about her new book. You can see our conversation below, which has been slightly edited for length and clarity.
Can you explain what you mean by the title of your book, The Second Estate: How the Tax Code Made an American Aristocracy? How does it relate to contemporary U.S. tax policy?
The title is no doubt potentially confusing, especially since the only estates that Americans hear about is the fourth estate, which refers to the crucial role played by the press.
However, this system of estates that I am referring to here comes from the official estates of pre-revolutionary France, which governed everything in French life. The Second Estate was the term for the aristocracy (the first estate was the clergy and the third estate was everyone else—from peasants to bourgeoisie). Members of the Second Estate enjoyed special privileges, including, most importantly, the right to not pay taxes. Because nobility status could be achieved by purchase as well as birth.
Sound familiar?
This idea—that the only way to escape taxation is to make a fortune—captures the tax lives of Americans today. That is because those who depend on salaries and other forms of compensation for work are subject to heavy taxes that are difficult to avoid, but those with enough wealth to forgo a salary can avoid taxes by avoiding taxable income, while still supporting a lavish lifestyle.
How are the wealthy able to accomplish this? Is it simply the case that those with great wealth can afford better advisors and if the rest of us could hire them, we could avoid taxes too?
For better or worse, the answer is no. The tax avoidance possibilities for the very rich are not available to the rest of us.
The reason is that not all taxpayers are subject to the same rules. Instead, our tax code operates effectively as two different systems: one for those who acquire their income through work (“earners”), and one for those who acquire their income through investments and inheritances (“wealth owners”).
Earners are subject to a tight web of rules that impose two different taxes (income and payroll) in ways that are almost impossible to avoid. By contrast, wealth owners benefit from a system with lower levels of tax that can often be avoided altogether.
The effect of this two-tiered system is that those with the greatest capacity to pay—the richest Americans—bear the fewest tax burdens, while workers at all income levels bear the most. This is the exact opposite from what our system has long been designed to do—impose its greatest burdens on those with the greatest capacity to pay.
So how are those with great wealth able to avoid income taxes?
They do so by following the three steps of the tax avoidance playbook:
- avoiding salaries;
- avoiding sales of their growing assets (and instead relying on tax-free borrowing to support their lifestyles); and
- inheriting wealth, which occurs tax free.
How has this disconnect been allowed to flourish, particularly since the U.S. tax system is often described as being highly progressive?
The answer lies in the fact that our tax system is intimidating, causing many Americans to believe it is not for them to understand. This has made the public susceptible to misleading statistics about who, in fact, carries the cost of government.
The most misleading is the oft-cited statistic that the top 1 percent pay 40 percent of all income taxes while 40 percent of Americans pay no income taxes at all. But this is misleading because it conflates top earners with top wealth owners. While those with the most income do in fact pay the most taxes, those with the most wealth can avoid taxable income and therefore are just as likely to be in the 40 percent of nonpayers as they are in the top 1 percent of payers
In your book you explain the history of how a campaign funded by 18 of the country’s richest families resulted in a transformation in which an obscure well accepted tax came to be seen as “an unfair, double tax that hurt family farms and businesses.” This campaign was so effective that for the past 35 years Congress stopped doing even the most basic upkeep, resulting in a situation where the tax is so riddled with loopholes that it has been effectively, if not formally, repealed. You argue that we should repeal the estate tax and instead bring inheritances into the income tax system. But wouldn’t those rules be subject to the same pressures?
The estate tax has an Achilles’ heel that made it particularly vulnerable to this type of public relations campaign. Because the estate tax is imposed on donors and not recipients, it is particularly vulnerable to the charge of “double taxation.” Americans who acquire their wealth through compensation, which is already subject to tax at relatively high levels, experience the estate tax as a second level of tax imposed on money that has already been subject to tax.
Of course, for many of the wealthiest Americans the story is very different because much of their wealth has been achieved as a result of the tax-free growth of their assets. For those individuals, the estate tax is the only tax that will ever be imposed on that money. While defenders of the estate tax might try to explain this to the public, it is a much more complicated story to tell and is hard to use to support the tax as a whole.
This vulnerability is increased by the fact that much of the public is unaware that inheritances and gifts are entirely exempt from income taxes, no matter how much is received. (Indeed, many people assume that they cannot give more than $19,000 to their kids in a year without them being subject to income taxes.) This also makes the estate tax seem excessively burdensome.
Bringing inheritances into the income tax system would be far more intuitive to the public and would avoid this perception of double taxation making it less vulnerable to attack.
Which would make more sense to accomplish your goal of informing people about these unfair practices and your ideas: strategically thinking with the public or politicians? Would you depend on one more than the other to spread awareness about this problem so that it gets fixed?
This issue must be tackled on both a grasstops and grassroots level. But given the growing awareness of the problems of the failures of our system to tax the richest Americans, I am more optimistic than ever about our ability to do so.
Further reading from ITEP:
- Trump 2025 Tax Law: Research and Resources
- Trump Tax Law Erases Economic, Racial Progress in the Tax Code
- The Estate Tax is Irrelevant to More Than 99 Percent of Americans
- How Do State Estate and Inheritance Taxes Work?
- Everything You Need to Know About Proposals to Better Tax Billionaires
- Investment Income and Racial Inequality
- The Billionaires’ Income Tax Is the Latest Proposal to Reform How We Tax Capital Gains
