Question

Explain why some argue that income tax loopholes primarily benefit the rich.

Answer 1

It is not illegal to have a tax loophole. It just seems that the person who benefits from the loophole often follows the tax law letter but not the spirit of the law. Ordinary taxpayers pay up to 35 per cent tax on their wages at regular income tax rates. However, the really rich are different from you and me in that they tend to make most of their money through investments rather than standard paychecks, meaning that most of their money is taxed at 15 per cent.

Many citizens on those tax rates have little, if any, cash left to spend after paying their bills. But by giving them the option, Congress members felt better about voting for a tax break which primarily benefits the wealthy. The advantages of deducting interest on mortgages are often geographically disproportionate. Even as high-income residents get more out of it, so do high-income, land- and housing-priced metropolitan areas. That has tended to be locations in California and the Northeast, historically.

Not to keep picking on homeowners but there's another residential deduction that needs to go: the interest deduction on a holiday home loan. Yes, some second-home owners are far from wealthy. But those who own a ski chalet in Aspen, Col., an ocean-view getaway along Miami's South Beach or a pied-a-terre in New York City where they are usually rich to rest after a late opening night on Broadway. And as an itemized deduction, they get to write off interest on those expensive second homes, for mortgage debt as high as $1 million.

Managers of most private equity funds get a percentage of the net gains as a management fee. This allowance is known as carried interest, and that is the wonderful part for the fund manager: Carried interest is not paid like normal interest on traditional savings accounts that most taxpayers receive. It is being paid as a gain in income.