At this writing the tax code of the United States, Title 26 of the United States Code, contains nearly four million words. And that’s just the statutory law passed by congress. The regulations set forth in the administrative code that govern the operation of the IRS, Title 26 of the Code of Federal Regulations, are about four times larger, and also have the force of law. This situation is inexcusable. It establishes a tax structure that is quite literally incomprehensible. Very smart people devote their entire careers to understanding small fractions of the tax code and regulations as applied to very narrow situations. Moreover, the law and the rules are full of loopholes and other spaghetti constructs that lead to gross inequities. For example, approximately half of American households pay no income taxes at all. And taxes on the type of income enjoyed by very wealthy people, called capital gains, are far lower as a percentage of their income than the taxes paid by ordinary wage earners. As a result, the middle class is getting squeezed hard in a government tax grab of extortionary proportions. As for corporate taxes, in one absurd example oil companies have enjoyed tax breaks amounting to billions of dollars at the same time they were making record profits. The tax code and regulations need to be overhauled. And not overhauled in a way that mainly benefits corporations and wealthy investors (ludicrously called “job creators”, even if they don’t create any jobs), which has long been the most common legislative approach. The tax structure needs to be redesigned in a way that unburdens the middle class, preferably without inflicting undue burdens on anyone else. Let’s see if we can come up with a plan to do this for ourselves. Politicians clearly won’t.

Let’s look at a couple of examples. At this writing the federally mandated minimum wage is at least $7.25 per hour. So a worker earning the federal minimum wage, working 40 hours a week, 50 weeks a year with 2 weeks off, earns $14,500 per year. If that person made $14,500 last year, they would have owed the federal government $1,709 in taxes, or about 12%. That’s a pretty big chunk of change for someone making minimum wage. And it’s exceedingly difficult for someone making minimum wage to sock away any money to invest.

Compare that to an executive who earned $250,000 last year in salary, and also owned stocks that increased in value a million dollars during the year. That executive would pay $65,900 in taxes on their earned income, or about 26%. Obviously the executive pays much more in taxes at a much higher tax rate than the minimum wage worker. That’s an example of “the more you earn the more in taxes you can afford to pay” philosophy that applies to earned income.

But what about the $1 million increase in the value of the stock the executive owns? Unless they sold some of the stock for a profit, no tax is owed on the increase because the gain wasn’t “realized”. They effectively made a million dollars tax free, and can keep that increase invested in the stock, along with the entire original investment, as the stock continues to increase in value. If the investor sold some of the stock for a profit, they would pay some tax on the amount sold. But the tax rate on their realized profit would be far less than the tax rate on their wages. What if the executive sells some of the investment at a loss? Then their other income is offset by the loss on their investment, which reduces the tax they pay on their wages.

Is the executive “rich”? That depends on how you define rich. The executive still has to work to get the wage income, which presumably takes up most of their time. If they’re keeping the stock for their retirement, it doesn’t really do them any good right now. The executive probably thinks $250,000 is a pretty good salary, but may not regard it as enough to be “rich”. So maybe the executive is rich, maybe they’re not.

Consider another example, of an investor who is indisputably rich. Say the investor has millions of dollars in cash at the beginning of the year sitting in a safe, and uses that money to pay bills all year long. The investor doesn’t have to work, doesn’t have a job, and has no “earned” income. So at the end of the year, the investor doesn’t pay any income taxes on earned income because they didn’t have any.

Suppose the investor also owns a ton of stock at the beginning of the year, and at the end of the year the stock has gone up in value a billion dollars. But the investor didn’t sell any of the stock, and doesn’t want to sell any because the stock price is going gangbusters. What’s the investor’s tax liability on the stock increase? Zero. Because the investor didn’t sell any stock, the increase in the stock’s value wasn’t “realized”, so there’s no capital gains income, and they pay ZERO taxes. Even though the investor “made” a billion dollars, they didn’t have any “income” for the purposes of paying income taxes. So, the investor pays nothing in taxes, even though they started the year already rich, and just made another billion dollars tax free! Not only that, but they get to keep their entire investment in the stock. Not a penny goes to the government.

When the cash in the investor’s safe is all spent and they finally sell some of the stock, the increase on the stock that is sold is indeed realized as capital gains income, and a tax must be paid on that increase. But even then, the capital gains income tax rate the investor pays is still much lower than the tax rate most wage earners pay on their hard-earned income.

So, under our current federal tax structure the rich investor gets to keep their money invested as their stock continues to go up in value without being taxed on the increase. If they sell and make some money on some of the stock, they owe taxes on the increase in value of the amount sold, but their taxes are far less than a wage earner who works their tail off to earn the same amount. That doesn’t seem very fair, does it? The worker has to pay thousands of dollars in taxes, even if they earn minimum wage, while the rich investor either doesn’t have to pay any taxes at all, or pays at a rate lower than the worker’s. Who set up this crazy system? There’s only one possible answer—politicians in congress. And there’s no realistic possibility they’ll ever change it. So let’s see if we can come up with a way to make things more fair for ourselves, preferably without causing any undue harm to the well-off executive or to the rich investor.