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Whether a tax system is judged to be fair depends, in part, on whether those citizens who are most able to pay taxes are perceived to pay a fair share of their income in taxes. Earlier analyses have focused on the extent to which taxpayers with high adjusted gross income (AGI) pay little or no tax. Such analyses are useful primarily in indicating the extent to which extraordinary itemized ("below-theline") deductions reduce tax liability of high-income taxpayers. But they do not shed much light on the extent to which taxpayers with substantial economic income are able to reduce AGI, and therefore taxable income and tax liability, with various "above-the-line" losses, including losses from tax shelters.

A computer analysis of all income tax returns for 1983 filed by high-income individuals provides further information on the tax burden borne by high-income taxpayers and on the commonly used means of lowering that burden. The analysis clearly identifies partnership losses as a primary source of offset to other income and thereby of reduction in tax liability for these high-income persons. Although the study does not measure the amount of tax reduction attributable to the specific tax incentives that provide opportunities for tax shelters, recent trends in the partnership sector suggest the growth and prevalence of tax shelter activity.

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It has long been recognized that losses allowed for tax purposes are often not real economic losses; frequently they are merely accounting losses that result from tax shelter activities. Because tax losses can offset normally taxable income, it is necessary in analyzing taxes paid by highincome groups to use a measure of income which is relatively unaffected by accounting losses that may not be real.

The measure of income chosen for this purpose is total positive income (TPI), which essentially equals the sum of (1) wages and salaries, (2) interest, (3) dividends, and (4) income from profitable businesses and investments. Unlike the more commonly used measure of adjusted gross income, TPI does not subtract various exclusions or deductions which reduce AGI, such as IRA and Keogh contributions and the

60 percent of long-term capital gains that is excluded from taxable income. TPI also excludes most business and investment losses which are taken into account in computing

AGI.

Based on this definition of income, a return was classified as a high-income return if total positive income exceeded $250,000. Since TPI excludes real losses as well as tax-shelter losses, it tends to overstate economic income; on the other hand, it understates economic income to the extent that tax shelter losses offset economic gains within many activities. Nonetheless, most returns with more than $250,000 of positive income can reasonably be classified as "high income." In 1983, 260,000 tax returns (or one-quarter of one percent of all returns) reported TPI in excess of $250,000; nearly 28,000 tax returns reported TPI in excess of $1 million.

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Many taxpayers with high positive incomes paid a substantial share of their income in taxes in 1983; nearly half (47 percent) owed at least 20 percent of their TPI in tax.

A significant minority, however, owed very low taxes, in spite of the current law minimum tax. (See Table 1.)

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Almost 30,000, or 11 percent, of returns with TPI in excess of $250,000 paid virtually no tax; that is, taxes paid were less than 5 percent of TPI.

Nearly twice as many owed no more than 10 percent of positive income in taxes. Fifty-five thousand, or 21 percent of all returns with positive incomes in excess of $250,000, paid 10 percent or less of positive income in taxes. Fifty-four hundred, or 19 percent, of returns with TPI over $1 million paid no more than 10 percent of positive income in

taxes.

Over 3,000, or 11 percent, of returns with TPI in excess of $1 million paid virtually no tax.

These high-income returns paying less than 5 or 10 percent of TPI in taxes are shouldering lower tax burdens than typical returns with substantially lower incomes.

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Upper-middle-income returns with TPI of between
$30,000 and $75,000 paid on average about 13
percent of their positive income in taxes.

Nearly 17,000 of the high-income returns with TPI exceeding $250,000 owed less than $6,272 in tax, the amount that a typical four-person family with $45,000 of income owed. Fifteen hundred returns with TPI in excess of $1 million owed less than this $6,272.

III. How Taxes Were Reduced

High-income returns with low tax liability relied most heavily on losses reported in current business activities, including those conducted in partnership form, to reduce their tax bills. (See Table 2.)

Returns with TPI over $250,000 and taxes of less
than 5 percent of TPI reported current business
losses amounting, on average; to 67 percent of TPI.
(Thus, for example, a typical high-income return
showing TPI of $300,000 might show losses of
$200,000 and AGI of $100,000; taxable income would
be even less, after allowance for itemized
deductions and personal exemptions.)

The capital gains exclusion and losses carried over from previous years also offset large amounts of positive income for the low-tax returns. Itemized deductions (such

as for state and local taxes, mortgage interest expenses, and charitable contributions) were much less important in reducing taxes.

For the high-income, low-tax returns--those with
taxes less than 5 percent of TPI--the combination
of the capital gains exclusion and losses other
than on current business activities offset
46 percent of TPI. (The combination of this
exclusion and these losses, together with current
business losses, offset more than 100 percent of
TPI, on average, for these returns.) Excess
itemized deductions offset only 18 percent of TPI.

The high-income returns with relatively high tax liability--those with taxes exceeding 20 percent of positive income--seem to have more in common with the typical upper-middle-income return than with the high-income, low-tax return.

"Above-the-line" offsets to TPI --primarily losses and the capital gains exclusion--were relatively unimportant for the high TPI returns with high taxes and for the upper-middle-income returns with TPI between $30,000 and $75,000. Current business

Table 1

1983 Returns with Total Positive Income of $250,000 or More

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For

Total Positive Income (TPI) measures gross income reported on tax returns before losses. It primarily equals the sum of positive amounts of income on the Form 1040, with the following exceptions: For capital gains, it equals long- and short-term gains before losses and before exclusions. Schedule E, TPI includes the income on rental and royalty properties with profits, on partnerships, on estates and trusts, and on small business corporations with gain. ΤΡΙ does not subtract various exclusions or deductions which reduce AGI, such as IRA and Keogh contributions, and the 60 percent exclusion of long-term capital gains.

Source: Extract from the 1983 IRS Individual Master File of all tax returns with TPI of at least $250,000.

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Current Business Losses include losses on partnerships; net losses from Schedule C, Subchapter S corporations, rental and royalty properties, and farms; and net supplemental losses.

"All Other Losses and Capital Gains Exclusions" are primarily the excluded portion of capital gains plus substantial loss carryovers.

*** "Upper-Middle-Income Returns" have $30,000 to $75,000 of TPI.

Sources:

Extract from the 1983 IRS Individual Master File of all tax returns with Total Positive Income of at least $250,000; and the Treasury Individual Income Tax Model for 1983.

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