Warren Buffett, one of the wealthiest people in the world, once pointed out that he pays a lower effective tax rate than his secretary. He said it to describe something broken about the tax code, and the mechanism behind it is worth understanding because it was deliberately designed to work this way.

The United States tax system is built backward. Work gets taxed at higher rates than wealth. If you earn money at a job, you pay ordinary income tax rates topping out at 37 percent. If you earn money because assets increase in value, you pay capital gains rates topping out at 20 percent. The worker pays more than the investor. That's the design problem.

Why Your Tax Rate and a Billionaire's Are Different

Most Americans get their income the same way: a paycheck. Wages, salaries, tips. The IRS taxes all of that as ordinary income. Add in Social Security and Medicare payroll taxes on top and the effective rate climbs further.

Wealthy Americans are different. Once you accumulate significant assets, most of your income doesn't come as a paycheck. It comes as capital gains, dividends, and returns on investment. Those are taxed at the lower capital gains rate. The billionaire whose net worth goes up by $50 million because their stock portfolio appreciated pays 20 percent when they sell, not 37 percent.

A teacher making $65,000 a year pays a higher tax rate on every dollar of income than a hedge fund manager making $50 million from investment returns. The teacher is doing the work. The hedge fund manager is earning returns on capital. The tax code treats the teacher's labor as worth taxing more heavily.

The Buy-Borrow-Die Loophole

The capital gains rate is only one part of the story. The more sophisticated strategy used by the very wealthy involves never selling assets at all.

Here's how it works. A billionaire owns $500 million in appreciated stock. If they sell it, they owe 20 percent on the gains. So they don't sell. Instead, they go to a bank and borrow against the stock as collateral. The loan isn't taxable income. They use the borrowed money to pay for everything: houses, jets, living expenses. They pay interest on the loan, which may itself be tax-deductible.

When they die, their heirs inherit the assets. At that moment, the IRS resets the cost basis to the current market value. The decades of accumulated gains are wiped out. No capital gains tax is ever paid. The heirs can then borrow against the inherited assets and repeat the cycle.

Buy the assets. Borrow against them tax-free. Die with a stepped-up basis. The loophole has a name in policy circles: buy-borrow-die. It allows the wealthiest Americans to accumulate and spend vast fortunes while paying effectively nothing in capital gains taxes across their lifetimes.

The Carried Interest Loophole

Hedge fund managers have their own version of this problem. When a fund manager earns fees for managing other people's money, that compensation is called "carried interest." It gets taxed at capital gains rates, 20 percent, rather than ordinary income rates, 37 percent.

A hedge fund manager earning $100 million in carried interest pays the same rate as someone who sold stock they'd held for a year. A teacher earning $65,000 pays a higher marginal rate than the hedge fund manager. Congress, under sustained lobbying from the finance industry, wrote the tax code to classify their compensation as investment income rather than wages.

Closing the carried interest loophole has been proposed by politicians from both parties for over a decade. It hasn't happened, which tells you something about who actually sets the terms of tax legislation.

The Payroll Tax Problem

There's another piece most people miss. Social Security is funded by a payroll tax of 6.2 percent on wages, matched by employers. But that tax only applies to the first $168,600 in wages. Every dollar earned above that threshold is exempt from Social Security tax entirely.

For someone making $65,000, the payroll tax applies to every dollar they earn. For someone making $1 million, it only applies to the first $168,600. As a share of total income, the millionaire pays a significantly lower payroll tax rate than the middle-income earner. The tax that funds Social Security is, by design, regressive.

How This Got Written Into Law

These provisions exist because of deliberate choices. Each one has a documented history of industry lobbying, campaign contributions, and political negotiation to protect wealthy interests.

The capital gains preference dates back decades, with the argument that lower rates encourage investment. The stepped-up basis at death has survived repeated reform attempts because estate planning is a major industry with significant political influence. Carried interest has survived because private equity and hedge fund managers are among the largest donors to both parties. The payroll tax cap has survived because raising it would increase taxes on high earners who fund campaigns.

The result is a tax code that, taken in full, asks more from the nurse or the warehouse worker or the teacher than it does from the investor, the hedge fund manager, or the billionaire. That's not a natural outcome of a free economy. It's a policy choice, made repeatedly over decades, by politicians responsive to donors rather than voters.

Why This Connects to Everything Else

The tax rate gap between wages and wealth compounds over time. Every year that investment income is taxed at lower rates than wage income, wealth concentrates further at the top. That concentration funds more lobbying to keep the rates where they are. The cycle continues.

The people who benefit most from this system are the same people funding the campaigns of both parties. Changing it requires politicians who don't owe them anything. That's the argument for a party that takes zero corporate donations: the tax code looks the way it does because the people who wrote it were answering to donors. Change who the politicians answer to and the code can change too.

Learn more at votelabor.org.