The Truth About Taxing the Rich: The Misconceptions About Wealth, Income, and Tax Policy

Recently, I found myself in a familiar conversation about taxes. A friend, who works on a federally funded project, was venting about the amount of taxes he paid each year and the unfairness of the tax system. He knew I was a business owner and, from previous discussions, was aware that I had built and sold several multi-million-dollar businesses. He also knew that I paid significantly less income taxes than he did. Frustrated by what he perceived as inequities in the tax system, he said, “We wouldn’t have all these government funding issues if rich people like you would just pay your fair share.”

While I understood his frustration, I also realized his understanding was based on a gross misunderstanding of the tax code. The term “rich” is often used, whereas it would be more accurate, in the context of income tax, to speak of “high-income earners.” By definition, the rich and the high-income earners are vastly different.

Our discussion quickly turned into a discussion about the differences between wealth and income, how our tax system really works, and how business ownership provides an entirely different framework for wealth accumulation and tax reduction.

Wealth vs. Income

The first thing I explained was the distinction between wealth and income. Wealth, or net worth, refers to the total value of assets – such as real estate, stocks, or businesses – minus liabilities like debts. Wealth represents accumulated resources and long-term financial stability and is what truly defines being “rich.” In contrast, income is the money earned over a specific period, such as wages, dividends, or capital gains, and is often a means to build wealth rather than a measure of being rich.

Here’s the key distinction: The U.S. tax system primarily taxes income, not wealth. For example, if someone holds $100 million in stocks, the value of these stocks is not taxed unless they are sold. At that point, the resulting profit (or gain) is taxed as capital gains at rates of 0%, 15%, or 20%, depending on their income level. These rates are often significantly lower than the tax rates applied to ordinary income, such as wages.

For example:

A billionaire might live comfortably without ever selling their assets, borrowing against them instead of realizing taxable income.
Conversely, a high-income earner like a doctor or lawyer, who may make $500,000 a year, pays a large percentage of their income in taxes because wages are taxed at ordinary income rates.

How the Progressive Tax Code Works

During our conversation, I suggested to my friend that he might want to consider starting a side hustle to help reduce his overall tax liability. He looked puzzled and said, “Why would I do that? Wouldn’t this extra income push me into a higher tax bracket and make me pay even more in taxes?”

His question highlighted a common misconception, so I explained. “That’s not how our tax system works,” I began. “Even if the additional income from a side hustle places you in a higher tax bracket, only the portion of your income that exceeds the threshold for that bracket is taxed at the higher rate. The rest of your income is still taxed at the lower rates for each bracket.”

Grabbing a pen and paper, I continued, “Let’s break it down. Say you earn $100,000 from your job and an additional $10,000 from a side hustle, giving you a total income of $110,000. Here’s how it works using the 2023 tax brackets for a single taxpayer:

You’d pay 10% on the first $11,000, which is $1,100.
Then, you’d pay 12% on the portion from $11,001 to $44,725, which is ($44,725 – $11,000 = $33,725 × 12%) = $4,047.
Next, you’d pay 22% on the portion from $44,726 to $95,375, which is ($95,375 – $44,725 = $50,650 × 22%) = $11,143.
Finally, you’d pay 24% on the portion above $95,375 (the remaining $14,625), which comes out to $14,625 × 24% = $3,510.

Your total tax would be $1,100 + $4,047 + $11,143 + $3,510 = $19,800. While your top marginal tax rate is 24%, your effective tax rate, the average percentage of your income paid in taxes, would be 18% ($19,800 ÷ $110,000).”

He seemed intrigued but still hesitant. “So, starting a side hustle wouldn’t just push all my income into the higher bracket?”

“Not at all,” I replied. “Only the income above $95,375 would be taxed at 24%, and even then, you can lower that taxable income with legitimate deductions. For instance, if you spend money on equipment, home office space, or travel for your side hustle, these expenses reduce the amount of income that’s subject to taxes.”

How Taxes Affect Wealth Accumulation

My friend posed another thoughtful question: “Why is the tax system structured so that employees pay more in taxes than the wealthy? Isn’t it supposed to treat everyone equally?”

This was my opportunity to explain a fundamental principle of the tax system: it is intentionally designed to collect more taxes from employees than from those with significant wealth to encourage investment in businesses or start new ones.

To address his question, I said, “Let’s take a closer look at how the tax system treats employees compared to business owners and investors and how these differences significantly impact the ability of the working class to accumulate wealth.”

I added, “Employees rely on wages, which, as we discussed, are taxed as ordinary income at progressively higher rates, up to 37% for high earners. On top of that, employees pay payroll taxes – 6.2% for Social Security and 1.45% for Medicare – on their income up to the Social Security wage base limit of $160,200. These taxes are deducted directly from their paychecks, further reducing their take-home pay. Employers match that 7.65%, but employees still feel the weight of these deductions, making it difficult to save and accumulate wealth.”

“In contrast,” I explained, “wealthier individuals, including business owners, often build their income through investments and business ownership rather than wages. Here’s the key difference:

Unrealized gains – the increasing value of assets like stocks, real estate, or businesses – aren’t taxed at all until the assets are sold. This allows their wealth to grow untaxed for years or even decades.
When they do sell, they pay long-term capital gains rates, which are much lower than ordinary income tax rates: 0%, 15%, or 20%, depending on their total income. This means that income from investments is taxed less heavily than income from wages.
Business owners enjoy additional advantages. By reinvesting profits into their businesses – such as hiring employees, purchasing equipment, or expanding operations – they can claim deductions that significantly reduce their taxable income.
Many wealthy individuals avoid selling assets entirely. Instead, they borrow against their growing wealth, using loans to fund their lifestyles without creating taxable income.”

I added, “This creates a stark contrast: employees are heavily taxed as they earn, with limited opportunities to offset these taxes, preventing them from saving and accumulating wealth. On the other hand, business owners and investors benefit from the tax code’s preferential treatment, which encourages deploying wealth into businesses or investments. These policies are designed to compensate for the inherent risks of entrepreneurship and investment while also driving job creation and economic growth.”

The Business Owner Advantage

My friend, now aware that the tax code is intentionally designed to encourage investment and entrepreneurship, began to connect the dots. “I get how investors pay less in taxes,” he said, “but I’m curious, how does business ownership fit into this? Are there really that many ways a business owner can reduce their taxable income?”

This was my opportunity to explain that business owners operate under an entirely different set of rules, offering significant tax advantages that not only reduce their tax burden but also help them accumulate wealth. “Here’s how owning a business creates these opportunities:

Deductions: Business owners can deduct expenses like office rent, utilities, equipment, and even part of their home if it’s used for work. These deductions lower taxable income, sometimes dramatically.
Tax-Advantaged Retirement Plans: By contributing to a SEP IRA or Solo 401(k), a business owner can reduce their taxable income while saving for retirement.
Lower Tax Rates on Capital Gains: Many wealthy individuals invest in assets like stocks, real estate, or businesses, where gains are taxed at lower capital gains as we discussed earlier instead of paying ordinary income rates. This applies to the sale of businesses as well, allowing owners to benefit from these lower rates when they eventually cash out.
Pass-Through Income: If the business is an LLC or S Corp, profits ‘pass through’ to the owner’s personal tax return, avoiding corporate taxes. Plus, they might meet the requirements for the Qualified Business Income Deduction, which allows up to a 20% reduction.
Deferring Income: Business owners can delay invoicing to defer income into the next tax year, reducing their immediate tax burden.
Family Employment: Hiring family members can shift income to lower tax brackets, reducing the overall tax bill.
Wealth Growth Through Debt: Instead of selling assets and triggering taxable gains, wealthy individuals often borrow against their assets to fund their lifestyles. Loan proceeds aren’t taxable income.”

Connecting the Dots: The Truth About Tax Policy

As we wrapped up our conversation, my friend reflected on what he had learned with a new understanding. “Wow,” he said, “the whole idea of “taxing the rich” and the claim that “the rich need to pay their fair share” really seem like misleading rhetoric. Most people assume those phrases target ultra-wealthy billionaires, but in reality, they’re designed to confuse the public while justifying higher income taxes for working-class individuals. These increases don’t really affect billionaires, who make their money in ways that are taxed minimally or not at all. Instead, they hit high-income earners such as doctors, lawyers, engineers, and other middle-class professionals who are still building their wealth. It’s not about taxing the rich, it’s about raising taxes on the working middle class.”

He continued, “The truly rich – those with substantial net worths from businesses and investments – are largely untouched. They’re not relying on salaries. Their income comes from portfolios taxed at lower rates, and they take full advantage of deductions, credits, and strategic planning to minimize taxable income. They let unrealized gains grow untaxed and, when needed, borrow against their assets tax-free to maintain cash flow. It’s no wonder they keep getting wealthier.”

After a thoughtful pause, he added, “The average person doesn’t realize this distinction. When they hear ‘tax the rich,’ they think it’s about billionaires. But in practice, it’s middle-class professionals trying to climb the ladder who bear the burden. It’s really eye-opening.”

Finally, he smiled and said, “Thanks for walking me through all of this. I’d love to schedule some time to talk about how I can turn what I already know into a consulting business. It seems like the best way to start using the tax code to my advantage, just like the truly wealthy do.”

Conclusion

The public has been deceived by language crafted to elicit an emotional response. Phrases like “tax the rich” sound fair, but they obscure the reality: most “rich” people are not earning high wages but instead generating portfolio income and using sophisticated strategies to reduce their tax liabilities.

Meanwhile, the brunt of income tax hikes falls on high-income earners and professionals, those who are still working to accumulate wealth. The progressive nature of the tax code makes it increasingly difficult for employees to save and invest enough to reach true wealth.

Understanding these dynamics is crucial. Without it, the average person unknowingly supports policies that hurt their own ability to build wealth while leaving the truly rich unaffected. It’s a classic case of rhetoric outpacing reality.

Are you ready to use the tax code to your advantage and start a business?