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With the release of her new book and the 2016 election just around the corner, Hillary Clinton’s wealth and tax rate have been fodder for talking heads the past couple weeks. Both the report on the Clintons estate tax planning and Ms. Clinton’s comments that she pays “ordinary income tax” provide useful lessons on the problems with the way the United States taxes wealthy individuals.

When Avoiding the Estate Tax Becomes the “Standard”

According to an in-depth report in Bloomberg, Bill and Hillary Clinton transferred the ownership of their New York residence into a pair of Qualified Personal Residence Trusts (QPRT), which tax experts believe could allow them to avoid hundreds of thousands of dollars in estate taxes.

The substantial tax benefit that the Clintons generated is driven by two key aspects of the QPRT. Most importantly, placing the residence into the QPRT locks in its current value as part of the estate, so all the future growth in the house’s value will not be taxable as part of the estate. In addition, because the residence ownership is split in half between two QPRTs, the total valuation of both trusts is discounted because partial ownership stakes are considered by the IRS to have a lower value.

In other words, the Clintons are indeed using a tax dodge. They are using a method that, unfortunately, has become “pretty standard” for wealthy individuals and, also unfortunately, is entirely legal under our broken estate tax system.

Unlike wealthy individuals such as Sheldon Adelson, the Clintons have historically supported strengthening the estate tax rather than dismantling it further. During the 2008 campaign for example, Ms. Clinton supported capping the per-person exemption at $3.5 million, which mirrors President Obama’s current proposal to strengthen the estate tax in his most recent budget (PDF).

Noting the Difference between the Tax Treatment Investment and Wage Income

In a much publicized interview with The Guardian, Ms. Clinton noted that she pays “ordinary income tax, unlike a lot of people who are truly well off.” While she certainly opened her mouth and inserted her foot, her adversaries attacks on her poor phrasing misses the point.  A big part of the problem with our tax code is the preferential treatment it gives to income derived from wealth (e.g. capital gains, stock dividends) versus income derived from work. So, indeed, the Clintons are wealthy by any standards. Between 2000 and 2007 had $109 million in adjusted gross income, and they paid a 31 percent tax rate. Their tax rate is more akin to the rate paid by working people because they derive a significant portion of their high annual income from speaking fees, book royalties and other activities that are classified as work.

A wealthy investor, like Mitt Romney and Warren Buffet, with the same income but all of it derived from capital gains and stock dividends would have paid about half the rate the Clintons paid. This preferential treatment helps to perpetuate income inequality.

Hopefully, Mrs. Clinton’s criticism of these low rates is an indication that she favors substantially curtailing or even ending the preferential rate on capital gains. If so, it would mark a positive shift from her position during the 2008 campaign, when she stated that she would not try to raise the top capital gains tax rate above 20 percent (the level it is today).