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Saturday, October 23, 2021

Certain Tax Increases and Fixes Needed for Equity and Fairness

Tax reform discussions in Congress for the week of October 17 have included possibly not including tax increases. Are taxes too high already? Perhaps. But they are also quite uneven in their application.  Here are a few examples:

  • Vastly different rates exist for capital gain versus ordinary income for very high income individuals. A wage earner with over $400,000 of earned income will enter a 37% marginal rate today (39.6% after 2025). In contrast, a person with capital gain and dividend income will be in a marginal rate of 23.8%. This is a frequent question I get from both students and practitioners - why are capital gains taxed lower than ordinary income. There are reasons, but I don't think it supports a difference once income passes the $500,000 level.* Tax it all the same after some high level such as $400,000 or more.  And that high income wage earner will have 2.9% Medicare tax on income above $147,000 (figure for 2022) and an additional 0.9% on income above $200,000 ($250,000 if MFJ).  So a capital gain rate of 37% (or 39.6% once AGI exceeds $1 million as President Biden proposes (see page 8 of this table)), causes the high wage earner and high capital gain recipient to both be at a marginal rate of 43.4%. Note that I am only talking about very high income individuals (less than half of the top 1% of individuals).

    Yet, 43.4% is a high rate. I think it would be good to include with Biden's plan, repeal of the extra 3.8% net investment income tax (NIIT) which would also simplify the tax system.  That though would cause the wage earner to still be paying an extra 2.9% on all of their wage income, so perhaps add that to the high capital gain person. Or, keep the top rate at 37% + the 2.9% extra to equalize the high wage earner and high capital gain person. Or even a lower rate could be used along with reduction in some of the tax breaks for high income individuals, such as capping the tax benefit of itemized deductions and exclusions at 28%.

    We are talking about far fewer than 1% of individuals. But these few thousands of individuals have lots of income which for some is in the hundreds of millions of dollars annually.

  • A big income tax break for those who die with millions or billions of gains (and their heirs). Tax reform should include a provision to tax all income including gains that exist at date of death for those with assets above a specified amount. Biden uses $1 million (see page 8 of this table). If that were $3 million, there would be far fewer affected by the tax or some of the complexity.  And a good portion of this untaxed income today are appreciated stock gains of multi-billionaires such as Zuckerberg, Musk and Bezos. I think few people can justify why their unrealized gains should disappear and never be taxed under our current income tax system. President Biden's proposal with backstops to prevent having to sell a family business to pay the tax should be discussed in Congress. While that is a tax increase compared to today's system of letting these gains be untaxed, it should be viewed as fixing a longstanding, inequitable flaw in the system.**

  • Tax breaks are worth a lot more to high income taxpayers. Let's raise taxes by reducing some tax breaks that don't make sense and are inequitable. Today, less than 10% claim a mortgage interest deduction. Perhaps this is the time to repeal this tax subsidy that primarily helps a higher income person buy a more expensive home. Reduce the exclusion for employer provided health insurance. Perhaps make some percentage of it taxable with that percentage higher as income goes up. This subsidy benefits about 65% of employees and reduces tax collections by about $200 billion annually. 

    And let's rationalize tax deductions. In a personal income tax, deductions should be allowed to remove some income from taxation (standard deduction and personal exemptions enable this) and for the costs of generating income.  And some would argue that the state and local income tax should also be deductible as that money is not available to pay federal taxes (but note that states don't allow a deduction for federal taxes) [see my 2008 article on reasons for and against state tax deduction]. But, some taxes are more in the voluntary category. For example, personal property taxes on more than one vehicle per person. And real property taxes on more than one home and when that home exceeds the median home value in the region.  Tax reform should include discussion of all these tax reductions (credits, exclusions and deductions) to be sure they make sense and are not providing breaks to people who don't need them or much larger ones to the highest income individuals.

What do you think?

*I'll cover pros and cons of lower taxes on capital gain income in my blog post for November 23, 2021 which is the 100th anniversary of the Revenue Act of 1921 that created a preference for capital gain income.

**There is a good deal of support for taxing gains at date of death and removing this odd and very large exclusion, usually with some threshold, such as President Biden's $1 million of assets per decedent.  That likely should be $2 or $3 million to be sure step up repeal is aimed at those holding the types of assets that might great appreciate providing significant income tax breaks to multimillionaires and multibillionaires. Think about the founder's stock that several billionaires have.

One of the founders of Facebook, Chris Hughes, a multimillionaire and author of Fair Shot, explaining and supporting universal basic income (UBI) states in this book: "we should adjust our tax code so that the wealthy ay the same tax rates on their investment income as hardworking Americans do on their wages. ... Second, we should cap deductions at 28 percent for the wealthiest Americans and close tax loopholes, like the one that allows for the gains on inherited assets to be be excluded from taxable income."

Also see a March 2021 press release from Senator Van Hollen and others on the rationale for eliminating the tax exclusion of gains at date of death and letting heirs get the assets at FMV.

Also see my September 2020 op ed in The Hill on not using a wealth tax to generate revenue but fixing the big leaks and inequities in our income tax.

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