Clinton Proposal on Capital Gains Tax: I Like It

hillary_stormbornI’ve written before about carried interest taxes, estate taxes, and real estate tax policy using the contrasting lens of what is ‘fair to me,’ (typically, If I don’t have to pay it, it’s fair to me) versus what is ‘fair to society,’ (My attempt to take the broad view, even if it hurts me personally.)

Another common way of thinking about tax policy – today’s way – would be to think specifically about what behaviors the policy would encourage and discourage.

Now, I understand you may resent the idea that Big Brother imposes its will on you via tax policy. I don’t have a big problem with it myself. The way I figure it, behavior-modification is one of the main things that determine good or bad tax policy.

capital_gains_tax_distribution

My state and local governments already discourage me from using tobacco and gasoline through targeted sales taxes on those products. The federal government discourages me from working for a living through income tax policy. In addition, the federal government encourages me to be born into a wealthy family via the $5.43 million estate tax exemption.[1] All of these behavior modifications are just part and parcel of tax policy, forming part of what we use to think about what makes for a good or bad tax.

Democratic Party candidate Hillary Clinton recently proposed behavior modification through changes in the capital gains tax.

I expect I’ll have plenty of critical things to say in the future about Clinton as she moves from candidate to President, but I actually dig this proposal.

Before getting into her tax proposal, however, I’m troubled by the insufficiency of the title I just used, “Democratic-Party candidate.” Because she is far, far more important than that title implies.

Can we instead go with something like “Hillary Stormborn, First Lady of the House of Clinton, Democratic Senator from New York, Secretary of State, Encourager of Benghazi Jihadists, Webmaster of Clinton.com, Queen from Across the Narrow Sea, First of the Andals, and Unburnt Mother of Dragons?”

clinton_dothraki

I think that about covers all of her past experiences accurately, no?

Anyway, back to tax policy.

Clinton’s campaign proposes capital gains tax changes for the highest income tax bracket that would step down each year that an investor holds securities.

Currently, taxpayers in the highest tax bracket pay 39.6% in taxes on gains for securities held less than a year, and 20% for holdings held longer than that. Taxpayers in lower tax brackets currently pay their regular income tax rate for holding securities less than a year, then 15% for anything held longer than one year.

Clinton’s proposals would incrementally lower the capital gains tax rate on the highest taxpayers, for each year that those investors hold securities. The tax rate on capital gains would drop to 36% by year 2, then step down to 32%, 28%, 24%, and finally to 20% by year 6.

clinton_capital_gains_proposalHave I lost you yet? I’m not trying to. Here’s the deal. If you make a lot of money each year, the Clinton proposal would encourage you, via tax incentives, to hold on to securities for a long time horizon, of at least six years or more.

This behavior modification tax has two explicit targets. The first target is investors, who would be rewarded for holding stocks for six years or more. If investors find they can lower their taxes by holding stocks for a longer amount of time, they likely will approach stock ownership with a greater emphasis on long-term wealth creation.

The second target is public-company managers.

“It’s time to start measuring value in terms of years – or the next decade – not just next quarter,” she announced in her speech proposing these changes, according to the Wall Street Journal.

Longer-term investors, the idea seems to be, will encourage longer-term thinking among the management of public companies. Without the pressure to perform on a quarterly basis, maybe, public companies will avoid short-termism in their decision-making.

By the Clinton campaign’s own telling, the capital gains tax modification would not raise much additional federal revenue.

One reason is that her proposal only affects investors already in the highest tax bracket, earning above $464,850 for married couples, or $411,500 for singles, or somewhat fewer than 1% of all income earners in the United States.

The second reason this would raise limited revenue is that many investors hold a majority of their investments in tax-protected accounts such as IRA and 401Ks, Investors do not need to pay taxes on capital gains on securities held within these accounts.

So again, the entire point of this is behavior modification, not revenue generation. If you already hate behavior modification via tax policy, you’re not going to like this idea as much as I do.

Since I feel so strongly that the correct time horizon for equity investments falls somewhere in the range between five years and forever, I think Clinton’s on to something good here in encouraging a six-year minimum holding period for securities, via tax policy.

One criticism I have of the proposal is that it doesn’t apply to the bottom 99% of earners. Since the point here is behavior modification of both investors and public company managers, I don’t see why the rules wouldn’t equally attempt to modify their behavior as well.

Everybody should have a six-year-or-greater time horizon with their investments, so everybody should be subject to the rule.

 

Please see related posts on taxes:

Can we have an adult conversation about income tax policy?

Real estate tax – Agriculture exemption rant

Carried interest tax rant #1

Carried interest tax rant #2

Estate taxes

 

[1] Think about it: Heavy taxes on income if you work to earn it, but a tax free $5.43 million if it comes from Daddy!

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The View From The Fiscal Gorge

fiscal gorgeHappy Fiscal Gorge[1] Day!

Guess who’s really happy from last night’s tax deal? Heirs, financiers, and people who live off their piles of money.

Guess who’s not saddened by the Fiscal Gorge tax deal? The top 2% of earners that Obama spent his campaign promising would pay a larger share of federal taxes if he won.

Let me explain what I mean.

All along this Fiscal Cliff discussion our leaders have focused our attention on top marginal tax rates and top income thresholds for taxing ordinary income, as if that was the most important way to raise revenue while simultaneously addressing growing societal inequality.[2]  The sticking point in discussions, at least in so far as most media followed it, appeared to be whether top income earners would pay the existing 35% income tax rate or Obama’s preferred 39.6% income tax rate, and where in the range between $250K and $1million in income that higher rate kicks in.

Why do wealthy folks celebrate the Fiscal Gorge?  Just this:  If you’re Sheldon Adelson[3] you really couldn’t care less about ordinary income.  What matters most are estate taxes, dividend taxes, and capital gains taxes.  Adelson makes $1 million a year in ordinary income, now taxed at a higher rate.  No big deal.  He makes billions of dollars in dividends and capital gains, now permanently taxed at 20% for Adelson.  Now that’s a big deal.  Now that’s cool.[4]

Did you notice what happened to those taxes?

Estate Tax: The estate tax exemption rises to $5 million, up from the $1 million it would have been without a Fiscal Cliff deal, and up from $675K when George W. Bush came into office.  The tax rate on inheritance locks in at 40%, down from 55% at the beginning of the Bush Administration.  Throughout the Bush administration the estate tax exemption stepped up each year or two, and the estate tax rate stepped down every year or two.  Under the Obama administration, with the new Fiscal Gorge law passed, the W. Bush-era generous estate tax rates become permanent. Richie Rich is so happy.

Dividends Tax: If you were Sheldon Adelson – which you are not, but let’s pretend you were – right now you would be celebrating a Happy New Year because you just took a special dividend payout in December 2012 from Sands Casino of an estimated $1.2 Billion, based on your ownership of 431.5 million shares and a declared dividend of $2.75 per share.  Adelson took the dividend in December fearing that his 15% dividend tax rate might rise to something like the 35% or 39.6% ordinary income tax rates, which would cost him close to $300 million in additional taxes in 2012.  He needn’t have worried.  The Fiscal Gorge law makes a 20% dividend tax rate permanent for folks in Adelson’s income range, a pillar of the Bush administration’s tax cuts.  The dividend rate stays at the 15% rate for those earning less than $450K.

Capital Gains Tax – This tax rises from 15% to 20% under the Fiscal Gorge law.  Given that top earners and top wealth holders benefit substantially from capital gains, the permanence of this change represents another victory for Bush-era tax cuts.

My logical mind tells me that political leaders and the media underplay the importance of these taxes because, firstly, they only somewhat affect the highest earning 10% of American citizens, and secondly, these taxes only substantially affect the highest earning 1% and above.  So the majority of the electorate and the majority of the media-consuming public doesn’t really know or care about these taxes.  It’s only logical they would ignore those taxes that are irrelevant to the majority of people, right?

My more paranoid mind[5] tells me that it’s convenient for political leaders on both sides of the aisle to ‘hide the ball’ when it comes to tax discussions because you can enact a devastatingly effective ‘win’ for Republicans while at the same time allowing Obama and the Democrats to point to higher marginal taxes on ordinary income as if they scored something important.

They didn’t.  They got rolled, at least when it comes to tax policy.

When it comes to spending, of course, they delayed any cuts in government spending.  Which I suppose makes Democrats feel smug as well.[6]

Which leads to the larger critique and larger structural issue highlighted by the Fiscal Cliff process.

  1. The Fiscal Cliff was an invented political crisis technique – which managed to hold the economy hostage – to force compromise and hard, responsible, fiscal choices from elected leadership.
  2. The resulting Fiscal Gorge law, in the end, involved no significant compromise.  Republicans got overwhelming tax cuts, permanently enacted, and Democrats got all their desired spending continued for a little while longer.  So we got the crisis, but no real compromise.  Thanks guys, awesome job.
  3. It’s easy to cut taxes.  Everyone’s happy.  It’s also easy to spend a lot of money because, again, everyone’s happy.[7]  The hard part is cutting spending or raising taxes, the two things required to, you know, pay our extraordinary debts.
  4. Hard choices like raising taxes or cutting spending require compromise and long-term thinking, of which we received no evidence of either throughout the Fiscal Cliff crisis.

 

One additional point about tax policy and my use of Sheldon Adelson as an example of a wealthy citizen.

I pick on Sheldon Adelson because, in the new era since the Supreme Court’s Citizens United decision, which allows for unlimited campaign contributions as a First Amendment-protected ‘free speech right,’ Adelson represents the paragon of a stated willingness – and most importantly ability – to use money to tilt the political process in his favor.  Multiples of those same campaign contributions then return to him through favorable tax treatment.

Adelson has become – for me at least – a short-hand way of pointing out a glaring structural flaw in our electoral democracy.  I’ve got no particular animus against his wealth accumulation, and I really don’t blame the guy personally for pursuing his self-interest as he understands it.  But we haven’t figured out a way to prevent, for the sake really of systemic integrity, guys like him from tilting the table too far in their favor.

While acknowledging that I’m re-stating the incredibly obvious, I like to talk about Sheldon Adelson simply because he’s my way of showing we’re light on the whole ‘checks and balances’ thing when it comes to the influence of money in politics.



[1] My friend “The Professor” who recently wrote a guest post about Sheldon Adelson, deserves credit for the “Fiscal Gorge”, which naturally follows when you go over the Fiscal Cliff.  The actual name for the legislation passed yesterday by the House and Senate to address the Fiscal Cliff is The “American Taxpayer Relief Act of 2012.”

[2] I know, we don’t talk about growing inequality in a straightforward way when discussing tax policy.  But that is clearly what Obama had in mind when he campaigned on raising taxes on people who make more than $250,000 a year.  Yes, it would have a small effect on fiscal solvency, but it would have a larger effect on our notion of what’s fair in an increasingly unequal society.  One simple illustration of the increase in inequality in the United States is captured by the picture of the historical increase in the US’ Gini Coefficient measuring income inequality from 1947 to 2007.

[3] Obviously I’ve written about him already, but he’s an incredibly convenient stand-in for wealthy Americans and their successful capture of the political process.

[5] What!?  You don’t have multiple voices in your head debating tax policy at all times?  Am I over-sharing?  Why won’t you answer me, damn it?

[7] Which reminds me of one of my favorite Jack Handey quotes: “It’s easy to sit there and say you’d like to have more money. And I guess that’s what I like about it. It’s easy. Just sitting there, rocking back and forth, wanting that money.”

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Adult Conversation About Income Tax Policy

With the Fiscal Cliff[1] looming, kids, it’s time for “The Talk.”

By ‘The Talk,’ I mean yank our minds into the grown-up world.  We have been innocent about how money really gets made, and kept, and taxed.  The ‘adults’ know, but they haven’t felt comfortable sharing the real truth.  We didn’t know, and we didn’t think we could talk about it.  It seems embarrassing for some reason.  Almost dirty.  Maybe it’s the way we were brought up.  Nevertheless, now’s the time for ‘The Talk.’

Here it is in a nutshell: The way the ‘grown-ups’ – our elected officials – set tax policy tells us how they value different ways of making money.  They see three different ways to make money, and they clearly favor the first two.

Inherited Money

According to our tax code it turns out the very best way to make money is the old-fashioned way:  Inherit it.

As of this writing, the first $5 million from a deceased individual can pass to you tax free.  Our elected leaders want you to know that the best way to get rich is to be born into a rich family and have the right people die at the right time.[2]

Stated that way, it seems a bit un-American, no?  A bit, well, aristocratic.  Nevertheless, that’s far and away the best way to earn your first $5 million.  Our leaders want you, Richie Rich, to have your first $5 million tax free.[3]  Mwah!

Make money with your money

The second best way to get wealthy, according to the tax code, is to already have a lot of money, and then earn money on your money.

If you already have a lot of money, then a significant proportion, probably a majority of your income, will come from three sources: Tax Free Bonds, long-term capital gains on your investments, or corporate stock dividends.[4]

The best of these investments, tax wise, is Triple Tax Free municipal bonds, which are exempt from local, state and federal income taxes.  You earn just about 0.5% interest[5] these days, but if you’ve got $100 million in triple tax free muni bonds then you’ve got yourself $500,000 a year, tax free!  That pays for quite a few golf outings a year, with money left over for the lobster roll at the club and a tip for the valet.

The next best way to make a living from your investments, according to the tax code, is to buy and hold stocks for at least 18 months before selling at a profit, so that your earnings will be taxed at a rate of only 15%, the long-term capital gains rate.

Should you be so fortunate as to start out in life with a massive stock portfolio, your elected officials say to you: “Good Job!  That’s an excellent way to make a living!  Let us incentivize you to earn the majority of your living by having your pile of money do all the work, while you join that swell municipal bond fellow at the club.”

The third best way to earn money from your money is to hold stocks for at least 60 days, thereby earning qualified dividends, likewise taxed at a comfortable 15% rate.[6]

I interpret all of these three tax policies combined as our elected officials’ way of saying that the next best way of making a living – after being born into a rich family – is to sit around like Scrooge McDuck investing money, and only paying 0% and 15% on one’s income.[7]

Mitt Romney’s 14% effective tax rate in 2011 derives from this tax advantaged way to ‘earn’ a living, just as your elected officials would like you to.

Working for a living

The ‘grown-ups’ who make tax policy tell us this is the worst way to make money.  You see, if you work for a salary, that income is liable to be taxed at the maximum income tax rate.

If you can make less than $35,350 a year, fine, they’ll tax you at a 15% rate.

But over that, you’re looking at 25%, 28%, 33%, or up to 35% for those making over $388,351.  The lesson of the tax code is that people who actually work for a living, rather than inherit from Daddy or live like Scrooge McDuck, should be taxed the most.  “Working for a living?” they taunt us, “that’s for chumps!  Tax that man at the maximum possible rate!”

That’s “The Talk” about our tax policy which creates better and worse ways to make money in this country.  No, Virginia, there is no Santa Claus, but there is a Richie Rich and a Scrooge McDuck.  And our elected officials just love them!

 



[1] Is it weird that I love the sound that the phrase ‘Fiscal Cliff’ makes in the mouth?  Its poetry, really.  To mangle a bit of Nabokov:  “Fis.Cal.Cliff.  Taking a trip of three steps through the split fricative to tap front teeth, at three, on the lower lip.”

[2] Yankees owner and billionaire George Steinbrenner famously died in 2010, the one year in recent memory during which the Estate Tax was wholly repealed.  George was worth an estimate $1.1 Billion, so the fact of the Estate Tax repeal in 2010 made the Steinbrenner heirs $500 million richer than they would have been had he died in 2009, as the estate tax rate was 45% of inherited wealth that year.  As a Red Sox fan, I’m just so happy for those boys, Hal and Hank.  It couldn’t have happened to a nicer family.

[3] We will hear, or we should hear, quite a bit about the estate tax in the coming weeks, as the limit exemption on tax-free inheritance reverts back to $1 million and a 55% rate in 2013, if Congress does not take action. “Death Taxes on Small Businesses” is how one political side always describes the Estate Tax, but that’s mostly a load of bull.  The real implication of the estate tax is to what extent our leaders signal that the best way to get $5 million is to be born into the right family.

[4] If you’re not making any money through tax free munis, long term stock holdings and dividends, well then you can just skip to the third section, you working stiff.  Our elected officials can’t be bothered with you, if you can’t take a hint about how to make money.  Jeez.

[5] On 5 year municipal bonds, for example.

[6] The low 15% ‘qualified dividends’ tax incentive ends in 2012, unless Congress acts to extend or modify it, as Congress did, with Obama’s approval, in 2010.

[7] The other great advantage to being Scrooge McDuck from a tax perspective, is that – unlike a working-stiff salaryman – you can choose what year to harvest stock market gains.  Scrooge McDuck can end up with virtually no taxable income in any given year should he choose to sell no appreciated stock.  Or Mr. Duck can match up investment losses with investment gains to have no net taxable income, or even to trigger a tax refund.  In a related story, did you know Mitt Romney got a $1.6 million tax refund last year?

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