The Capital Gains Tax Cut Proposal – Dead Letter?

About two months ago the Trump Administration floated the idea of a new tax break on income from capital gains, requesting a review by the US Treasury of the idea.1 The tax break would in effect protect investors from having to pay capital gains taxes that result from inflation.

The response from the lamestream media – of which I am a proud member – was swift and condemnatory. “Unilateral Tax Cut for the Rich!” said the New York Times headline. “$100 billion tax cut for the rich” wrote Vox, and “Huge Windfall For The Richest 1%” said The Washington Post. The Times followed up with an Op-Ed questioning its legality, “Trump’s Crony Capitalists Plot a New Heist.”

As a general rule, I enjoy new income tax proposals. They’re fun and instructive. That doesn’t mean I think we should frequently enact new tax laws willy nilly. I just mean that, because taxes are the means by which government leaders most clearly enact their philosophy of what makes for a good society, tax proposals are a great way of figuring out what our leaders care about, and also what we care about.

In reviewing tax proposals, generally we should ask the following questions: Is it practical and enforceable? Does it reward or discourage economic behavior that we want? Is it fiscally prudent? Finally, is it fair? I’m interested in all these questions.

So how would the tax break work?

Capital gains occur when you buy an investment – a business, a stock, some real estate – and then sell that for a gain. If you made a profit of $100,000 on buying and selling your investment, the money you make gets taxed, generally at 20 percent, or $20,000. The proposal would allow you to avoid taxes on the portion of your gains attributable to inflation. But if inflation accounted for half of that $100,000 gain then under this new proposal you’d only owe taxes on half the gain, or $10,000. So yes, this represents a potentially big tax cut.

The tax cuts would be especially beneficial under two scenarios. First, if inflation is high, and second, if the investment is held over a long period of time, such that inflation accounts for a significant portion of the gains. One theory floated by proponents of the tax cut is that wealthy people holding highly appreciated stock, for example, would be motivated to sell if they faced a lower tax bill. Texas Representative Kevin Brady, Chairman of the House Ways and Means Committee is reported to favor this reform, because “I think we ought to look at not penalizing Americans for inflation.”

Beyond those ideas, what’s the main case for this tax break? If you ascribe to the idea that investment and risk-taking is the engine of the economy, then rewarding risk-taking should lead to a more revved economic engine. Lower taxes might mean higher rates of investment, which should mean more economic growth. It’s a theory.

More than a theory, it’s an axiomatic beliefs of Republican leadership, currently in charge of the executive and legislative branches. These beliefs drove the tax changes of December 2017. Larry Kudlow, the top economic advisor to the White House, favors lowering capital gains through inflation-adjustment.

Is it legal?

Critics object to the idea that the US Treasury would enact this inflation-adjustment rule, rather than have Congress pass a tax reform law. Traditionally, constitutionally, the power of taxation resides with Congress. In practice however, the executive branch often leads the charge in proposing changes to tax laws.

What has taken some commentators by surprise is the Trump administration’s proposal that they enact the tax break through executive means. Hence the claims of illegality.

Smaller-scale capital gains on home ownership, small commercial properties, and small businesses – already benefit from targeted tax breaks and tax deferrals like homeowner exemptions and Section 1031 exchanges. Middle-class owners of stocks would tend to own them through tax-protected IRA and 401(k) retirement accounts. so would not pay capital gains taxes, and would not benefit from this change. This proposal seems specifically calibrated for larger-scale investments and the wealthiest taxpayers.

So is it fair?

This is where societal context matters the most, at least to me.

This proposal, theoretically sound or not, legal or not, smacks of class warfare from above. Here’s the context.

If we started from a relatively equal society then I’d be open to the theory of juicing investment through a targeted capital gains tax break. That’s not where we are.

The trend of the last 30 years has sharply increased inequality.

An estimated 65 percent of the gains from the 2017 tax law change will go to the top 20 percent of earners, who will benefit from the drop in corporate tax rates.

The Washington Post – citing a Wharton School study – found that 86 percent of the estimated $100 billion tax cut over the next 10 years would benefit the highest earning 0.1 percent of Americans, the top one-in-a-thousand wealthiest folks. $95 billion of the $100 billion tax cut would benefit the highest earning 5 percent of Americans. So, yeah, this tax cut overwhelmingly favors the people who are already well off.

We already have an income tax system that greatly favors “capital” over “labor.” What I mean by that is that if you are well off and primarily make money from your money – from investments in stocks, businesses or real estate – you generally pay a 20 percent tax rate on the money you make each year.

When you make money from your labor, however your tax rate increases with your salary but above about $50,000 your tax rate on labor will range between 22 and 37 percent.

Finally, can we afford it?

We are far from fiscally sound. The 2017 tax change is likely to increase the deficit by $1 trillion. By comparison, with a price tag of only $100 billion over ten years, this proposal is only a small bad thing, but definitely not a move in the right direction.

 

 

 

 

 

 

 

 

 

 

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  1. This week, President Trump floated the idea of yet another tax break, although Congress – the folks who write tax laws – claims it has no idea what he’s talking about

A Tax Proposal Worth Considering

The Center for American Progress (CAP) recently published a summary description of their proposals for addressing tax and spending policy, in the light of the ‘Fiscal Cliff,’ Simpson-Bowles, and the ongoing flustercluck of fiscal policy negotiations going on before January 1, 2013.

Their summary report is as good as anything I’ve seen yet in terms of both credibility and reasonableness for addressing tax policy and fiscal deficits.

Who is the Center for American Progress?  The CAP represents the Clinton Wing of fiscal policy, with such getting-the-band-back-together Clinton Administration veterans as Bob Rubin, Larry Summers, Roger Altman, William Daley, John Podesta, and Leslie Samuels.  Before you roll your eyes at those same-old left-of-center Democrats, consider the facts:

  1. This team produced fiscal surpluses at the end of the Clinton Administration[1]
  2. This team cut Welfare
  3. This team is EXTREMELY Wall Street friendly

And, so, now that I’ve established why both the Left and the Right will hate whatever these guys propose, my reply to the haters is that they have fiscal and financial credibility in a way nobody from the Bush era can claim, and they are far from being European Socialists when it comes to policy.

Some specific things I like about the CAP proposals:

  1. They eliminate the ‘Carried Interest’ loophole, which I wrote about here.
  2. They tax dividends like ordinary income – as they were taxed for 90 years before 1993[2]
  3. They raise long-term capital gains taxes from 15% to 28% – as they were taxed after the Reagan tax reform of 1986[3]
  4. They limit the kind of tax breaks which disproportionately favor high earners, such as mortgage interest tax deductions[4]
  5. They simplify and reduce the need for itemization of one’s personal tax returns
  6. They eliminate the Alternative Minimum Tax, aka the Tax Accountants and Preparers Full Employment Act[5]

Here’s the most compelling statement from the summary report:

[T]he real-world experience of raising taxes on those with higher incomes in the 1990s and cutting them in the 2000s strongly supports the view that higher taxes for those at the top – in the range seen in the United State in recent decades – don’t depress growth, and lower taxes don’t spur it.  In 1993 when President Bill Clinton raised taxes on the top income earners, his opponents argued loudly that such tax hikes would mean economic decline, with some even promising lower tax revenues as a result.  Needless to say, they were proven wrong in spectacular fashion with the longest period of economic growth in US history, increased business investment, 23 million jobs added, and, of course, budget surpluses.  Eight years later, President Bush promised that his tax cuts would spark an economic boom.  That boom never materialized, but renewed large deficits did.  In addition to the clear historical record, study after study has found no relationship between deficit-financed tax cuts and economic growth.

 

On the other hand, here’s some things I don’t like or don’t understand well enough from the CAP proposals on spending to find credible:

  1. They rely on a series of health care delivery reforms for fiscal savings.  I’ve heard that one before.  I’m calling BS on that one.
  2. They rely on lowering drug costs and Medicare payments for savings.  I’ve heard that one before too.  If it was easy they’d have done it by now.
  3. They propose $100 Billion in savings from nondiscretionary programs.  “Non-discretionary” to me implies that somebody is going to squeal very loudly when you try to save $100 Billion on their particular non-discretionary item.  I’m seeing a political hot mess.
  4. They propose $300 Billion in new “job creation” spending by the Federal Government.  Hey guys?  Now you’re just opening yourselves up to being accused of typical lefty Democratic thinking.  Just stop it.

In sum, I like the tax side of this CAP Report, and either can’t agree or remain skeptical of the spending side of the CAP Report.  But hey it’s a start.



[1] Which is a reminder of the enraging fact that only 12 years ago the big problem was figuring out what to do with the expected fiscal surpluses we’d have by 2012.

[2] And the world didn’t end

[3] And again, the world didn’t end

[4] A helpful reminder of why this is, from their report: A high earner who pays $10K in mortgage interest could potentially deduct $3,500, while a low earner who pays $10K in mortgage interest could potentially deduct only $1,500.  They both paid $10K in mortgage interest over the year, but the higher earner gets a much better deal on the deduction

[5] In other words, eliminating the AMT could greatly increase the # of folks who could file their own taxes.  Which seems like a good idea to me.

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Life After Debt Part IV: Another Bizarro World Villain

Continuing the theme of ironic historic statements in the light of present circumstances explored in Life After Debt Part I,[1] today’s bizarro world villain is Alan Greenspan.

No other financial celebrity (with the possible exception of Warren Buffet) carried more weight a decade ago than then-Federal Reserve Chairman Greenspan.  So when he said in 2001…

The most recent projections from OMB and CBO indicate that, if current policies remain in place, the total unified surplus will reach about $800 billion in fiscal year 2010, including an on-budget surplus of almost $500 billion. Moreover, the admittedly quite uncertain long-term budget exercises released by the CBO last October maintain an implicit on-budget surplus under baseline assumptions well past 2030… Indeed, in almost any credible baseline scenario, short of a major and prolonged economic contraction, the full benefits of debt reduction are now achieved well before the end of this decade — a prospect that did not seem reasonable only a year or even six months ago. Thus, the emerging key fiscal policy need is now to address the implications of maintaining surpluses beyond the point at which publicly held debt is effectively eliminated.[2]

… people listened.

And what they heard from Greenspan in 2001 was, “we deserve a tax break” given the impending massive federal surpluses.  Greenspan further went on to warn us of the problems of investing the federal surplus, just as the economists at Treasury had worried about in the ‘Life After Debt’ memo.

When I read this, even eleven years later, my face tightens up and my lips curl outward and my stomach gathers into a little tiny ball and I just start spitting f-bombs at Greenspan’s image on the computer screen.  The way he used his financial celebrity and political capital in 2001 drives me bonkers.

Now, I know the world is too complicated to blame all of our problems on the heads of a few individuals or institutions, and especially on the head of one person.  But, if I was forced to name the biggest enabler of our country’s shift in the past decade from surplus to deficit, from creditor to debtor, from strength to weakness, from leader to follower, I’d pick that guy.

If only he’d used his powers for good instead of evil.



[1] Also, please read related posts Life After Debt Part II and Life After Debt Part III

[2] If Greenspan’s bureaucraticoeconomicspeak needs translation, he’s saying something like: “The government’s statistics office says we’ll have a federal surplus by 2010, which will continue to grow, under reasonable assumptions, through 2030.  We just realized this 6 months ago.  Now the big issue to worry about is what to do with our surpluses.”

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