Biden Tax Proposals

I am attempting to model good financial writer behavior by inserting some actual boring tax policy discussion into presidential politics. From what I can glean from media over the past year, the presidential race was declared an entirely policy-free zone. But we should care a lot about boring tax policies!

Now that Biden is heading to the Presidency 1 what the heck did he promise in terms of tax policy changes?

Biden’s proposals on two headline tax rates essentially indicate a rollback of marginal tax rates to Obama-era levels.

For individual taxpayers, Biden proposes a 39.6 percent top tax rate. That’s up from the current 37 percent. This represents a return to the top income tax rate in effect through 2017.

Biden also proposes a 28 percent corporate tax rate, an increase from the current 21 percent corporate tax rate. Still, 28 percent represents a lower corporate tax rate than the United States had on the books between 1994 and 2017.

Biden’s most common campaign slogan with respect to taxes was that people making less than $400,000 per year will not pay higher taxes. Obviously, by implication, he’s warning us (promising us?) that higher income folks will see a rise in their taxes. This rise comes most clearly from targeted changes that would affect the wealthy, and/or the more highly-compensated among us.

For individuals making more than $400,000 per year, Biden proposes a 12.4 percent payroll withholding tax specifically for Social Security. I think that’s mostly where Biden’s $400,000 claim comes from since it’s a new, and clear, tax hike. 

More subtly, but probably more importantly, Biden proposes taxing capital gains more highly in certain cases. Taxes on money made from selling appreciated assets – capital gains – are potentially more important to wealthy folks than taxes on earned income. Biden’s plan would charge higher capital gains taxes for households that make more than $1 million per year. 

Currently, capital gains tax rates are lower than earned income tax rates. Which, if you ask me, has a lot more to do with who funds political campaigns than it has to do with the moral or economic merits of taxing wealth at a lower rate than income, or any other justification for rewarding capital over labor. Biden’s proposal doesn’t upset that apple cart – this traditional tax-code preference for capital over labor. Rather, it says that if you make more than $1 million per year, you don’t get a tax break just because you make money on your wealth rather than on your labor. I’m probably wrong to think this but I feel like if you earn over a million dollars per year, you can survive (maybe, barely) paying a regular tax rate like the people who make a living through their labor. Call me a Socialist, whatever.

Also in the category of tax proposals applying to the few, but sadly not me: Biden has proposed that people worth between $50 million or more would pay a 2 percent wealth tax, rising to a 6 percent tax rate for those with a $1 billion net worth. This seems terribly unfair. Specifically, unfair in the sense that I wouldn’t get to pay that tax. I aspire to pay that tax some day. I want to be in a position to pay that tax. And, I will promise to not complain about it, when the time comes. You can hold my feet to the fire on that one.

Vox_on_Biden_taxes
Graphic from Vox, December 2019

Another Biden proposal affects folks who inherit wealth. This proposal is captured by the phrase “eliminating stepped-up basis,” and the meaning is that inherited assets would not continue to enjoy a massive tax break. Like the capital gains tax proposal, this is a targeted tax change that has huge implications for wealthy heirs as well as the folks who do estate planning. It has very few implications for non-wealthy people who do not inherit highly appreciated assets.

Finally, Biden has not specifically made estate tax proposals, but he did sign off on some Biden/Sanders “unity” principles in July 2020, including rolling back estate taxes to 2009 levels. Those 2009 estate tax levels were set by the Socialistic Bush/Cheney administration.

There are a few other detailed tax credits and exemptions, but that covers most of Biden’s big tax proposals.

Now, the Political Reality

After January 2021, there’s a strong chance that the Senate remains in Republican hands, making most of Biden’s tax proposals backburner issues.2

Sweeping tax reform is also not something I’ve noticed is a priority for Democrats. Between COVID emergency stimulus, health care plans, and a Green New Deal, tax reform isn’t really on-brand for the 2021 Democratic Party.  Still, we should at least understand where the incoming President’s head is at, with respect to tax reform.

Joe_Biden

A version of this post ran in the San Antonio Express News.

Please see related posts:

Let’s have an adult conversation around taxes

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  1. Barring the unlikely success of Trump’s slow attempt at a coup. Which, I don’t know, might work. But I hope it doesn’t.
  2. As of this writing two Georgia Senate run-off races will happen in January. Democratic candidates would have to win both to allow for a 50-50 split in the Senate (tie-broken by Vice President Kamala Harris). It feels like something as complex as comprehensive tax reform is unlikely to pass with this kind of squeaker of a vote majority, even in the unlikely event that Democrats win both races.

Book Review: Automatic Millionaire Homeowner

How important is homeownership to building wealth in the United States? I’d put it on a list of the top five most important things people should do.

Off the top of my head the other four are probably

  1. Stay out of high-interest debt
  2. Automate your savings and investments
  3. Invest in risky, not safe, things
  4. Invest for the long term, greater than 5 years.

As a top five action, why and how is homeownership important? And can it go wrong? Oh yes, it can go wrong. It’s been less than a decade since homeownership went terribly, horribly wrong for many, so even while I want to extol ownership, it’s worth reviewing painful lessons too.

In 2014, the last time the Federal Reserve published their Survey of Consumer Finances, reporting median homeowners’ net worth of $195 thousand compared to renters $5 thousand net worth. Homeowners have nearly 40 times as much net worth as renters.

Of course you scientists will point out that correlation does not imply causation, and also that causation goes both ways. People own a house because they have wealth, AND people have wealth because they own a house. Even so, the mechanism by which home ownership builds wealth matters.

Homeownership works to build wealth because of automation, tax advantages, and leverage.

By automation, I really mean to highlight the way in which paying a mortgage over 30 (or even better, 15) years steadily builds, month after month, year after year, your ownership in a valuable asset, and in a way that matches your monthly budget. Your monthly mortgage payment is a combination of interest and principal, and every bit of principal you pay adds a steady drip into your bucket of positive net worth. Sleep like Rip Van Winkle and then wake up 30 (or even better, 15) years later and boom! You own a valuable asset free and clear of debt.

By taxation, I really don’t want to highlight the mortgage interest tax deduction that everyone seems to know about already, and that quite frankly I’d be happy to see disappear.

Instead, the tax-reducing key to wealth building through a lifetime of home ownership is the capital gains tax exclusion of $250 thousand, or $500 thousand for a married couple. Home ownership doesn’t work like other investments. It works better. If you buy a house for $200,000, and then manage to net $450,000 when you sell it many years later, you have a $250,000 capital gain. Normally, Uncle Sam takes a cut of a wealth-gain like that, like 20 percent, or $50 thousand. But as long as certain conditions are met – you lived there 2 out of the last 5 years – then that entire $250 thousand gain is yours to keep, tax free.

In the bad old days – before 1997 – Congress only let you do this tax trick once in a lifetime. Since then, however, you can do it over and over as much as you like. Now doesn’t that make you love Congress more? Congress is WAY better than cockroaches, traffic jams, and Nickelback, even if it consistently polls worse.

By leverage, I mean that middle class people can’t normally borrow four times their money to buy a valuable asset. If you experience home inflation, that borrowing juices your return on investment in an extraordinary way.

Please forgive the oversimplified math I’ll use as an illustration of leverage: If you invest $50 thousand as a down payment and borrow $200 thousand for a home, and then the home goes up in value by 10 percent, what’s the immediate return on your investment? Hint: The answer isn’t 10%.

If you managed to sell your house with a 10% gain in value, you’d clear $75 thousand after repaying your loan. If you invest $50 thousand in a thing and net $25 thousand on that thing, you have a 50% return on investment. That’s the power of leverage.

When you combine automation, tax advantage, and leverage, you have a powerful wealth-building cocktail from home ownership.

Ready for the cold water to spoil your mojito? Home ownership as an investment can also go terribly wrong.

I was thinking of this recently because I checked a personal finance book out the library that has aged very badly, David Bach’s The Automatic Millionaire Homeowner.

Published in 2005, a few years before the 2008 Crisis, Bach’s book is a combination of good advice, like I reviewed above, and terrible advice.

Bach urges people with weak credit scores to check with their banks about alternative mortgages specifically tailored to them. Bach also describes in detail the opportunities for prospective homeowners to purchase with just 5 percent or 10 percent down, or even “no money down,” rather than seek the conventional 20 percent down-payment mortgage. Bach describes without apology the idea that your house could increase in value by 6 percent per year, every year for 30 years, turning your $200,000 starter home into something worth $1.1 million. In fact much of the book reads, in retrospect, like an excited exhortation to flip one’s way from a starter home to a millionaire mansion through risky mortgages, low money down, and price appreciation as far as the eye can see. Needless to say, that isn’t the way to do it.

I’m not saying low down payments, or buying with weak credit will always go wrong and should be forbidden. I’m just saying that, given what we experienced a few years later, we know it will lead to tears for many. And I’m not saying your house won’t appreciate, I’m just saying that a more normal annual price increase like 2 percent – in line with inflation – is a much better bet.

millionaire_homeowner

Good personal finance books are evergreen, and that one isn’t. If you want a good one however, may I suggest Bach’s excellently readable and important The Automatic Millionaire, in which he extols the concept of automating savings and investments, a key for most middle-class people to build wealth over a lifetime.

 

 

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Hillary Clinton Tax Proposals

hillary_clinton_tax_policyLast week I described future Republican Presidential nominee Jeb Bush’s tax proposals. This week, for balance, I will review future Democratic Presidential nominee Clinton’s tax proposals.

Now, before you #FeelTheBern folks write to tell me about your favorite candidate’s chances in the Democratic primaries, I should say the following: Every letter you write me must be followed up with a $1 bill in the mail to me when Hillary seals the nomination in Summer 2016. I’ll do the same if your candidate wins. Agreed? I’m happy to receive your letters, in that case. Thanks.

Prominent on Clinton’s website – under the topic of “Economy” – are two tax breaks.

Education tax breaks

The first tax break for students is standard stuff. Every family with a student enrolled in higher education is eligible for a $2,500 credit, via the already existing American Opportunity Tax Credit, currently set to expire in 2017. Clinton’s idea there is to make it permanent. No big change there.

Profit-sharing

More interestingly, Clinton calls for private employers to receive a tax advantage for including employees in a profit-sharing plan. Meaning, if every eligible worker receives a proportion of annual profits, then the federal government would incentivize the private employer through lower corporate taxes. Clinton cites studies that link higher worker productivity to profit-sharing plans.

In my town, a large grocery chain (with an estimated 80,000 employees!) named HEB recently announced plans that sound quite similar to Clinton’s tax proposal. HEB’s stated purpose is to foster employee loyalty and enhance employee financial stability. Employees who own HEB shares would qualify for profit-sharing dividends, similar to what Clinton would like to push companies to do through this tax plan.

HEB did not wait for Clinton’s tax incentive to announce the change. It’s unclear from Clinton’s website whether profit-sharing in the form of private stock ownership is what she has in mind, or some other unstated mechanism.

A skeptical part of me thinks employers like HEB will decide to share profits – or not – based on factors much bigger than a possible one-time federal tax incentive like Clinton proposes. But I could be wrong.

clinton_logoPaying for tax breaks

Interestingly, the Clinton campaign includes estimates of the cost of these two taxes, something not obvious on the Bush campaign site.

The college credit, she estimates, would cost $350 Billion over 10 years.

The profit-sharing tax incentive, she estimates, would cost $20 Billion over ten years.[1] So, combined, we’re talking $37 Billion per year, which sounds like a big number to me, but really comes to less than 1% of the Federal Government’s annual expenditures.

How do you pay for these things?

The only answer on her website is to “close loopholes” to make up the lost revenue. This is an interesting example of closing loopholes to pay for other loopholes. But I suppose one person’s “loophole” is another person’s thoughtfully crafted tax benefit? Also, “closing loopholes” is what one always says when one needs a cop-out answer.

Estate Tax

This is the best of all taxes, just ask me. Clinton’s campaign website does not mention her views, but I can make an educated guess.

Clinton voted as a Senator to maintain taxes on estates as small as $1 million, so we can intuit that she supports maintaining or increasing estate taxes. On the other hand, since that time she’s acquired a grandchild and we’ve learned she and her husband have earned over $100 million (!) after leaving the White House, mostly through speaking fees (!). Her personal incentives at least have evolved a bit on this issue

Burden of tax compliance

The Jeb! campaign made comprehensive tax reform its central proposal, arguing that the cost of filing taxes added up to $168 Billion per year for individuals and corporations.

The Clinton campaign also mentions this problem in the section on jumpstarting small businesses. Her focus remains small, however, stating “The smallest businesses, with one to five employees, spend 150 hours and $1,100 per employee on federal tax compliance. That’s more than 20 times higher than the average for far larger firms. We’ve got to fix that.”

I’m pretty sure adding loopholes isn’t going to help, and there is not a single specific simplification proposal on her website, but I guess it’s the thought that counts?

Carried Interest

I’m a bit obsessed with carried interest taxes – as a former hedge funder – except my views would not be popular with hedge funders.

Fortunately Clinton says she would eliminate hedge funders’ favorite tax break. This makes me happy.

Progressive taxation

Along a similar vein, Clinton proposes enacting the ‘Buffett Rule’ to ensure that wealthy folks pay a higher proportion of their income than lower earners. Only a monster – or, you know, Steve Forbes – disagrees with the idea of progressive income taxation, so that’s not a surprise.

The real reason Buffett pays a lower tax rate than his secretary is that he earns money on his money through capital gains, rather than through a salary. If you want progressive tax rates, you have to address the favorable taxation of capital gains and dividends, rather than salaried income, because that’s where wealthy people actually make their money.

What is a bit innovative is Clinton’s proposal to incentivize long-term investing through a gradual reduction in the capital gains tax. Under Clinton’s plan, the longer you hold the investment, the less you pay in taxes.

Clinton’s capital gains tax proposal is a bit of behavior-modification meddling, but I mostly forgive that because it rewards the buy-and-hold investor behavior that everyone should adopt.

 

Next week: An analysis of third-party candidate Trump’s tax policies. Kidding! A genius like Trump knows tax policies are for Losers!

A version of this post ran in The San Antonio Express News.

 

Please see related posts:

JEB! Tax policies

Death Taxes and Fairness

Shhhh…Please don’t talk about my tax loophole

Adult conversation about income tax

Real Estates Tax Rant

 

[1] Incidentally, for a wholly new tax proposal, I have no confidence that Clinton’s $20 billion is the right number. It totally depends on how many companies adopt the plan to share profits, and that seems quite unknowable at this time.

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