By Anja Manuel
November 8, 2017
IDEAS
Manuel, a former U.S. State Department official, lectures at Stanford University and is the author of This Brave New World: China, India and the US.

With all the cacophony about how to pay for tax reform and who will benefit — effective lobbying by the wealthy from both political parties means that there has been deep silence on the tax expenditure that most benefits the hyper-rich. No one is seriously discussing raising the capital gains rate to the same as income tax, which is how President Reagan paid for his 1986 tax reform.

If the Trump administration went back to the Reagan tax plan and taxed capital gains at the same rate as income tax, the government would save between $148 billion and $226.3 billion a year. Currently 62% of that windfall tax expenditure goes to the top 1%. It is the tax expenditure that most skews in favor of the wealthy, according to the nonpartisan Tax Policy Center.

With this kind of money, you could double spending on education and affordable housing and still not have spent it all. Or if you believe in smaller government, give the middle class a giant tax break — you choose.

But no one is talking about this. Why? Generally, only wealthy elites get what they want from US politics. As a recent Princeton study finds: “When the preferences of economic elites … are controlled for, the preferences of the average American appear to have only a minuscule, near-zero, statistically insignificant impact upon public policy.

In other words, if the very wealthy have the same views on an issue as you do, you might get what you want. But if your views don’t line up — and the hyper-rich clearly don’t think like the masses on capital gains taxation — you’re out of luck.

Here is how this works in practice. The top federal income tax bracket is 39.6% and will stay that way under the proposed House bill. That is what you pay if you earn a lot from actually doing work, such as doctors, lawyers, journalists and others do who went to college but are not investors, real-estate or tech- moguls.

The top long-term capital gains tax bracket is 20% (or 23.8% with the Affordable Care Act surcharge). That is what you pay if you sit at home and watch the money you inherited grow, or if you are wealthy enough to have lots of money to invest. That’s very, very few of us.

The top “qualified small business stock” rate is 0%. That’s what you pay if you’re an early investor in an internet business (for up to $10 million or 10 times your gain, whichever is more) if you get in before the business is worth $50 million. So some Silicon Valley seed investors pay effectively no tax. This provision was supposed to help small time entrepreneurs. In actual fact, almost only tech-internet businesses take advantage of it, because the lady who runs a dry cleaner or salon has no idea this tax provision exists. And the types of businesses that regular Americans start — any service or farm business (or anything that’s an LLC) — are specifically excluded.

As Warren Buffett memorably put it in a New York Times op-ed in 2011, “If you make money with money, as some of my super-rich friends do, your [tax] percentage may be a bit lower than mine [under 17.4%]. But if you earn money from a job, your percentage will surely exceed mine – most likely by a lot.”

Those who favor different rates for income tax and capital gains tend to argue that people wouldn’t invest if investment income were taxed at normal rates, and that it would stop job creation. There is absolutely no evidence for this. Others argue that taxing capital gains is unfair double taxation. Whether this is true is complex, and depends entirely on what the underlying asset is and how long it is held. There’s an easy fix: either have a reasonable total minimum tax rate for the wealthiest Americans, as Warren Buffett has suggested, or make capital gains rates progressive. This would let average Americans who invest a little of their hard-earned money have preferential rates, but the very rich — who get the large majority of their income from capital gains — would pay rates closer to what others do.

The Trump administration and Congress rightfully put several other beloved and mostly far less expensive tax expenditures up for consideration. According to the House bill, the mortgage interest deduction will be reduced, the deduction for state and local taxes almost abolished, and even a future tax on fancy healthcare plans is being preserved. (Other than the exclusion for health plans, these cost far less than the windfall tax rates investors have on capital gains.)

But those that most benefit the hyper-rich — the stepped-up basis for stocks at death, and capital gains treatment — will be maintained. In sum, this sounds like socking it to the fairly wealthy who work for a living, especially those from high-tax blue states, but sparing the billionaires. Because where else would Congress get its campaign contributions?

President Trump was elected to help the forgotten man, not the wealthy donors who sustain both parties. Time for his administration to begin to do that.

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