The U.S. Can't Afford a Tax Policy That Punishes Wealth
Bloomberg Markets|June - July 2021
HIS CRITICS AND supporters agree: President Joe Biden’s tax plans are radical. He wants a substantial increase in U.S. public spending and means to pay for it by raising taxes on the rich, in particular by almost doubling the top tax rate on investment income. Unsurprisingly, the idea seems to be playing well in opinion polls. It would be odd if the promise to lift up the poor and middle class at the expense of the top 3% was unpopular. The question is whether it’s smart.
CLIVE CROOK

There are reasons for doubt. They start with technical matters: the effect of the changes on revenue and on saving and investment. Broader questions also arise. Is Biden’s approach to tax reform coherent? And can it be squared with one of America’s great strengths: its regard for profit-driven innovation and its willingness to reward and applaud success?

The president’s most arresting idea combines two changes to the taxation of investment income. At the moment the top rate of the capital-gains tax is 23.8%. Biden wants to almost double it, to 43.4%. He also proposes to abolish the so-called stepped-up basis at death. This longstanding treatment erases unrealized capital gains for tax purposes when the owner dies; assets pass to the heirs with their acquisition value (or “basis”) stepped up to current prices.

The two components are linked. Capital-gains tax is paid only when assets are sold, and owners can usually choose when that is. The higher the rate, the bigger the incentive to delay the sale and defer the tax. Stepped-up basis goes one better, eventually canceling any taxes owed. If stepped-up basis were left in place, the rate that maximizes proceeds from the tax would likely be less than 43.4%, because a rate this high gives too big an incentive to defer and avoid the tax. Scorers at Congress’s Joint Committee on Taxation have estimated this revenue-maximizing rate to be as low as 28%. Abolishing stepped-up basis would push it higher, but it’s unclear by how much.

The expert consensus on this question has been moving in Biden’s direction. Recent studies emphasize, for example, that the preferential tax rates for capital gains reward efforts to disguise wages as investment income, as with the notorious carried-interest loophole. A higher capital-gains tax would curb such avoidance. On the other hand, taxpayers won’t see these changes as permanent. For the wealthiest households, Biden’s changes would put enormous sums in taxes at stake—and the rewards for deferring sales of assets until a change of control in Washington reverses his plans would be huge. His proposals would likely raise substantial new revenue, but probably less than he hopes.

Biden also wants to raise the tax on corporate profits from 21% to 28%. Again, avoidance is an issue. The new rate would be the highest of any major economy, restoring the incentive to move profits offshore. The administration recognizes the problem and aims to mitigate it with new anti-avoidance measures— including an international agreement on minimum global taxation of corporate income, which is being negotiated.

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