Cost of Various Tax Proposals

Factual Questions
1

I have various notions for things that I think would the tax system more logical and fair, but I’m wondering what the cost of these various changes might be. I wonder if anyone has ever studied them and/or otherwise analyzed the costs of these taxes. The proposals are:

[ol]
[li]Eliminate the corporate income tax.[/li][li]Tax all capital gains as ordinary income.[/li][li]Index the cost basis of capital gains to (some measure of) inflation.[/li][li]Allow unlimited income write-offs of capital losses.[/li][li]Eliminate the inheritance tax.[/li][li]Tax estates at death on all unrealized capital gains.[/li][/ol]
Any data?

2

Rough numbers and some guesstimates coming.

  1. Eliminating the corporate income tax costs $343.8 billion in 2015. That’s expected to drop in 2016 and 2017.

  2. I can’t find great numbers on how much personal income tax is from capital gains. In 2007, after a big run-up in equity markets and real estate, capital gains taxes were 5.3% of personal income taxes. Assuming 2015 was a similar ratio, 2015 would have had $173.3 billion in capital gains taxes. These are paid mostly by people in the top bracket. You would be looking to increase the capital gains tax rate from 20% to roughly 40%. Unfortunately, increasing the capital gains tax rate causes people to delay taking capital gains. One study says a 1% increase in the rate causes capital gains recognition to drop by 6%. Accordingly, if this effect holds, a 20% increase in capital gains tax rates would cause recognition of gains to drop 70%. That means your net capital gains taxes would likely drop from an estimated $173.3 billion to only $103.5 billion, for a net cost to Federal tax revenue of -$69.8 billion.

  3. This would decrease the effective capital gains tax rate but would improve recognition. My hunch is that recognition wouldn’t increase as much as effective rates dropped, so it would cost something but I don’t know how much.

  4. Again, this would cost something but I don’t know how much. It’s probably a function of the aggregate carry forward capital losses but I don’t have that number handy.

  5. This would cost approximately $19.3 billion in Federal tax revenue as of 2014.

  6. This probably raises almost no revenue because people will give their estates away before death, escaping your tax. If you implement a unified gift and estate tax structure (resembling today’s) that taxes gifts too, it might raise some money, but the details matter. Until you’ve specified those details, I can’t hazard a guess what the revenue might be.

Your tax plan would be an enormous gift to the country’s wealthy and would balloon the deficit by over $420 billion, approximately doubling the 2015 budget deficit.

3

I don’t have your answer … I just wanted to point out that these proposals don’t solve the problem with our current tax code … we can set up a simple and fair tax system like we did in the mid 1980’s … but then Congress has had thirty years of riders, amendment and ear-marks that just, once again, makes our tax code insanely complicated … that leads to the hyperbole “200 pages of tax code apply to 99% of the tax payers, the other 15,000 pages only apply to the richest 1%” …

4

Thanks!

I would quibble with this. Any delay would only decrease revenue in the short term. Eventually it would have to be recognized, either on sale or death (or transfer). If you assume that over the long term the actual capital gains would average out what they are today, then that would double the $173.3B.

These seem inconsistent. Why assume people will give their estates to escape one tax but when they don’t to excape another?

But again, thanks for the numbers.

5

Right now in the US if you give an appreciated asset, the donee has to take your cost basis for capital gains purposes. If you inherit an appreciated asset, you get a cost basis as the value at the time of death (or six months later) so you escape the capital gains tax, though the estate has to pay an estate tax. If you eliminate the estate tax, you should probably eliminate the write up of the basis as well.

If you give an appreciated asset to a charity, you can deduct the market value at the time of the gift, but you don’t have to pay a tax on the unrealized capital gain. It seems to me you should either have to pay that tax or only be able to deduct your cost basis.

6

I’m kind of thinking of #5 & #6 as a package. The transfer itself wouldn’t be taxable, but at the time of the transfer the capital gain is taxed.

So if a guy purchases an asset for $100K, dies when it’s worth $300K, and then his heirs sell it later for $400K, then the estate would be taxed for the appreciation from $100K to $300K, and the heirs would later be taxed for the appreciation from $300K to $400K.

I don’t have any numbers but I was kind of thinking it would be a net increase in tax revenue, because the threshold for the inheritance tax is pretty high, while I’m not envisioning any threshold on the capital gains tax at death. It would be as if the guy realized $X of income at death.

That’s pretty much what I’m saying as applied to estate taxes. (ISTM that your two options are mathematically the same thing. Deducting the market value but realizing the capital gain is the same thing as deducting the cost basis.)

7

I can’t find analysis of your specific questions, but this link has some CBO analysisof other tangentially related proposals.

8

IIRC, the logic for not implementing 5 & 6 is to do with problems like family farms and family businesses. If Joe Sr. builds a thriving widget business, worth several dozen million - when he kicks the bucket, Joe Jr. and Sally inherit that asset. But, they don’t have any liquid cash, just a business worth a bit. Now, they are faced with either borrowing millions from the bank to pay off the estate taxes, or cashing in selling the business, whether the market is in a good state or not. Sad for a widget business, devastating for a family farm.

9

Would that include houses? For instance, my dad bought his current house in 1963 for $15k. It is currently worth twenty or thirty times that much. When he dies and my mom inherits, she has to pay capital gains on the difference?

Regards,
Shodan

10

Your scenario may be different due to different circumstances, however generally the basis of inherited assets will be the FMV at the time of death. Even still, inheritance tax is only true in a few states and in all of them property passing to a surviivng spouse is exempt. In addition, that amount is well below the universal life time credit so without the step up in basis there wouldn’t be a tax liability. The credit amount changes each year, but it is north of $5M.

11

Check out The Dwindling Taxable Share Of U.S. Corporate Stock from the Tax Policy Center. I’m having trouble linking to the PDF URL on my phone, but Google should get you there. A large portion of stocks are held by untaxed institutions or in tax-advantaged retirement accounts, so the effect might be smaller than expected.

Would you tax qualified dividends as ordinary income in this scenario? Or we could examine it either way. Although I’m not entirely sure how to add it all up.

There are a few supposedly revenue-neutral tax proposals bouncing around Congress that fiddle with various rates, but thus far I’ve only read summaries of summaries.

12

Something to take into account, which most guestimates of tax reduction costs don’t do, because it’s very difficult to do, is that the overall economic system is highly reactive. Make a big change in one place, and everyone will react in ways that will make the numbers shift all over the place.

But there will also be a time-delay between the change, and the results. Lots of tricks have been played on Americans over the decades, by making changes, and then pointing to the IMMEDIATE results, as though they are characteristic of the change.

It’s a bit like, if you stop paying your energy bills today, you will seem to be that much richer, right away. But after a while, the energy suppliers will turn off your power, and then you will have to spend that “extra” money to cope with that reaction.

So-called Reaganomics, was based on the ASSUMPTION that lowering taxes on the richest people would nearly instantly result in them investing more, and growing the economy, thus more than offsetting the revenue losses to the government, as taxes on everyone else’s rising incomes, made up the difference. It was BS, and it didn’t happen, for the most part, because the economy was never that simple.

Also, there are more “costs” involved with making changes, than the cash itself.

It would probably behoove you to look up WHY each tax that was enacted, WAS enacted. Some taxes are arranged, because the people enacting them want revenues, and look for places where they think “extra money” wont be missed. But other taxes are there to try to influence the economy, either to discourage things, or encourage them.

But the INTENTIONS of the tax changes don’t always pan out (see the utter failure of Reaganomics, for example).

By the way, the reason I say that Reaganomics as advertised failed, is because in the event, Reagan’s government didn’t JUST lower taxes on the rich. They also spent government money like there was no tomorrow, and goosed the hell out of the private sector that way. So the economy DID go into positive territory, but it wasn’t because the tax cuts caused business investment. It was because the government joined the Customer Class big time, and drove business expansion the old fashioned way: by BUYING STUFF.

13

Just for some historical perspective: The federal estate tax actually was repealed for one year, 2010. It came back in 2011.

They also repealed the step-up in basis for that one year. But they allowed a $1.3 million exemption on capital gains per estate and a $3 million spousal exemption on capital gains.

In addition to the extra taxes the heirs would have to pay when they sold the inherited assets, there was a tremendous paperwork burden. Heirs would have to hunt down the paperwork to establish the deceased’s basis, which was often nearly impossible. Imagine someone who had been reinvesting dividends for 50 years in a stock that split and a company that merged, split, and divested multiple times. Or imagine a farm that the deceased had owned for 50 years and made improvements to, suffered casualty losses. bought and sold equipment and parcels of adjacent land.

14

Capital gains accrue generally to the pretty wealthy. Whether they ever get taxed depends on how long they wait to realize gains. If they give the appreciated assets during their lives to their children, they don’t realize the gains. Their less well-off children might recognize those gains at much lower tax rates. High marginal tax rates also promote cheating.

Today, it’s hard to give enormous estates away during a rich person’s life without triggering the gift tax. Despite this difficulty, many rich people succeed in doing so with several types of trusts and by maximizing annual gift tax exclusions and using their lifetime unified credit. This is called estate planning and it’s a big business. Most billionaire wealth passes this way and evades estate taxes. That’s why estate tax collections seem so small today.

If you get rid of the estate tax and the gift tax, you make the job of estate planning easy. Just give the wealth away during your life.

If you replace today’s estate tax with your version of taxing unrealized gains on death at ordinary income tax rates and keep the gift tax as it is today, it would lead to three effects:

  1. You would subject more estates to tax. Today, roughly 1.4% of estates are subject to estate tax. You would subject essentially all of them to tax. The wealthiest 1% of people in the US control over 1/3 of the country’s wealth. That suggests that that if you subjected every estate to your new tax, you would subject increase the tax base by less than three. Let’s call it 2.5 as a guesstimate. Even that might be generous.

  2. Keep rates somewhat similar, at least at the high end. Ordinary income tax rates max out at about 39.6%. That is also roughly the max tax rate on estates, which is 40%. Those marginal rates kick in at different taxable amounts though, but not that different. Income tax rates hit 39.6% with just $415,000 in income for single filers. You need a taxable estate of over $500,000 to hit the 37% bracket. Of course, these are measured on different bases since income is taxed at income rates and inherited wealth is taxed at estate tax rates. Your plan would essentially transmute the unrealized gain portion of the estate into ordinary income.

If an estate hasn’t used up it’s unified credit, the first $5.45 million is currently exempt from tax. Accordingly, the average effective tax rate on estates is only 16.6% due to exemptions and exclusions. By subjecting nearly all estates to the estate tax at potentially similar income tax rates, you give everyone with an estate the same incentive to structure around the tax that only the wealthiest people have now. Let’s assume that, because of this incentive, the effective tax rates on estates stay roughly the same as they are now. That means your version of the estate tax would theoretically bring revenue up in proportion to the increase in taxable estates (2.5 times). Optimistically, this means you would increase estate tax collections from roughly $19.3 billion to about $50 billion.

  1. You would add a generous indexing for inflation that would greatly reduce the effective tax rate. I don’t have numbers on how much this would cost, but I’ll bet it’s a lot. If we assume that real appreciation of assets is only about 2/3 as much as nominal appreciation, this exclusion could cost you 1/3 of your potential estate tax revenue, or roughly $15 billion. Stocks probably appreciate at roughly this rate. Houses and real estate barely appreciate at all in real terms. The mix between rapidly appreciating assets and slowly appreciating assets greatly affects how much you realize with your new tax structure.

So, with a little optimism, you have forgone over $400 billion of revenue and generated maybe $15 billion in new revenue to replace it.

15

I should probably acknowledge that eliminating corporate income taxes would increase dividends and/or capital gains and thus push up personal income taxes. There would be a lot of slippage though. Many holders of corporate securities don’t pay income taxes (e.g, retirement plans and foreign shareholders). Of the remainder that do, many will defer recognizing gains so you create a timing problem and perhaps allow them to effectively evade taxes altogether.

16

None of these things supports saying that raising the capital gains tax rate lowers revenue, which is your claim.

This is all very long and detailed, but best as I can tell you’re essentially conceding my point. Which was that it’s inconsistent to claim that eliminating the estate tax costs money but that taxing capital gains at death does not raise money. These are inconsistent, as I’ve noted.

What you’re saying now is that while the net impact of these two changes is to raise revenue, you think the net gain is smaller than might be anticipated, due to the likely impact of tax planning. I think that’s somewhat speculative, in presuming that the same types of tax planning that are effective for estate taxes would also work for a tax on capital gains. But worth bearing in mind, thanks.