The Estate Tax, like the Graduated Income Tax and the Capital Gains Tax, has been under attack for many years by “conservative groups.” I always have difficulty with the media’s use of this appellation for it is inherently misleading. A “Conservative,” as the term implies, wishes to conserve. He/she opposes innovation, or at least is cautious about it, but reveres that which is established. But as I have shown when they attack the Graduated Income Tax or the Capital Gains Tax, they attack systems that have been with us for a century and a half. That is not conservative! That is as radical as one can get.
This history applies equally to the Estate Tax if not more so. It was as early as 1797 not long after the constitution was ratified, that Congress imposed a “legacy tax.” It was repealed in 1802. In 1862 Congress enacted an inheritance tax and repealed it in 1870. In 1898 an inheritance tax was again passed and repealed in 1902. In each of these cases the sole purpose of the tax was to raise revenue, usually to finance wars, which is why they were repealed when the funds were no longer needed. But until 1916, the US, unlike European and South American countries, did not have a landed aristocracy or an inherited concentration of wealth. In 1916 money was needed to finance World War I but there was also a concern with the increasing concentration of wealth, or as the House Ways and Means Committee put it the tax was needed to deal, “in part (with) concentrations of inherited wealth.”
Nevertheless, Theodore Roosevelt, a Republican, who McCain lauded as the President he most admires, said as early as 1907, "A heavy progressive tax upon a very large fortune is in no way such a tax upon thrift or industry as a like tax would be on a small fortune. No advantage comes either to the country as a whole or to the individuals inheriting the money by permitting the transmission in their entirety of the enormous fortunes which would be affected by such a tax; and as an incident to its function of revenue raising, such a tax would help to preserve a measurable equality of opportunity for the people of the generations growing to manhood."
In 1935 Franklin Roosevelt proposed to Congress that they pass both an estate and an inheritance tax but only the estate tax passed the Congress and it went unchallenged until the year 2000. Even during the Reagan years the tax went unchallenged. But in 2000 a major drive to repeal both the Estate tax and the Gift tax was undertaken. It was backed by the wealthiest in our society, who using that wealth mounted a campaign full of misleading and outright false claims. One of the things I personally remember were radio ads that purported to be from financial advisors warning people that unless they sought estate planning they risked having their estate confiscated. Secondly, other groups mounted a campaign that family farms and small businesses were being endangered and that many would have to sell their farms/businesses in order to pay the taxes. The campaign was so effective that when HR 8 the Death Tax Elimination Act Came up for a vote in the House it passed by a vote of 279 to 136 without a dissenting Republican vote and 65 Democrats voting for it. The bill did not pass because President Clinton vetoed it and there were not enough votes to override his veto. The Office of Management and Budget in warning Congress that President Clinton would veto the bill, said in part, “The Administration strongly opposes H.R. 8, which would repeal the estate and gift taxes. Repeal of these taxes would be fiscally unwise, would reduce the overall fairness and progressivity of the tax system, and would harm charitable giving. The President would veto this legislation repealing the estate and gift taxes if it were presented to him.
“The Administration believes that such a tax reduction would harm the important priorities of maintaining fiscal discipline, paying down the national debt, extending the solvency of Medicare and Social Security, and maintaining core government functions such as education and fighting crime. The Administration estimates that this legislation, when fully phased in, would cost close to $50 billion annually, far more than the stated costs of the bill, because most of the cost is delayed to beyond the first five years.
“While the Administration supports appropriately targeted estate tax relief for small business and family farms, a tiny fraction of the tax relief provided under this measure accrues to these important sectors of the Nation's economy. Only the wealthiest two percent of all estates pay any estate tax at all. The estate tax promotes the integrity and fairness of the overall tax system by acting as a backstop to the income tax, ensuring that even income on which income tax is deferred or avoided is ultimately subject to at least some tax. In addition, recent studies suggest that repeal of the estate tax could reduce charitable gifts and bequests by close to $6 billion annually.
“The Administration worked with the Congress in 1997 to lift the burden of the estate tax on the vast majority of small businesses and family farms. The Taxpayer Relief Act of 1997 raised the effective deduction for qualified family-owned business interests to $1.3 million ($2.6 million for a couple), which exempts almost all family farms and small businesses from the estate tax. Current law also allows small businesses and farms to exclude part of the value of real property used in their operations. Those few businesses and farms that are subject to this tax can pay it in installments over 14 years at below-market interest rates.”
I quote this at length because it sums up the case against repeal so well that I feel I cannot possibly improve upon it.
I want to specifically discuss some of the arguments made for repeal and rebut them, but that will have to wait for my next exposition. Let me close here by quoting Louis Brandeis, a highly distinguished Justice of the Supreme Court who served from 1916 to 1939 and who said "We can have democracy in this country, or we can have great wealth concentrated in the hands of a few, but we can't have both."
In my opinion this should be self-evident, particularly at a time when we see both the power and abuse of great wealth.
Showing posts with label Capital Gains Tax. Show all posts
Showing posts with label Capital Gains Tax. Show all posts
Monday, December 15, 2008
Sunday, November 30, 2008
The Capital Gains Tax
In my last commentary entitled, “The Graduated Income Tax," I pointed out that the reason the very rich pay a large percentage of our taxes is because they have most of the income and most of the wealth, and the gap between the haves and the have-nots gets ever greater. I showed that the graduated income tax only closes the gap a miniscule amount since after tax income shows only a slight closing of that gap.
I quoted Warren Buffett as pointing out that in the final analysis despite our theoretical graduated income tax, his marginal tax rate is 17.7 % on the $46 million he made last year, without trying to avoid paying higher taxes, while his secretary, who earned $60,000, was taxed at a marginal tax rate of 30%.
While many provisions of the tax code play a part in this, I have little doubt that a major reason is the favorable treatment given capital gains. It has often been said that America has a Protestant work ethic that places special value on work, and everyone in American society has an obligation to “work.” This, however, is not reflected in our tax system, for here we penalize work with a substantially higher tax rate than passive income, i.e. income earned without work. At the moment earned income is taxed at a marginal tax rate of 35% on incomes over $357,000, (This is extremely low by historical standards. Between 1941 and 1945 taxpayers with incomes over $1 million faced a top marginal rate of 94 percent.) but unearned income or capital gains (if held for more than a year) and dividends are taxed at 15%. I submit that there is no justifiable reason to tax unearned income at a rate below that for income, which is earned by actually working. While people at the lower end of the income scale often make a small percentage of their income from capital gains, those with high incomes, who often have never made a cent in their lives by the sweat of their brow, or even from intellectual effort, having often inherited their wealth, make the bulk of their income from unearned income. Furthermore, they have every opportunity to cheat even from this minimum burden, for while the wage earner has his income reported to the IRS by his employer, the investor is on his honor when reporting the cost of his asset, (stock or other) and can easily inflate his cost (“basis” in tax lingo) and even misrepresent the date of the acquisition to gain long term status (assets held less than a year don’t get this favorable treatment). Under present Internal Revenue law the broker must report the sale of stock to the IRS, but he is not required to report a purchase. Thus the IRS has no way of knowing whether tax evasion is occurring short of an audit, which is rare. I strongly urge, (and I am sorely disappointed that no major columnist or candidate has addressed this issue) that brokers and other sellers of assets, including real estate agents, be required to report the purchase and sale of all assets subject to tax.
I also believe that the present system which taxes capital gains only when the asset is sold (realized capital gain) distorts the capital markets. It is far better for the capital markets to function when the only consideration is to maximize ones gains or minimize ones losses, without tax consideration being a major factor in decision making. This becomes particularly egregious when one considers that the wealthy can postpone selling their assets indefinitely if they want to avoid paying taxes, while those in lesser financial positions must frequently sell to meet expenses, particularly after retirement. I believe that it would be far better if the value of the asset be assessed at the end of the taxable year (easily done with stocks and bonds) and that to the extent that the value of the asset has increased or decreased be used as the taxable gain or loss minus an allowance for inflation. It becomes an outright scandal when we consider that those who can afford to not sell their assets before they pass away, can avoid paying a capital gains tax altogether on their gains, since their heirs get the assets with a basis, not as of acquisition, but as of the death of the legator thus escaping ALL capital gains taxes.
Those who generally argue for reducing the tax burden on those who can best carry it maintain that dividends and capital gains are different from other income and not only deserve favored treatment but should be exempt from all taxation. Their arguments are so that numerous that it is difficult to set them all forth even without pointing out their fallacies, but let me attempt to cover at least the most prominent ones within the circumscribed length of this article. See here.
1.) “High effective capital gains rates reduce the capital stock and lower growth and productivity.” I discussed this in my previous article on the income tax. More capital will not be deployed unless there is consumer demand, which according to the Wall Street Journal accounts for 70% of GDP.
2.) “Capital gains taxes encourage a "lock-in" effect that discourages investors from selling their assets.” I think there is merit in this, which is why I advocate taxing all gains at the end of each fiscal year instead of at the time of sale.
3.) “Capital gains are not income -- as the Supreme Court held for many years, and even after the passage of the 16th Amendment.” This is more a reflection on the makeup of the Supreme Court than an argument and the Supreme Court has long since reversed this erroneous holding.
4.) “Capital gains are already taxed more than once through the corporate and personal income tax -- and taxing appreciating stocks or real estate can be a third layer of taxation.” This is the favored argument not only for not taxing capital gains and dividends, but for not taxing estates, but it is nonsensical, because ALL taxation is of a multiple nature. When a worker’s pay is taxed is it double taxation because that money was already taxed when the corporation earned it? Is it double taxation when a worker is taxed and then pays a portion to his grocer, who is taxed, who then pays his doctor, who is taxed, who pays his landlord who is taxed? The whole point of taxes, and the only way it can work, is that money, or any asset, is taxed every time it changes hands. What the corporation earns is taxed and when it passes those earnings to its stockholders it is taxed - it has changed hands. An even better illustration is the real estate tax where the same piece of property is taxed year after year. If it were otherwise the government would get a tax once and never again.
5.) “Lowering capital gains taxes substantially raises tax collections and increases tax payments by the rich” (Source) This is true in the short run but untrue in the long term, or as Professor Richard Serlin of the University of Arizona put it, “When there is a cut in the capital gains tax rate, there is an incentive to sell the stock then, and get the lower tax rate before a new administration raises it again. Thus, when the capital gains tax is cut, there is a rush of investors selling stocks to pay their capital gains taxes now, when the rate is law, rather than later when the rate may be raised back up. Capital gains tax revenue to the government thus may go up now, but it will go down later, and it will go down overall.”
But logic is not the strong point of the advocates of reverse taxation, i.e. placing the greatest tax burden on those who make the least, who are to be grateful for the opportunity to serve those who make the most.
I quoted Warren Buffett as pointing out that in the final analysis despite our theoretical graduated income tax, his marginal tax rate is 17.7 % on the $46 million he made last year, without trying to avoid paying higher taxes, while his secretary, who earned $60,000, was taxed at a marginal tax rate of 30%.
While many provisions of the tax code play a part in this, I have little doubt that a major reason is the favorable treatment given capital gains. It has often been said that America has a Protestant work ethic that places special value on work, and everyone in American society has an obligation to “work.” This, however, is not reflected in our tax system, for here we penalize work with a substantially higher tax rate than passive income, i.e. income earned without work. At the moment earned income is taxed at a marginal tax rate of 35% on incomes over $357,000, (This is extremely low by historical standards. Between 1941 and 1945 taxpayers with incomes over $1 million faced a top marginal rate of 94 percent.) but unearned income or capital gains (if held for more than a year) and dividends are taxed at 15%. I submit that there is no justifiable reason to tax unearned income at a rate below that for income, which is earned by actually working. While people at the lower end of the income scale often make a small percentage of their income from capital gains, those with high incomes, who often have never made a cent in their lives by the sweat of their brow, or even from intellectual effort, having often inherited their wealth, make the bulk of their income from unearned income. Furthermore, they have every opportunity to cheat even from this minimum burden, for while the wage earner has his income reported to the IRS by his employer, the investor is on his honor when reporting the cost of his asset, (stock or other) and can easily inflate his cost (“basis” in tax lingo) and even misrepresent the date of the acquisition to gain long term status (assets held less than a year don’t get this favorable treatment). Under present Internal Revenue law the broker must report the sale of stock to the IRS, but he is not required to report a purchase. Thus the IRS has no way of knowing whether tax evasion is occurring short of an audit, which is rare. I strongly urge, (and I am sorely disappointed that no major columnist or candidate has addressed this issue) that brokers and other sellers of assets, including real estate agents, be required to report the purchase and sale of all assets subject to tax.
I also believe that the present system which taxes capital gains only when the asset is sold (realized capital gain) distorts the capital markets. It is far better for the capital markets to function when the only consideration is to maximize ones gains or minimize ones losses, without tax consideration being a major factor in decision making. This becomes particularly egregious when one considers that the wealthy can postpone selling their assets indefinitely if they want to avoid paying taxes, while those in lesser financial positions must frequently sell to meet expenses, particularly after retirement. I believe that it would be far better if the value of the asset be assessed at the end of the taxable year (easily done with stocks and bonds) and that to the extent that the value of the asset has increased or decreased be used as the taxable gain or loss minus an allowance for inflation. It becomes an outright scandal when we consider that those who can afford to not sell their assets before they pass away, can avoid paying a capital gains tax altogether on their gains, since their heirs get the assets with a basis, not as of acquisition, but as of the death of the legator thus escaping ALL capital gains taxes.
Those who generally argue for reducing the tax burden on those who can best carry it maintain that dividends and capital gains are different from other income and not only deserve favored treatment but should be exempt from all taxation. Their arguments are so that numerous that it is difficult to set them all forth even without pointing out their fallacies, but let me attempt to cover at least the most prominent ones within the circumscribed length of this article. See here.
1.) “High effective capital gains rates reduce the capital stock and lower growth and productivity.” I discussed this in my previous article on the income tax. More capital will not be deployed unless there is consumer demand, which according to the Wall Street Journal accounts for 70% of GDP.
2.) “Capital gains taxes encourage a "lock-in" effect that discourages investors from selling their assets.” I think there is merit in this, which is why I advocate taxing all gains at the end of each fiscal year instead of at the time of sale.
3.) “Capital gains are not income -- as the Supreme Court held for many years, and even after the passage of the 16th Amendment.” This is more a reflection on the makeup of the Supreme Court than an argument and the Supreme Court has long since reversed this erroneous holding.
4.) “Capital gains are already taxed more than once through the corporate and personal income tax -- and taxing appreciating stocks or real estate can be a third layer of taxation.” This is the favored argument not only for not taxing capital gains and dividends, but for not taxing estates, but it is nonsensical, because ALL taxation is of a multiple nature. When a worker’s pay is taxed is it double taxation because that money was already taxed when the corporation earned it? Is it double taxation when a worker is taxed and then pays a portion to his grocer, who is taxed, who then pays his doctor, who is taxed, who pays his landlord who is taxed? The whole point of taxes, and the only way it can work, is that money, or any asset, is taxed every time it changes hands. What the corporation earns is taxed and when it passes those earnings to its stockholders it is taxed - it has changed hands. An even better illustration is the real estate tax where the same piece of property is taxed year after year. If it were otherwise the government would get a tax once and never again.
5.) “Lowering capital gains taxes substantially raises tax collections and increases tax payments by the rich” (Source) This is true in the short run but untrue in the long term, or as Professor Richard Serlin of the University of Arizona put it, “When there is a cut in the capital gains tax rate, there is an incentive to sell the stock then, and get the lower tax rate before a new administration raises it again. Thus, when the capital gains tax is cut, there is a rush of investors selling stocks to pay their capital gains taxes now, when the rate is law, rather than later when the rate may be raised back up. Capital gains tax revenue to the government thus may go up now, but it will go down later, and it will go down overall.”
But logic is not the strong point of the advocates of reverse taxation, i.e. placing the greatest tax burden on those who make the least, who are to be grateful for the opportunity to serve those who make the most.
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