Tax reform: Focusing on the doughnut and not the hole

Under current tax regulations, capital gains on assets must be realized in order to generate a tax liability. In other words, unless or until you sell an appreciated asset, you won’t be subject to any taxes on the paper gain. If you never sell the asset — i.e., if you die holding assets — your heirs who inherit your assets would be subject to an estate tax, which currently applies only to inheritances in excess of $11.7 million per individual. That estate tax notwithstanding, however, the appreciated value on an any asset is exempt from taxation. That is, the receiving individual recognizes the value of the asset as of the date at which the asset is transferred, and any subsequent tax liability for the new owner would be calculated with reference to this stepped-up basis.

I get the self-interest of those on both sides of inter-generational wealth transfers; but, philosophically, the idea that these gains end up being tax exempt doesn’t exactly seem kosher — particularly since the current structure gives the most generous benefits to our nation’s richest families. Moreover, it should be widely acknowledged that wealth creates a systemic advantage that passes generation to generation. Considering America to be the land of opportunity glosses over the obvious advantages that children of the affluent have relative to their less well-off peers.

That fact should stand alone as a justification to take corrective action, but there’s more: failure to consider the racial disparities in this context seems to me to be willful blindness. The most recent Federal Reserve Survey of Consumer Finances deals explicitly with this issue, with findings summarized in Fed Notes of September 20, 2020. According to that survey, “the typical White family has eight times the wealth of the typical Black family and five times the wealth of the typical Hispanic family.”

(A frequently cited Boston Globe study appears to be at odds with the Fed’s conclusions. The Globe study sought to compare the wealth of black and white families in Boston and found the respective median family wealth amounts to be $8 (sic) versus $247,500, respectively. While this analysis has been faulted on a number of counts, the conclusion that the two household wealth measures are starkly different still stands.)

How can there not be a consensus that something is wrong with this picture? And similarly, how can we fail to recognize that the progressivity of our tax system is insufficient. Some measure of redress can and should be implemented in connection with inherited wealth.

Currently, the Biden administration is trying to do this in connection with the American Families Plan. This proposed legislation addresses inherited wealth issues within a broader legislative package that involves a host of spending initiatives. For the most part, Republicans speaking in one voice and a couple of “moderate” democrats have claimed that this plan is simply too expensive — elements that would increase tax revenues notwithstanding. Rather than accommodating to some form of compromise, their response is the all-to-common refrain, “Just say no!” This posture is unfortunate, as the American Family Plan’s taxing elements are hardly extreme, and they deserve bipartisan support.

The plan would limit the tax exemption on unrealized capital gains to $1 million per decedent, but as far as I can tell, the bill is agnostic as to the size of the estate tax limitation. That issue, however, is addressed in a different bill authored by Bernie Sanders that would lower the exemption to $3.5 million per person in 2022. (Uh oh. I hear the murmurings of creeping socialism!)

I see both of these legislative initiatives as being corrective. Things have simply gotten out of hand. In that regard, it’s kind of interesting to see how — or more specifically, when — we got to the current situation. The step-up of the basis treatment had actually been repealed — twice — once back in 1976 and then again in 2001. Both times, the repeal was short-lived and the step-up basis was re-installed. The estate tax exemptions, on the other hand, have been raised over the years — never lowered. Before G.W. Bush, the exemption was less than $1 million, but in the year following his presidency, it had shot up to $5 million, with annual inflationary adjustments that ultimately brought the exemption to $5.49 million by the end of the Obama administration. Trump’s 2017 tax law more than doubled the exemption to $11.18 million, again, with a mandated annual inflation adjustment. And again, those exemptions are per person, so for a married couple, you can double the amounts.

Isn’t enough enough? Or, stated in the affirmative, too much is too much. Critics of these Democratic proposals are looking at the hole and ignoring the doughnut. These critics aren’t giving sufficient consideration to the benefits that still would go to the heirs under this legislation. Instead, their focus is on the reductions from excessively generous starting points. These poor heirs would only get a tax exemption of $1 million of capital gains and $3.5 million of inherited wealth. How hard it must be for them! We must protect them!

It’s a bit rich to hear Republicans bemoan the fiscal irresponsibility of Biden’s American Families Plan in light of the posture that they’ve taken during past administrations with respect to tax policies. In this instance, championing of fiscal responsibility is a smokescreen. What’s really going on is that Republicans are looking out for the interests of their rich cronies and their donors, as opposed to the greater good.