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Michael Meeropol: What The Candidates Have To Say About President Obama's 2016 Tax Proposals

Today I want to talk about some of the tax changes proposed in the 2016 budget just submitted by President Obama.   It would be a great public service if we could get the predicted presidential candidates to respond to some of the specific elements of his proposals.   I wish that those interested in running for the Democratic nomination would be forced to explain which of these proposals she or he supports and which he or she doesn’t support and – most importantly – why?    The Republicans probably have it easier because they can just complain about how many billions (or trillions) of dollars of tax increases are in that proposal and leave it at that.  In fact that is just what they did when the budget was first released.  However, but even given the Republican mantra against any tax increases, it would be great to force them to get more specific about their objections.

Substantively the proposals make a lot of sense.  For instance, he wants to reduce the tax advantages to receiving income in the form of Capital Gains -- income from the sale of stock or other assets that have appreciated since they were first bought.  Very few Public Finance economists believe that lower taxes on Capital Gains are justified on either efficiency or equity grounds.   An outstanding Public Finance Economist working for Ronald Reagan’s Treasury department in 1985 (a man I know and respect highly, Eugene Steuerle) wrote the first draft of what became the Tax Reform Act of 1986.  A key measure removed the preferential treatment for capital gains but this lasted only a few years.

[For details about the ins and outs of actually achieving the bi-partisan compromise that led to the passage of the Tax Reform Act of 1984, see C. Eugene SteuerleThe Tax Decade:  How Taxes Came to Dominate the Public Agenda  (Washington, DC:  Urban Institute Press, 1992).   See also Meeropol, Surrender, How the Clinton Administration Completed the Reagan Revolution (Ann Arbor:  U. of Michigan Press, 2000):  108-112.]

President Clinton restored the preference when he raised the top rate to 39.6% in 1993 leaving the capital gains rate at the 28% rate specified in the Tax Reform Act.  President George W. Bush widened it – cutting the top rate to 15%.   Obama’s deal with the Republicans in 2012 raised the top rate to 23%  which was well below the 39% for ordinary income he established for taxpayers with incomes above $400.000).  Obama’s current budget proposal wants to raise the top capital gains rate back to 28% -- the rate it was at under the regime of tax reform from 1986 to 1997.  That rate would still be well below the top rate for ordinary income but a bit closer than it is now.

[For details on a number of the proposals in the Obama budget for fiscal 2016, see http://www.bloomberg.com/graphics/2015-budget-release/]

There are a number of reasons why most public finance economists believe the preferential treatment for income received as a result of selling assets and realizing a capital gain is unwarranted.  On the simplest level, let us ask why someone who makes $200,000 selling stock should pay a lower rate than someone who makes the same amount working as a doctor, lawyer or engineer?   This violates a major tax principle --- horizontal equity – which says that people in the same circumstance should pay the same taxes.   It also violates the basic principle of progressivity in the tax system – that those with greater ability to pay (as in higher incomes) should be taxed at a higher rate.  95% of the benefit from the capital gains preference go to those making more than $200,000 per year.  [For details of the distribution of the benefits from the preferential treatment for capital gains as well as a historical graph of increases and decreases of the benefits over time see http://crfb.org/blogs/tax-break-down-preferential-rates-capital-gains.]

The reason Warren Buffett pays at a lower overall rate than his secretary and the reason Mitt Romney paid a rate of 14% on his income as per his tax return for the year 2011 is largely due to the capital gains preference.

There’s one other proposal in Obama’s budget that relates to Capital Gains.   He proposes that when a person dies and leaves assets to his or her heirs, they should have to pay the capital gains tax on the increase in the value of those assets.  Currently, the value of the asset is automatically raised to its current value with no tax paid at all.  Thus, even if your father had achieved millions of dollars in capital gains over his lifetime of accumulating stocks, the day your father dies, the stock immediately jumps to its current value.  If you sell the stock immediately you will report a zero capital gain on your income tax return.   True, you will have to pay an estate tax on the value of the capital you receive but the estate tax exempts the first $5.43 million of the estate.   Thus, imposing a 28% tax on the gains that had accrued to the assets before you inherited them will not be a terrible burden.   If anything, it will partially make up for the dramatic reduction in the scope of the estate tax over the last decade.  (When George W. Bush took office the exemption for the estate tax was less than half a million dollars.   The current $5.43 million exemption is a result of a compromise between President Obama and the Republicans.)

The budget proposes that the revenue gained by raising taxes on high income people be used to expand tax credits for higher education, to create a $500 tax credit for families with two working parents and to offer some parents child-care tax breaks of as much as $3,000 a year.   This makes tremendous economic sense.  Not only does it increase the fairness in the tax system but it will actually stimulate the economy.  The tax relief for middle income people will be translated into increased spending.  The very high income people who see their tax burdens rise will not cut back on their spending because they already consume as much as they want to.  Thus, there will be a net short term kick to total spending (therefore total employment) in the economy.   The counterargument to what I have just written is that the high income individuals will have their incentives damaged and they won’t invest as much, won’t save as much and won’t put out as much effort.  There is no evidence from recent tax changes going all the way back to the 1980s and the so-called Reagan revolution and including the Clinton tax increase that this argument works.  (For details, see Meeropol, Surrender:  Chapter 8.   It would be great if potential Presidential candidates were forced to explain why they oppose this tax relief for middle class families just to protect advantages that mostly accrue to the top 1%.   I urge everyone to make a habit of asking pointed questions of all potential Presidential candidates on this and all other issues discussed in these commentaries – which, as promised last time, will focus on issues that should be explored in depth by the prospective candidates for President.

Michael Meeropol is professor emeritus of Economics at Western New England University. He is the author (with Howard Sherman) of Principles of Macroeconomics: Activist vs. Austerity Policies.

The views expressed by commentators are solely those of the authors. They do not necessarily reflect the views of this station or its management.

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