Out of the mouths of Congressmen sometimes come gems.
No one should ever be taxed twice on the same income. It’s not fair and it’s not just.
So tweeted Jerry Nadler back in April. Nadler is a Democratic member of the U.S. House of Representatives.
There’s something to what he’s saying. As I noted in my recent article on capital gains taxes, a tax on capital gains is a fourth tax on income. The first is the income tax, the second is the tax on corporate income (if you invest some of your earned income in corporate stock), the third is the tax on dividends that the corporation pays you, and the fourth is the capital gains tax when you sell the asset. There’s even a fifth tax if you die very wealthy: the estate tax.
Unfortunately, Nadler doesn’t oppose the corporate income tax, the tax on dividends, capital gains taxes, or estate taxes. So he doesn’t really mean it. What he had in mind was much more parochial: his opposition to the $10,000 limit on the deductibility of state and local taxes (the so-called SALT limit) from taxable federal income.
It’s interesting, though, that Rep. Nadler made a principled argument. Why did he make it? Presumably because he thought it would resonate with people. I agree with his argument and I think people should start making it and and, unlike Rep. Nadler, mean it.
READER COMMENTS
Alan Goldhammer
May 26 2021 at 6:30pm
You should have mentioned that the capital gains tax is optional. It is not triggered until the stock is sold. Furthermore, when you croak, your heir(s) don’t have to pay any cap gains as it is now reset to the price they inherit it at (this is one of the reasons for an estate tax as significant capital gains go untaxed). I don’t think this fits in with what you say in the post above. Is it your position that captial gains on the sales of stock should not be taxed?
MarkW
May 27 2021 at 8:02am
How about this — we’ll get rid of the ‘angel of death’ loophole for capital gains in inheritance in exchange for indexing. So you’d only pay tax on capital gains (or interest) above and beyond the rate of inflation. For the money people have in interest-bearing accounts right now at 1/2 a percent, not only shouldn’t they have to pay tax on the ‘gains’, they should be able to deduct a loss because inflation is greater than the interest earned and their investment is losing value. Are you good with that?
Mark Z
May 27 2021 at 2:22pm
That’s an interesting conception of ‘optional.’ You can’t buy things with stocks and bonds, so you have to sell them at some point to derive any worth from them. This is kind of like saying income tax is optional because you can get out of it by donating all your income to charity. Yes, if you don’t care about getting to spend any of your income, I guess it is optional.
David Henderson
May 28 2021 at 5:51pm
You write:
Your first sentence is correct. I’m willing to bet dollars to doughnuts (although with inflation that’s a less lopsided bet than it used to be) that Nadler would vote for Biden’s proposal to abolish the reset. Regarding the fit, you’re right. If the capital gain is not taxed at death, then the fourth tax I discussed does not take place if the person waits until death.
Vivian Darkbloom
May 29 2021 at 3:27am
“(this is one of the reasons for an estate tax as significant capital gains go untaxed)”.
That puts the cart before the horse. The estate tax was not implemented because there was a pre-existing step-up in basis rule for income tax purposes. The basis rules of Section 1014 were adopted after the estate tax in order to avoid that heirs would effectively pay both estate and income tax on the same value of the appreciated asset. In other words, the avoidance of double estate and income tax on capital gains is the reason for the *step-up*, not the reason for the estate tax (as an historical note, we’ve had various forms of federal estate or inheritances taxes since the early days of the Republic).
I am puzzled by the discussion of the “step-up in basis” rules in the media and indeed by Biden’s summary of his own proposal. To my way of thinking, Biden’s proposal does nothing to change the step-up in basis rules. While the mechanics of the proposed rule are not explained in detail, I believe that the proposal is intended to do the following:
To the extent that a decedent has unrealized gains of more than $1 million at her death, those unrealized gains will be deemed to be realized at death (either a sort of “income in respect of decedent” or income to the estate). In either case, the heirs who inherit that appreciated asset *will* obtain a step-up in basis of the assets to which this deemed sale rule applies (and the existing step-up rules will continue also to apply to assets with less than $1 million of un-realized gain) . If the mechanics were different, that is, that the heirs would simply inherit the asset with its historical basis, there would be no tax levied immediately. And, there would be no need, as stated in the Biden proposal, for example, to exempt certain small businesses from the rule.
If the asset simply carried over to the heirs without step-up, this would have large revenue and practical effects. No tax would be collected immediately and heirs could indefinitly postpone the gain by not selling the appreciated asset they inherit (except to the extent needed, perhaps, to pay the estate tax). Further, if there is no step-up, I would expect that the value of the asset for estate tax purposes would need to be reduced to account for the deferred tax liability that it carries. Any person who has ever bought or sold a business knows that deferred tax liabilities reduce the current FMV of that asset. The logic of the FMV rules for estate tax should be no different. Immediately taxing the unrealized gain at death eliminates those difficulties.
To the extent that unrealized gains are less than $1 million, the existing step-up to FMV at death should apply as it does today under Section 1014.
Rather than speaking of “eliminating the step-up rule”, the description, I think, should more accurately be “introducing a deemed realization of gains at death rule”. I could be wrong about the mechanics underlying the proposal, but I don’t think I am.
Frank
May 26 2021 at 9:54pm
Oh, hell, just go for a consumption tax! 🙂
Jerry Brown
May 27 2021 at 12:11am
I don’t understand how taxing each source of income means you are being taxed multiple times on your total income. It seems to me that you are saying that while it might be ok to tax the first source, it is not ok to tax any other source after that. Even though they are all additional income. So if I was to spend part of my already taxed earned income in a mega-millions lottery ticket that hit- well those millions aren’t income and should not be taxed?
I think I would rather just go with an expanded consumption/use tax than an income tax that did not recognize most all income. But then we have a plethora of currently implemented taxes to choose from.
Mark Brady
May 27 2021 at 1:55am
What does David think of a single tax on the site value of land?
Thomas Lee Hutcheson
May 27 2021 at 7:05am
I think rather than cite a “principle” (Why not tax income, or anything else multiple times, nibble rather than chomp down?) I’d ask about the deadweight loss. What behavior are we incentivizing or disincentivizing with a particular tax? Wouldn’t a progressive’s income tax that exempts non-consumption (like SALT) reduce the present-future consumption distortion that we try to avoid with preferential taxation of certain kinds of “already taxed” income.
Jens
May 27 2021 at 7:39am
Perhaps it was clear from the context what exactly he meant. Maybe he thought nobody should be taxed twice for the same taxable event. Just like nobody should be punished twice for the same offense (ne bis in idem).
Dave Smith
May 27 2021 at 10:31am
Even if you are correct, that interpretation does not weaken Professor Henderson’s point.
Vivian Darkbloom
May 27 2021 at 9:23am
What is the logic behind the idea that the federal government must allow a deduction for state taxes, but the state governments need not allow a deduction for federal taxes? (Actually, six states do allow a deduction for federal income taxes, but New York state is not one of them.) What “principle” does that New York state stance represent? A good question for Congressman Nadler would be “Why doesn’t New York state income tax law allow a deduction for federal tax in order to avoid income “from being taxed twice? Why is that New York policy fair and just?”
I suspect that in attempting to answer those questions Nadler might be forced into some sort of “states rights” argument or historical constitutional argument, which would be strange positions for a modern-day progressive, not that such arguments would be persuasive as to the issues raised.
David Henderson
May 28 2021 at 5:53pm
Good point.
Vivian Darkbloom
May 27 2021 at 9:35am
“What he had in mind was much more parochial: his opposition to the $12,000 limit on the deductibility of state and local taxes (the so-called SALT limit) from taxable federal income.”
The limit on SALT deductions is actually $10,000 ($5,000 if the filing status is “married filing separately”).
David Henderson
May 28 2021 at 5:54pm
Oops. You’re right. Correction made. Thank you. I was confusing the number with a UBI number when I was mentally planning today’s UBI post.
Daniel
May 27 2021 at 10:34am
Same problem as the “X% wealth tax is actually a Y% capital income tax” line. Almost anything can be conceived as a tax on something else. The estate tax is very obvious on this as you aren’t taxing Sr. on their income, you’re taxing Jr. on *their* income. In the same vein, anytime you tax an activity that uses after-tax income, it’s double taxation (though this is even more untrue in investing as you have a cost basis – think on the margin)! It’s good for scoring political points, but it’s not an ingenuous characterization.
The problem with capital double taxation reasoning is a little different. It isn’t that a particular dollar of income is taxed “multiple” times as a matter of accounting that is problematic, but that it reduces the “legibility” of the tax code to average people. It’s important to realize that a stream of $100 in corporate profits will flow to shareholders and is not just taxed at 21% or a weighted average of the individual dividends/capgains rate. It’s a combination of all of those. So when someone thinks they’re paying 15% on their capital gains, well, they are. But instead of receiving 85% of the residual value of corporate activities, they receive 67%. The problem isn’t *that* they miss 33% of that value (that’s just a question of what is the proper tax rate), but it’s that to the non-astute, it facially looks like they miss 15%, and the double taxation police help point that out!
The SALT issue is interesting because of dual sovereignty in the US. Coursing a dollar through a tax funnel is fine, as long as it’s a funnel of different taxes going to the same sovereign. The unfairness arises when multiple governments are claiming a share of the same dollar. Theoretically, this could result in insane tax burdens. Who has first dibs on taxing you and to what extent should the federal government be wary of states strategically leveraging the deduction to their own budgeting ends? It’s complicated, much more so and much more truly so than all these other framing complaints.
David Seltzer
May 27 2021 at 5:07pm
I currently pay property tax on my home. An unsold asset with unrealized capital gains. A sixth tax on unrealized gains? I’ve acquired wealth by dint of industry, assumption of risk and fair play. Biden’s tax plan has incentivized me to reorder my estate plans. Exchange real estate for inc0me producing real estate with no taxes paid for the exchange. Capital Gains Bypass Trust and a Family limited Partnership.
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