Reasonable arguments can be made in each case. But taking only the “limit tax incentives” approach to reform has several major defects.
First, if reform is designed to avoid perverse outcomes, such as the crushing of charitable contributions or more pressure on state budgets, then it will raise only limited amounts of revenue.
Second, this approach will address very little of the code’s complexity and is unlikely to do much for recovery, as it will do little to increase demand.
Third, it will do little to address concerns about fairness because the richest taxpayers actually make relatively little use of deductions and credits.
What’s needed is an element that has largely been absent to date: the numerous exclusions from the definition of adjusted gross income that enable the accumulation of great wealth with the payment of little or no taxes. The issue of the special capital gains treatment of carried interest — performance fee income for investment managers — is only the tip of a very large iceberg. Far too many provisions favor a small minority of very fortunate taxpayers. They effectively permit the accumulation of wealth to go substantially underreported on income and estate tax returns, which forces the federal government to consider excessive increases in tax rates if it is to reach any given revenue target.
Whether their primary concern is preserving incentives for small businesses, closing prospective budget deficits or protecting the social safety net, all parties should be able to agree that it should not be possible to accumulate and transfer large fortunes while almost entirely avoiding taxation. Yet this is all too possible today.
Here are some issues the Obama administration and Congress should consider in light of the magnitude of prospective deficits and the extraordinary good fortune of those at the top of the income distribution:
Current valuation practices built into the tax code make it possible for investment partners to end up with $50 million or more in tax-free individual retirement accounts when most Americans are constrained by a $5,000 annual contribution limit.
Our estate tax system is broken. Assets passed to relatives or other personal relations are often badly misvalued relative to what they cost on an open market. The total wealth of American households is estimated at more than $60 trillion. It is heavily concentrated in very few hands. An estimated $1.2 trillion, or 2 percent, is passed down each year, mostly from the very rich. Yet estate and gift taxes raise less than $12 billion, or 1 percent of this figure, annually.