THE DEMOCRATS’ recapture of the House of Representatives has broadened the debate over tax policy beyond the cut, cut, cut mind-set that prevailed during the previous two years of Republican domination in Washington. It is too late to undo the GOP-authored tax bill that passed in 2017. Repealing or replacing it is also off the table as long as divided government prevails. Still, the Democrats can use their platform in the House to advocate a fairer system that brings in more revenue than the current one.
Their focus should be on eliminating or reducing the biggest source of favoritism toward the rich in the current code: the preferable treatment of capital gains and dividends. These forms of income are accrued overwhelmingly by the highest-earning households and reward activity that is, in principle, no worthier morally, or useful economically, than laboring for a wage or salary. Yet the top marginal rate for ordinary income is now 37 percent, while it is only 23.8 percent for capital gains and dividends.
Favorable treatment of this type of income — which the 2017 tax bill perpetuated but did not create — is a major reason for the anomaly, famously noted by billionaire Warren Buffett , that some billionaires pay lower tax rates than their secretaries. It’s probably also why newcomer Rep. Alexandria Ocasio-Cortez (D-N.Y.) struck a nerve with her off-the-cuff proposal to tax all income over $10 million at 70 percent — which, given how much of the wealthy’s income comes in non-wage forms, could be a big deal if it applied to capital gains and dividends, but perhaps not so earthshaking if it did not.
Heavily favoring ownership of capital enables the accumulation of great fortunes and, accordingly, greater inequality of wealth, which is probably even more damaging to the social fabric than inequality of year-to-year wages, salaries and bonuses. We’re not against family wealth, per se — it has founded many a museum and university. But it’s possible to have too much of a good thing, and current tax law may be doing just that. Certainly, the 2017 bill’s near-elimination of the estate tax, which affected precious few households in the first place, should be a high priority for reversal by the Democrat-controlled House.
Two additional changes would also dramatically improve tax fairness while raising significant sums for the Treasury. Under current law, profits on sales of inherited assets are taxed based on the price when inherited, not when first acquired by the decedent; ending this “stepped-up basis” giveaway for wealthy heirs would raise $105 billion over the next decade, according to the Congressional Budget Office. Eliminating a mere two percentage points of the differential between the tax rates on capital gains and ordinary income, and adjusting tax brackets, could raise another $81.4 billion over 10 years, CBO says. Meanwhile, increasing the Internal Revenue Service’s enforcement budget by $500 million from its fiscal 2018 level of $11.4 billion would net the government $35.3 billion over 10 years. Most of that would probably come from wealthy taxpayers who can afford to game the system.
There! We just made the United States more egalitarian and cut future deficits by $220 billion (or paid for that much-needed spending). And we did it without breaking a sweat or reducing anyone’s incentive to make productive investment.