Harry’s Wealth Tax Breaks… for the Middle Class?

I had a conversation (if me yelling a lot can be called a conversation) with Seth Scott, Representative Harry Mitchell’s Press Secretary about Harry’s co-sponsorship of a tax cut plan to keep Capital Gains taxes at their current Bush-mandated rate, and to decrease estate taxes by increasing the exemption to 3.75 million and graduating the rate.

I still am firmly against these tax reforms and even more strongly against any Democrat sponsoring such legislation. Seth led me to understand that Harry’s concern is that middle class folks saving for retirement and small businesses owners could be impacted by the scheduled increase in these taxes after 2010, but I find this rationale to be labored, at best.

I challenged Seth to send me a workup of the distributional result of these proposed tax cuts and I’ll publish them here when he does. I maintain that the vast majority of the benefits will go to those in the highest income groups who don’t need any tax relief. Indeed, I would be very surprised if the vast majority of the $332 billion price tag doesn’t end up in the pockets of the wealthiest Americans. I’ll reserve judgment until Harry’s tax wonk gets me figures, but every Congressional Research Service report on the matter supports my view of these tax cuts as disproportionately benefiting the very wealthy.

You only have to look at how the different income groups make their living to see that this is a tax cut for the very wealthy. CRS RL33285 "Tax Reform and Distributional Issues" of Feb. 27th, 2006 says, "According to tax data, over 80% of income in the middle class came from
wage income, while only a third to a half of income in the very high
income levels was derived from wages. Some forms of income do not fit
clearly into the wage or capital income categories. When adjustments
are made to allocate these forms of income, such as pension income and
proprietorship income, the concentration of labor income increases in
the middle classes. When all income is assigned to either capital
income or labor income, over 90% of income earned in the middle classes
derives from labor, while half or less of income in the highest
brackets derives from labor."

When you tax capital gains at a rate preferential to the rate of labor, you automatically privilege wealth, and tend to increase the share of national income accruing to the wealthiest. If you want to really give middle income working people a tax break, then capital gains cuts are absolutely the least efficient way to do it. The best way would be to reduce payroll taxes and general income tax rates, especially the personal exemption.

We should tax capital gains and labor at the same rates. Anything less privileges wealth over work, and unfortunately, except for some brief periods at the beginning of the income tax and, ironically, under the first Bush Administration, we have failed to do that. The result has been a creeping and deepening inequality of wealth in this country, much to our shame and social detriment.

Capital gains should be taxed exactly like income from any other source. There is no economic efficiency benefit demonstrable from a lower rate on capital gains. There is plenty of rhetoric about encouraging the wealthy to put the capital to work to create jobs, but there is no evidence that this actually happens. CRS 98-473 "Individual Capital Gains Income: Legislative History" of May 18, 2006, from which the above table derives, puts it thusly:

"The logical question to ask after reviewing past legislative changes and new legislative proposals is why after 80 years are we still unable to agree on the appropriate means of taxing capital gains income? From a purely economic perspective the appropriate way of taxing capital gains income and loss is relatively clear. Under a tax system that measures income in a comprehensive manner, real capital income and loss would be treated as regular income and taxed or deducted as it accrues to the taxpayer. Untaxed real gains would be taxed when transferred as gifts or bequests."

What we should stand for as Democrats is clear. Fair taxation of work and wealth is equal taxation. So why is Harry seeking to introduce legislation that rejects that view? Well, Seth Scott indicates that it is because Harry sees the potential for a lot of middle class and working folks to get caught up by a tax increase that will harm them when selling a house (even though there is a 500K exclusion for selling a home and buying another), or saving for retirement (even though all the capital gains in a qualified retirement plan is accrued tax free), or selling a business (this last certainly has tax consequences, but they are seldom structured as a simple one-time capital gain).

But just Follow the money. Where does the majority of the benefit go, and are there more efficient means to provide relief to working folks trying to save and build their future? CRS RS21014 "Economic and Revenue Effects of Permanent and Temporary Capital Gains Tax Cuts" of January 29th 2003 says:

"A capital gains tax cut appears the least likely of any permanent tax
cut to stimulate the economy in the short run; a temporary capital
gains tax cut is unlikely to provide any stimulus. Permanently lower
capital gains taxes can contribute to economic efficiency in some ways
and detract from it in others. Capital gains tax cuts would favor high
income individuals, with about 80% of the benefit going to the top 2%
of taxpayers."

I see no reason why, without an income cut-off, which is missing from Harry’s bill, there is any reason to suppose that freezing the capital gains rate at the current level would do anything but perpetuate this iniquitous situation with no compensation to middle and lower income Americans. Harry’s rate freeze simply means working people taking up more of the burden of paying for government operations into the future.

What Harry says he wants is tax relief for middle income folks, but what his bill achieves is a continuation of a highly unfair status quo. We elected Democrats to make our country better and more fair. Not to entrench the evils of the Bush/GOP era. Here is what Harry wants to perpetuate as set forth in CRS RL30317 "Captial Gains Taxes: Distributional Effects" from September 24th 1999, at which time the capital gains rate was 5% higher (or 33% higher tax) than now and in the future under Harry’s proposal:

"These measures are presented for 1999 and indicate that capital gains
taxes are concentrated among high income individuals. Those with
earnings over $200,000, who constitute the top 1.8 percent of income,
account for 78.6 percent of capital gains taxes. While the average
capital gains tax paid is $476, the average for the highest income
class is $20,536 and the average for the bottom half is less than $10.
Capital gains taxes contribute to a progressive tax system: while
capital gains taxes average 1.3 percent of disposable income, they
account for 5.7 percent in the highest income bracket and less than one
tenth of one percent for the bottom 70 percent of the population. Some
of this concentration in higher income classes occurs because of the
concentration of taxes at higher income levels. However, capital gains
taxes are also concentrated relative to other taxes. The capital gains
tax is 4.5 percent of total federal income, payroll and excise taxes;
however, it is 14 percent of total taxes in the highest income bracket,
and less than one half of one percent for the bottom 70 percent of the
population. For the income tax alone, capital gains taxes are 8.1
percent of total income taxes, but 16.2 percent of income taxes in the
top income class. In the bottom 70 percent of the distribution, the
capital gains tax is less than one percent of income taxes. About a
quarter of taxpayers who pay a capital gains tax are in the bottom 70
percent of the distribution, while 11 percent of capital gains
taxpayers are in the top 1.8 percent of the population. About 12
percent of all taxpayers pay a capital gains tax; in the highest income
class, 75 percent pay a capital gains tax."

The impact of capital gains is overwhelmingly on the wealthiest Americans. That is the reason why the capital gains rate has historically been lower than the rate on labor: the power of concentrated wealth to disproportionately affect our political process makes itself felt in our tax code. Harry seeks to extend the hegemony of the wealthy over our tax code, but is doing so in the name of middle class tax relief and while proclaiming his action to be representative of Democratic legislative priorities. That lends support and credence to the outright lies of the GOP about these taxes and their effect on the middle class and undermines the Democratic message of real tax fairness and middle class tax relief. Unless Harry has some pretty extraordinary evidence that contradicts everything the CRS has even written on the subject, I can’t see how his tax proposal is justified as tax relief for average folks.

Capital Gains and Estate Taxes contribute to the overall progressivity of our tax code. Cuts in either disproportionately benefit the very wealthy and penalizes work in favor of wealth. There are means of avoiding much of the harm that cutting these taxes can do, such as income tests and graduation, but according to Harry’s office there are none of those measures in the Capital Gains portion of Harry’s proposal.

The Estate Tax cuts Harry proposes are more sensible economically, but just as poorly conceived politically. We need predictability and stability in the Estate Tax more than anything. What the GOP did in creating a completely irresponsible and wholly political sliding change in the Estate rate is institute uncertainty and a death lottery for heirs more than anything else. The Estate Tax goes to ZERO in 2010 and then rebounds to 55% on estates in excess of 1 million in 2011. We as Democrats can and should do better.

I don’t have the full details of Harry’s plan as yet, but there will be an exemption of $3.75 million and a lower tax rate on up to $25 million estates. This is a reasonable reform and I could support it if I believed that it would mollify the GOP or pull the rug from under their political support for abolishing the so-called Death Tax. I don’t think it will do either. I think it simply plays into their framing of this issue and provides cover for their campaign against the Estate Tax. I don’t think we should give an inch until we are fully satisfied with middle and lower income tax relief. Estate Taxes should be a chip in the big game, not an ante. We should wait and see how much tax relief we can afford for big estates, not propose it before anything else is on the table. I don’t object to reforming the Estate Tax in principle, but I think it is bad politics and bad budget strategy to have a tax cut this size, benefiting so few, at this stage of the game.