Wyden's Bold Move
Steve Novick
Progressives have one and only one job to do this week: Unleash a hailstorm of praise for Senator Ron Wyden's tax reform proposal.
This morning, Wyden completed a stunning two-month transformation from being one of the least progressive Democrats on tax issues -- he was an estate-tax repeal supporter until Katrina -- to being one of the most progressive. The plan he proposed today wouldn't just roll back major Bush tax cuts; it would undo Bill Clinton's worst mistake on tax policy. By far the most significant part of Wyden's plan is his proposal to tax income from wealth at the same rate as wages. He'd tax dividends and capital gains at the same rate as ordinary income, eliminating absurdly favorable tax treatment for forms of income that mostly go to the rich.
Right now, a teacher and truck driver making a combined $60,000 pay a 25% tax rate on their last dollar of income (that's not their overall rate, but the marginal rate; if they get a $1,000 raise, they pay $250.) But if Paris Hilton or Bill Frist buys and sells some Halliburton stock for a $100,000 profit, they only pay 15%. And those are not unfair examples. According to a New York Times article last year, capital gains and dividends make up, on average, 3 to 4% of the income of people who make less than $100,000 ... but 24.7% of the income of those who make between $500,000 and $1 million, 37.6% of the income of those making between $1 and $10 million, and 61.4% of the income of those making over $10 million. As a result of favorable tax treatment for these forms of income, as Pulitzer prizewinning tax reporter David Cay Johnston has noted, the richest 400 Americans pay a lower Federal tax rate than the merely rich, people making, say, $300,000 a year.
Again, what this proposal means is that Wyden would not just be rolling back the Bush tax cuts; he'd roll back a Clinton tax cut on capital gains, to 20% (a tax cut that Joe Stieglitz, chief of Clinton's Council of Economic Advisers, decried). (Under Wyden's plan, the rich would pay a 35% marginal rate on all income, from whatever source.)
Now, as a deficit hawk, I am disturbed by the fact that Wyden's proposal only raises $100 billion over five years -- but it is a big step for anyone in Congress to propose raising any revenue at all. And the progressive direction of the plan is irrefutable.
In case you wind up in an argument about the economics of capital gains and taxes thereon, here are some weapons:
To reiterate: Capital gains represent a much higher share of the income of the rich than the rest of us. According to an October 6, 2004 New York Times story, capital gains and dividends combined represent 3 to 4% of the income of people making less than $100,000. Meanwhile, according to respected Michigan economist Joel Slemroad, capital gains represent over 70% of the income of the richest 400 Americans. According to Department of Revenue figures (for 2002, the most recent year available), the highest-income 1% of Oregonians make 63% of all capital gains; the top 5% make 81%; and the middle 20% make 1.4%.
Having different rates for capital gains promotes financial game-playing by sophisticated taxpayers. One problem with taxing capital gains at a different rate than ordinary income is that “Tax preferences accorded to capital gains also create a tremendous incentive to repackage ordinary income into capital gains ... sophisticated taxpayers make use of stock options or ‘collapsible’ corporations to convert labor compensation into capital gains. Some lawyers speculate that, before the Tax Reform Act of 1986 when the capital gains tax rate preference was especially large … about half of all the transactional complexity of the tax law was due to this feature of the law.” Joel Slemrod and Jon Bakija, “Taxing Ourselves,” MIT Press 2001. (This book was praised by Bruce Bartlett in the Wall Street Journal as “one of the best book on taxation I have ever read.”)
Slemrod and Bakija also point out that “Expanding the preferential treatment of past capital gains provides no incentive to buy new stock or new real estate; it just provides a windfall gain related to past decisions.”
Studies of capital gains tax cut proposals at the Federal level have repeatedly disproved the economic arguments for capital gains tax cuts. As the Center on Budget and Policy Priorities found in 2001, “The vast majority of capital gains are related to the sake of real estate and stock in well-established corporations, not venture capital.” Similarly:
- The Congressional Research service found in 1999 that “There is no apparent relationship between venture capital investments and the capital gains tax.” (Note: both houses of Congress were controlled by Republicans at the time.) “Capital Gains Taxes, Innovation, and Growth,” Congressional Research Service, January 28, 1999.
- Slemrod and Bakija state that “innovative entrepreneurial ventures represent only a tiny fraction of the total value of capital gains.”
- A 1998 Congressional Budget Office study used economic models to project the effect of a cut in capital gains taxes. The two projections that did not rely on “extreme or unwarranted assumptions” projected “small increases in GDP – well below 0.1% after 10 years.” The CBO also addressed the ‘venture capital’ argument, noting that “nearly 90 percent of venture capital comes from existing corporations or nontaxed institutions, such as pension funds,” which are not affected by the tax rate on personal capital gains. “An Analysis of the Potential Macroeconomic Growth Act of 1998,” August, 1998.
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Oct 27, '05
Once again Wyden, and now his advocate, Steve, have demonstrated their ignorance of how capital gains taxes work. Capital gains are, to a great degree, elective. The big, bad wealthy people can, to a large degree, choose when and whether or not they will recognize capital gains. When the tax rate is as high as Wyden proposes (35%), Uncle Sam is in effect a silent partner. The investor with capital gains can elect to recognize the gains, and pay the tax at the higher rate, or "stay in the game" and let the winnings run and defer the tax to some later year. The rational investor usually chooses to defer. That's why capital gains tax increases almost always fail to generate increased revenues.
As far as dividends are concerned, with the lower rate in effect, Microsoft declared a huge dividend, which will generate a significant increase in dividend tax receipts for 2005. Does Wyden or Steve think that dividend would have ever been declared with dividends taxed at 35%? The Wyden proposal should be renamed the Deficit Increase Act of 2005. Thank goodness it has no chance of passage.
11:39 a.m.
Oct 27, '05
Heads up: If you're near a TV - Ron Wyden is about to be on CNBC talking about this proposal.
Oct 27, '05
Good post, great topic. While Novick seems more excited about the plans progressivity, I'm more keen on the goal of simplifying the tax code. Progressivity is generally good, but there's more to the incentive of lower capital gains than a spur to investment; there's also the separate goal of encouraging savings. If rigging capital gains a bit means that, in an effort to hang on to more of their cash, middle class folks stow some part of their cash into IRAs or their company's 401(k), that's a good thing. (I did leave out the poor, I know. Last time I checked, they're so rogered that investing more than a nickel in the market simply isn't a possibility.)
On the larger score, sure, the rich make out like bandits on the current system, but you can only buy so much crap before you've got to do something else with your cash, so why not encourage them to invest it? For all its ills, most of the incentives exist for a reason - and it's not just to make "Bush's rich friends richer" (though that's definitely a real outcome).
Finally, with regard to Mr. Novick's post, one thing would be good: links to the sources. I imagine not a few of them are pdf files (which my Mac can't handle), but ready access to the source material would be nice. If nothing else, put up a link to the page where one can find the pdf files. That's just a quibble. As I said, good post. Thanks for posting it. It's a welcome relief to the Miers/Plame mono-focus.
With regard to Bill Holmer's thing, is Wyden's tax proposal temporary? If so I didn't catch that. I raise that point because, really, one can only put off realizing capital gains for so long, right? If there's no shift coming down the pike, they lose their incentive to postpone and make the decision based on other factors.
1:13 p.m.
Oct 27, '05
Jeff, go here for source material.
Oct 27, '05
Great Article! Apologies about the multiple trackbacks - WizBang kept claiming it hadn't worked. Hope there's a way to erase those extras.
1:50 p.m.
Oct 27, '05
Here's all the source material at www.ocpp.org.
Oct 27, '05
While Bill Homer is correct about the ability to put off realization of capital gains, that ability is not universally applicable and it is not infinite in practical terms. Some capital gains cannot be postponed, and no one will keep invested forever in order to escape taxation.
So, if we play a game of moving capital gains rates every few years, then the wealthy will game the system. If the rate is raised and stays there, the revenue increase will be realized after a few years.
It's good to see Middle of the Road Ron push for progressive taxation. While the idea has little chance of success now, it may become part of the much needed Democratic version of the Contract with America.
Oct 27, '05
Bill H. may be accurate about the theory of capital gains.
But as far as specifics go, perhaps he can explain something on the state level. As I understand it, the capital gains tax cut which passed the House was the one with Wayne Scott and Oregon Restaurant Assoc. in the masthead of the legislation. Did it pay for itself, or isn't that supposed to matter? Was there another capital gains tax cut that was left in committee which did pay for itself but did not have powerful friends?
When it comes to tax policy, we are allowed to debate not only the general theory but also the specific legislation and how similar legislation has or has not worked. I believe in budget rules that say tax cuts should pay for themselves, and that any new spending OR tax cuts should be required to prove where the money comes from.
I admire Ron's Bold New Plan. Like the details or dislike the details, it is better to debate a specific proposal rather than the theory of progressive taxes or flat taxes or any other kind of taxes. And in the debate some are having about which party has any new ideas, I'd say "score one for the Democrats".
Oct 28, '05
Responding narrowly about capital gains -
I have paid capital gains on four transactions, spread over 8 tax years, all real estate related. In every one of those situations, the choices I had to avoid the tax were not as good as going ahead and paying the tax. I could have done a 1031 exchange and reinvested the money in "like or similar" investments, but I needed the money variously for a career change, and putting family through college. I could have waited, but real estate is not a fluid investment, it takes time to sell, and sometimes you just have to sell when the time is right. -- So, for many investors, the argument that a higher capital gains tax will reduce capital gains as investors slow down the exchange of money is only a little true and a lot more untrue.
On the broader issue of this plan -
I was forwarded from Sen. Wyden's office several documents about the Fair Flat Tax. Overall it is a very positive step forward. Personally, it looks like a break even or slightly less tax for me personally. I can't really tell, because the literature out so far does not address what is done on Schedule C (I'm self employed), and Schedule E (I own income producing real estate.) If those don't change too much, then this plan is a total winner for small businesses and farmers.
Beyond the debate of who wins or who loses under any plan, this plan does something that other plans fail to do. Without complexity, one can be planful about their personal and business financial growth. As it stands now, the tax consequences of various business decisions often takes a day or more to work out. Since taxation is a very expensive element of any business decision (now or with the new plan), being able to accurately predict the tax consequences of various business options is very important. The Fair Flat Tax makes it all very simple. You can determine in a few minutes with a hand held calculator what the tax consequences will be - and generally - who wouldn't want to make more money (and pay more tax)???? Simple is good for business.
I applaud Sen. Wyden for having the courage to step out and take the risk of angering the big corporations on this. They would be the big losers. No longer would they be able to avoid US taxation by shipping profit overseas.
If we could implement this plan it would be very good for rural America. We can't compete against a playing field that is tilted against us like we have under the current tax codes. Large Corporations manipulate nearly every aspect of rural business. In farming, supplies come from these major corporations and crops are sold to them directly or indirectly. By playing loose and fast with our current tax code, they can play off foreign crops against ours to drive down prices. This new tax code would make it unattractive to business to out source jobs, farm products, and revenue. It would keep America working for America.
The one element I would suggest adding, to truly keep this a "flat tax" would be to eliminate the cap on the Social Security/Medicare tax. With a cap on Social Security, you effectively have a higher overall tax rate on the lower income than the higher income.
Does the plan have a chance to pass? Well, this is part of why we must elect a replacement for Greg Walden that has a "D" after their name.
Oct 28, '05
Responding narrowly about capital gains -
I have paid capital gains on four transactions, spread over 8 tax years, all real estate related. In every one of those situations, the choices I had to avoid the tax were not as good as going ahead and paying the tax. I could have done a 1031 exchange and reinvested the money in "like or similar" investments, but I needed the money variously for a career change, and putting family through college. I could have waited, but real estate is not a fluid investment, it takes time to sell, and sometimes you just have to sell when the time is right. -- So, for many investors, the argument that a higher capital gains tax will reduce capital gains as investors slow down the exchange of money is only a little true and a lot more untrue.
On the broader issue of this plan -
I was forwarded from Sen. Wyden's office several documents about the Fair Flat Tax. Overall it is a very positive step forward. Personally, it looks like a break even or slightly less tax for me personally. I can't really tell, because the literature out so far does not address what is done on Schedule C (I'm self employed), and Schedule E (I own income producing real estate.) If those don't change too much, then this plan is a total winner for small businesses and farmers.
Beyond the debate of who wins or who loses under any plan, this plan does something that other plans fail to do. Without complexity, one can be planful about their personal and business financial growth. As it stands now, the tax consequences of various business decisions often takes a day or more to work out. Since taxation is a very expensive element of any business decision (now or with the new plan), being able to accurately predict the tax consequences of various business options is very important. The Fair Flat Tax makes it all very simple. You can determine in a few minutes with a hand held calculator what the tax consequences will be - and generally - who wouldn't want to make more money (and pay more tax)???? Simple is good for business.
I applaud Sen. Wyden for having the courage to step out and take the risk of angering the big corporations on this. They would be the big losers. No longer would they be able to avoid US taxation by shipping profit overseas.
If we could implement this plan it would be very good for rural America. We can't compete against a playing field that is tilted against us like we have under the current tax codes. Large Corporations manipulate nearly every aspect of rural business. In farming, supplies come from these major corporations and crops are sold to them directly or indirectly. By playing loose and fast with our current tax code, they can play off foreign crops against ours to drive down prices. This new tax code would make it unattractive to business to out source jobs, farm products, and revenue. It would keep America working for America.
The one element I would suggest adding, to truly keep this a "flat tax" would be to eliminate the cap on the Social Security/Medicare tax. With a cap on Social Security, you effectively have a higher overall tax rate on the lower income than the higher income.
Does the plan have a chance to pass? Well, this is part of why we must elect a replacement for Greg Walden that has a "D" after their name.
Oct 28, '05
Responding narrowly about capital gains -
I have paid capital gains on four transactions, spread over 8 tax years, all real estate related. In every one of those situations, the choices I had to avoid the tax were not as good as going ahead and paying the tax. I could have done a 1031 exchange and reinvested the money in "like or similar" investments, but I needed the money variously for a career change, and putting family through college. I could have waited, but real estate is not a fluid investment, it takes time to sell, and sometimes you just have to sell when the time is right. -- So, for many investors, the argument that a higher capital gains tax will reduce capital gains as investors slow down the exchange of money is only a little true and a lot more untrue.
On the broader issue of this plan -
I was forwarded from Sen. Wyden's office several documents about the Fair Flat Tax. Overall it is a very positive step forward. Personally, it looks like a break even or slightly less tax for me personally. I can't really tell, because the literature out so far does not address what is done on Schedule C (I'm self employed), and Schedule E (I own income producing real estate.) If those don't change too much, then this plan is a total winner for small businesses and farmers.
Beyond the debate of who wins or who loses under any plan, this plan does something that other plans fail to do. Without complexity, one can be planful about their personal and business financial growth. As it stands now, the tax consequences of various business decisions often takes a day or more to work out. Since taxation is a very expensive element of any business decision (now or with the new plan), being able to accurately predict the tax consequences of various business options is very important. The Fair Flat Tax makes it all very simple. You can determine in a few minutes with a hand held calculator what the tax consequences will be - and generally - who wouldn't want to make more money (and pay more tax)???? Simple is good for business.
I applaud Sen. Wyden for having the courage to step out and take the risk of angering the big corporations on this. They would be the big losers. No longer would they be able to avoid US taxation by shipping profit overseas.
If we could implement this plan it would be very good for rural America. We can't compete against a playing field that is tilted against us like we have under the current tax codes. Large Corporations manipulate nearly every aspect of rural business. In farming, supplies come from these major corporations and crops are sold to them directly or indirectly. By playing loose and fast with our current tax code, they can play off foreign crops against ours to drive down prices. This new tax code would make it unattractive to business to out source jobs, farm products, and revenue. It would keep America working for America.
The one element I would suggest adding, to truly keep this a "flat tax" would be to eliminate the cap on the Social Security/Medicare tax. With a cap on Social Security, you effectively have a higher overall tax rate on the lower income than the higher income.
Does the plan have a chance to pass? Well, this is part of why we must elect a replacement for Greg Walden that has a "D" after their name.
Oct 31, '05
cool, it reminds me of a more simplified version of CAP's "A Fair and Simple Tax Plan".