A new tax hike on high-income taxpayers might seem politically implausible but calls for one continue. Among the supporters are some Republican senators, who favor extending provisions of the Tax Cuts and Jobs Act and enacting other priorities but are also worried about the impact of unfettered spending and tax cuts on the federal debt.
In three recent analyses, my Tax Policy Center colleagues and I explore ways to tax either the capital gains or wealth of high-income taxpayers to raise revenue or reduce the deficit.
Tax capital gains at a higher rate at death than during life
Under current tax law, long-term capital gains—the net gains on assets held over a year before sale—receive preferential treatment. First, long-term gains face a lower rate than “ordinary income,” such as wages and interest. Second, owners pay capital gains tax only when they sell (“realize gains”). Third, capital gains taxes do not apply to the unrealized gains on assets still held by taxpayers when they die; the heirs will generally pay taxes only on the gains that accrue between the time of the taxpayer’s death and when they later sell those inherited assets.
This preferential treatment encourages wealthy investors to hold their appreciated assets — including stock, businesses, real estate, and other property — throughout their lifetime. This “locks in” capital and perpetuates dynastic wealth among the richest Americans.
In their paper, Steve Rosenthal (formerly of TPC) and Robert McClelland estimate that taxpayers with net worth above $100 million hold $13.4 trillion of unrealized gains. They compare different approaches to taxing those locked-in gains and their potential impact on revenues and fairness. They conclude that the best approach is to tax unrealized gains at death at a higher rate than during the investor’s life.
Rosenthal and McClelland’s approach would give wealthy investors a reason to sell appreciated assets well before they die—a lower tax rate. If investors sell an asset during their lifetimes, they would be subject to a tax of up to 23.8 percent, the same preferential rate on realized gains under current law. If they waited until death, their unrealized gains would be taxed at a rate of up to 40.8 percent (the top income tax rate on ordinary income plus the net investment income tax).
By reducing the tax advantage from locking in capital, the Rosenthal and McClelland option might generate substantial revenue. Relative to other proposals to tax unrealized gains during the taxpayer’s lifetime, the authors expect their approach would have lower administrative burdens, since assets would be appraised only once, at the owner’s death, both for income and estate tax purposes.
If enacted, a tax on unrealized gains at death might be challenged in the courts as to its constitutionality. However, Rosenthal and McClelland conclude that the arguments in favor of the constitutionality of their approach are stronger than for other options that would tax unrealized gains.
Tax wealth in the United States
Other countries have imposed a tax on the net value of assets. TPC’s Gabriella Garriga and I examine the issues and challenges of adopting a wealth tax in the United States.
We estimate that a wealth tax could raise substantial revenues while concentrating the increased taxes at the top of the income distribution. For example, we find that if all assets greater than $50 million ($25 million for unmarried filers) were subject to a 1 percent tax, the tax would raise nearly $2 trillion over a 10-year period.
However, wealth taxes are hard to administer, partly because of the difficulties of placing a value on some types of assets (like privately held businesses). Often, countries exempt some assets from their taxes—either because the items are hard to value or to achieve other economic and social policy goals—but exemptions may distort investment decisions and increase opportunities for avoidance and evasion.
Even if enacted, a wealth tax may not survive political pressure and judicial reviews. Most OECD (Organization for Economic Cooperation and Development) countries that had wealth taxes in 1990 repealed them because of administrative difficulties and concerns about economic growth. Like Rosenthal and McClelland’s approach, a wealth tax would likely be challenged on constitutional grounds, with prospects uncertain.
Tax capital gains of high-income taxpayers
Historically, lawmakers have adopted incremental changes to the tax treatment of long-term capital gains. In their brief, Robert McClelland and Lillian Hunter discuss the considerations when choosing capital gains tax rates and the rate brackets.
For example, increasing the capital gains tax rate may encourage taxpayers either to defer realizing their gains or rush to realize them before the new rate goes into effect. Researchers have found that the impact of a higher rate on realizations varies, depending in part on economic conditions and how much time investors have to react to the announcement.
To ensure that middle-income taxpayers would not pay more taxes on capital gains, lawmakers could increase the rate only for taxpayers with a high level of income. But a high threshold would give taxpayers just below it (who typically have larger shares of their income in capital gains realizations than those with less income) more reason to time their realizations to keep their income below the threshold. However, research shows that taxpayers’ ability to time realizations depends on the type and value of the asset.
In the current political environment, perhaps any type of tax increase lacks broad appeal. But if lawmakers are looking to offset the cost of desired tax cuts or make a dent in the deficit, TPC’s three reports offer a menu of options.
