Expect Biden’s tax proposals to collapse

The good news today is that, despite the fears of some, the Biden administration is subject to the laws of entropy, decay, gravity and inertia.

The most striking example of that is the current status of its tax proposals. Those proposals include an increase in the capital gains rate, stepped-up basis for inherited assets (think of it as a death tax on the increased value of assets), an increase in the corporate tax rate and increased IRS enforcement.

For a number of years and for a number of reasons, Republicans have protected wealthy progressive Democrats from the consequences of their political choices. This year, however, because the Democrats have the majority in Congress and are willing to use reconciliation to push through their agenda, Republicans cannot protect them.

Let’s start with the most troublesome part of the proposal. The proposed increases in capital gains directly affect those households making $400,000 or more annually. Unfortunately, for many elected Democrats, that is dead center of their governing coalition.

According to the latest IRS Statistics of Income data, for the tax year 2018, in terms of highest capital gains per income tax return filer, House Democrats represent almost two-thirds of the districts with the highest share of tax filers with capital gains on their returns. 

Only one quarter of the ZIP codes with the highest percentage of capital gains filers are in districts represented by Republicans. The parties split the remaining one-tenth of the ZIP codes with such returns.

In short, Democrats seem to benefit more from capital gains than Republicans, which suggests that some elected Democrats likely will hesitate to increase the rate.

Moreover, there is some academic work that suggests a capital gains rate above 28% is counter-productive. The Wharton School at the University of Pennsylvania estimates that raising the top capital-gains tax rate to 43.4%, as proposed, would reduce (not increase!) federal revenue by $33 billion over 10 years. The Tax Foundation thinks the loss from a capital gain increase is more like $124 billion over 10 years.

Apparently, people who make a bunch of money are smart enough to figure out how to reduce their tax exposure. Who knew?

In many cases, people simply hold their assets and pass them to their inheritors. To prevent this clever tax evasion, Mr. Biden wants to tax all inherited assets at the moment they pass from the deceased to the survivors, with capital gains tax paid on the increased value.

Not surprisingly, this second death tax has drawn opposition. Farmers, small businesses, even those with relatively modest stock holdings would be damaged by this new tax. Predictably, a few weeks back, 13 House Democrats sent a letter to the president asking for farms to be exempted. That seems like a reasonable request, but once that exception is made (which it will be), eventually everyone will ask for — and be granted — an exemption. After that, the entire idea will collapse.

On the business side, corporate giving to the Democratic Party over the past generation probably means that corporate tax rates will settle at or near 25%, not the 28% proposed by Mr. Biden.

How about IRS enforcement? The administration has suggested that better enforcement of tax laws would raise as much as $700 billion in the next 10 years. It is the single largest revenue raiser in the entire proposal.

Unfortunately, just last year the Congressional Budget Office projected that giving an extra $40 billion to the IRS might generate … $103 billion more revenue over 10 years. So that idea fails as well.

Apart from all that, some Democrats have taken this opportunity to reopen the discussion about the SALT deduction, which was a federal tax break for those who pay above a certain amount for state and local taxes. In the 2017 tax reform, it was capped at $10,000. It is important to note that prior to the cap, about 90% of the deduction went to millionaires (mostly in New York, New Jersey, California and Illinois), and that self-proclaimed democratic socialist Sen. Bernard Sanders of Vermont has explicitly noted that its inclusion in tax legislation would be contrary to progressive ideals.

Nevertheless, the entire House Democratic delegation from New York (except for Reps. Alexandria Ocasio-Cortez and Kathleen Rice) has made it clear that they will vote against tax legislation that does not include removing the cap on the SALT deduction.  

It’s not clear how the SALT deduction story ends, but New York Democrats tend to mean what they say and they follow through on their promises. With a margin of error of just four votes, House Speaker Nancy Pelosi needs to take such threats seriously.

So, what happens to the overall proposal? Expect it to collapse under the weight of Republican opposition based in principle and Democratic opposition based in self-interest. That will leave the spending in both the “infrastructure” and “families” plans without accompanying revenue increases.

That means at least another trillion dollars in spending (and probably more unless the Republicans stop negotiating with themselves on the “infrastructure” plan). That’s not great, but it’s better than initially feared. More importantly, it signals that there are limits to the damage that the Biden administration can cause.

That’s good news.

• Michael McKenna, a columnist for The Washington Times, is the president of MWR Strategies. He was most recently a deputy assistant to President Trump and deputy director of the Office of Legislative Affairs at the White House.

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