It's All in the Preparation
At my house, when we are getting ready to take a hike, you can tell lot about the seriousness of the undertaking by the preparation. If boots are waxed, maps repeatedly checked, and backpacks filled with food, water and first aid kits, then something pretty substantial is planned.
When Congress holds tax reform hearings, we all will get a look at their seriousness, or lack thereof, for preparation for future legislation. Thursday, the House Ways & Means and Senate Finance Committees will hold a joint hearing on “Tax Reform and the Tax Treatment of Capital Gains.” Here are five questions I will be asking to assess how serious the committees are about tax reform.
1. Do the committees show a willingness to challenge the fundamental belief that capital gains should be afforded a preference in the tax system?
As I noted in an earlier post, conventional wisdom in Washington holds that lower rates on investment income encourages capital investment, and therefore, economic growth. Are the committees ready to ask for the evidence of a positive correlation between low capital gains rates and higher personal savings rates and higher growth in GDP? Are they willing to ask why people save and whether tax rates really drive those decisions?
2. Do they have a substantive discussion about who benefits from capital gains preferences?
In 2009, over one half of all long-term capital gains were reported by taxpayers earning more than $1 million in adjusted gross income (AGI) (0.17% of those filing tax returns). Over a third of all long-term gains were received by taxpayers with more than $5 million of AGI (0.02% of all returns). The Committees have a challenge here. If they ignore the issue of very-high income individuals paying relatively low percentages of their income in taxes, they will lack credibility. But, if Democrats raise this issue, which has been so evident in the Presidential campaign, they may be accused of injecting partisan considerations into the discussion.
3. Do they ask who pays for the advantages accorded capital gains?
For any given amount of income tax revenue to be collected, lower collections from capital gains transactions mean higher taxes on other income. The committees should ask why, and to what extent, we should tax income from human capital (wages) at rates higher that those imposed on income from financial capital.
4. Do they explore limiting capital gains treatment?
A number of legislative proposals would change special rules or practices related to capital gains taxation. These include proposals to tax income from certain carried interests as ordinary income and to repeal capital gains treatment for a portion of gains received by certain broker-dealers. No discussion of capital gains preferences is really complete without addressing these and other proposals.
5. Do the Members avoid the silly arguments?
Proponents of capital gains preferences have many good arguments to make; these are included in the Joint Committee on Taxations pamphlet prepared for this hearing. One not-so-good argument that is often made is the notion that capital gains treatment should be afforded investors to encourage them to take risk. Risk is what first responders and members of our Armed Forces take, including my son, Charlie, one of my favorite hiking buddies. What investors do is invest. Sometimes they win, sometimes they lose; just as a regular job sometimes lasts until retirement and a pension, and sometimes it does not.
Another poor argument for capital gains relief is the idea that capital gains treatment is appropriate as a way to “average” the income of taxpayers who do not have capital gains income every year. These taxpayers are not unique. Authors, inventors, and others often put years of work into an eventual big payday; we do not grant them a special tax rate.
If the Committees can address these kinds of difficult questions, thus making preparations for a substantive tax reform effort, then we should all consider packing for the journey. If not, we should anticipate an easy walk along the path of small tax changes.