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Raising Taxes on Millionaires Is a Piece of Cake–But Which Kind?

February 9th, 2012 . by economistmom

millionaire-taxes-from-tax-notes-column

My column in this week’s Tax Notes (subscription-only access here) focuses on just a few of the different ways we could get more tax revenue from millionaires, summarized in the table above.  (The sources for all these numbers are various distributional estimates from the Tax Policy Center, referenced in the Tax Notes publication.)  The progressive nature of the federal income tax system, where tax burdens as a share of income in general rise with income through marginal tax rates that rise with income, and the implied upside-down subsidies created by poking holes in the tax base with exemptions and deductions (a.k.a. “tax expenditures”), makes it easy to raise tax burdens on the rich.  We can either make the rate structure steeper, or we can broaden the tax base for any given (already-progressive) rate structure.

Some ways are better than others from an economic efficiency standpoint, in that they level out the very uneven playing field, reducing the tax distortions between fully taxed and more lightly taxed (or untaxed) activities.  These would include proposals 3 and 4 –treating capital gains and dividends like ordinary income, and limiting itemized deductions to 28 percent.  Others might be viewed as preferable from a fairness perspective if the goal is to reduce income inequality and increase the share of the tax burden borne by millionaires–a statistic I dubbed “millionarity” in the table.  These include proposals 2 (letting just the high-end Bush tax cuts expire) and 5 (the millionaire surtax).  Still, my favorite tax policy option to point out is the one already in current law (#1 on the list above): letting all the Bush tax cuts expire, which scores low on “millionarity” but high in terms of total revenue raised and even the total dollar amount of higher taxes on millionaires.  You want to collect more in taxes from millionaires?  Just collect more taxes in general by not passing any more tax policy changes (allowing the Bush tax cuts to expire as scheduled, this second time around, at the end of this year), and you’re assured that you’ll get a disproportionate amount coming from those same millionaires who now disproportionately benefit from those tax cuts we keep extending (and deficit financing).

Another way to raise taxes on millionaires is to use yet another Alternative Minimum Tax (AMT), focused on millionaires only–like the proposal recently introduced by Senator Sheldon Whitehouse (D-RI).  I spoke with Forbes’ Janet Novack about why that’s more clever from a political perspective than an economic one.  Also in Janet’s column, my friend Len Burman astutely points out the huge incentive to divorce that would be created–if you’re lucky enough to be an unhappy but rich couple, at least.  ;)

6 Responses to “Raising Taxes on Millionaires Is a Piece of Cake–But Which Kind?”

  1. comment number 1 by: AMTbuff

    There are a few problems with targeting large tax increases on the rich:

    1. As California’s legislature learned long ago (not that it changed their behavior), when you tax the rich heavily your revenue jumps during booms when you don’t need it and drops disproportionately during busts when you really need it.

    2. After the next round of increases the marginal rates on the rich will approach the Laffer Peak. From that point on, all tax increases will need to be regressive. Taxing the rich now paints us into that corner all the sooner.

    3. It perpetuates the false belief that the fiscal gap can be closed without massive pain to the middle class in the form of slashed benefits or major tax increases. There is no time to waste in persuading the public that our fiscal problem will hit everyone very hard.

    You are correct that the AMT contains a large marriage penalty that was not mitigated by the 2001-2003 tax cuts. Marriage penalties appear to be a standard feature of all back-door tax increases.

    Here’s what I posted elsewhere on the “Buffett Rule” a few days ago:

    The Buffet rule is essentially a second Alternative Minimum Tax. Call it AMT2.

    At its inception in 1982 the original AMT taxed capital gains at 20%, the same rate it applied to other income. Currently capital gains are excluded from the AMT1?s regular income basket and they have a lower tax rate. The concept of AMT2 is a return to the roots of the AMT.

    The problem is that applying high tax rates to realized capital gains is an expensive and unfair way to make the tax code appear more fair. The richest taxpayers have no difficulty avoiding selling appreciated assets. They don’t need the money, so they don’t have to liquidate assets. The capital gains tax will hit those who hold most of their net worth in a single asset and who need to raise cash.

    What kind of tax hits taxpayers who need to raise cash but spares those who have so much cash that they never need to sell anything? Not a progressive tax, that’s for sure.

    In my opinion, AMT2 will make sense only after enacting mark-to-market taxation of large unrealized gains. This will eliminate the tax-free build-up that billionaires like Warren Buffett and Bill Gates have always used to shield their wealth from the IRS.

    Unrealized appreciation is where the money is, not in taxing realized capital gains beyond the revenue maximizing rate. The Buffet Rule is a bad idea unless the Buffett Shelter of tax-free build-up is first removed.

  2. comment number 2 by: Vivian Darkbloom

    There seems to be a coordinated movement underway to abandon the long-standing “realization” requirement in the tax code that is a pre-requisite for taxing “income”. We can thank Zuckerberg’s success for that even though he will likely make the largest individual tax payment ever recorded.

    First Martin Sullivan:

    http://www.tax.com/taxcom/taxblog.nsf/Permalink/MSUN-8R7LKQ?OpenDocument

    And then David Miller in the NYT:

    http://www.nytimes.com/2012/02/08/opinion/the-zuckerberg-tax.html?partner=rssnyt&emc=rss

    (These first two were so close in time, I suspect there may have been some covert coordination).

    And, now, AMTBuff.

    I doubt this will get much traction, but it seems to be the tax idea du jour.

    A close relative to adopting a mark-to-market regime would be simply to adopt a wealth tax which many countries have.

    An interesting variant of this was adopted a number of years ago by the Netherlands. The Netherlands does not directly tax portfolio dividend, interest or capital gain income. Previously, they had a wealth tax equal to 1.2 percent of wealth (with exempt amounts and assets). They abandoned that for a regime that imputes income on wealth equal to 4 percent of one’s net wealth per annum (again, with exempt amounts and assets) and taxed the result at 30 percent. Voila, the result is more or less the same as a flat wealth tax of 1.2 percent; however, unlike some other jurisdictions it avoids taxing *both* wealth and income so it was in effect a tax reduction.

    I speculated at the time that the resulting tax should not be a creditable tax because it constituted, in essence, a non-creditable wealth tax both under US domestic law and the US-Netherlands Treaty; however, the US Treasury came to the Dutch rescue with a revenue ruling that it was creditable as a tax in lieu of an income tax, a decision which was accommodating, but highly suspect.

    The Dutch regime, does, however, exempt from this tax assets from a “substantial interest” which is generally defined as a 5 percent or greater interest in a corporation (with attribution rules). Instead Income (realized dividends and capital gains) from those interests is taxed at a flat 25 percent. Thus, Warren would likely avoid the imputed income on his holding of Berkshire Hathaway. The Dutch reason that substantial interest holdings should not be subject to tax without a realization event because to do so would tend to destroy (or at least discourage) entrepreneurial activity.

    The Dutch regime is interesting because it tends to smooth out tax revenues and is easier to administer than a mark-to-market regime. On the other hand, strangely for an “income tax”, it can be assessed even when one’s wealth is in constant decline.

  3. comment number 3 by: Patrick R. Sullivan

    If Megan McArdle is right, this is another case of the generals fighting the last war;

    http://www.theatlantic.com/business/archive/2012/02/will-inequality-keep-getting-worse/252841/

    ‘If something can’t go on forever, it won’t. Trends like this come to seem inevitable because they have been going on for a long time–but since inequality cannot actually rise until the 1% own everything in the world while the rest of us suck on wood chips, the longer inequality has been growing, the closer that trend must be to slowing, or reversing. So the more you feel that inequality growth is a state of nature, the less likely this is to actually be true. And even very smart, knowledgeable people who have read a lot have an abysmal record at forecasting these things. Look at Karl Marx, the intellectual grandfather of mindless trend extrapolation bolstered by entirely plausible theoretical mechanisms.’

  4. comment number 4 by: zrakoplovom

    The new AMT is the best idea: once the AMT for “Millionaires” is in place, we cause a few years of hyperinflation (crank up those printing presses!) and Voila!: everyone is a millionaire. Then no one can complain about those nasty millionaires hoarding their money: we’ll all be one! Ah, the miracles of modern economic theory…

  5. comment number 5 by: Jason Seligman

    Here is my students assignment for this week:
    http://glennschool.osu.edu/faculty/seligman/730/readings_assignments/2012%20Public%20Finance%20730%20Assignment%205.pdf

    check out the first question and ask yourself, what is the marginal tax rate on the 1 millionth dollar? Seems pretty dang high…

  6. comment number 6 by: AMTbuff

    Nice work. I would have added mark to market for taxpayer assets, liquid or not, in excess of $10M total. Maybe 50% of today’s tax due as a prepayment for credit against the tax when sold or 100% of today’s tax as a full payment with basis increase.