I worked for several years in my first wife’s family business started by her father. It was an enterprise that spanned generations, as all his children were involved in running the operation. The left’s idea of inheritance is that there is no connection between generations in creating the wealth that is being passed on. Again, this is simply not true.
By William R. Hawkins l January 26, 2015
In the days and weeks leading up to President Barack Obama’s State of the Union (SOTU) address on January 20, the administration sent to the media a list of tax increases that the president planned to propose in support of his desire to redistribute wealth from the “rich” to the middle class. However, when the speech was delivered, there was no specific mention of tax hikes. The closest he came was a call to “close the loopholes that lead to inequality by allowing the top one percent to avoid paying taxes on their accumulated wealth. We can use that money to help more families pay for childcare and send their kids to college. We need a tax code that truly helps working Americans trying to get a leg up in the new economy.” He was eager to talk about what he would give to voters, but not what he would take away. It was an exercise in demagoguery, not statesmanship.
However, the devilish details are accessible on the White House website. And on examination it is clear why the President did not want to mention his tax plan on national television, as it would have provoked criticism from economists, business leaders and the very middle class to which he is trying to appeal. His taxes would not just hit the “rich.” They would take money out of the pockets of most middle class Americans and slow the economic growth upon which the maintenance and expansion of middle class living standards depends.
Reducing Accumulated Wealth
The ideological target of the administration is the “accumulated wealth” of those who have been successful in their careers. Thus, the tax increases that will be proposed in the budget President Obama will be sending to Congress targets capital gains and inheritances. In one case, both are hit at the same time in a major proposed recalculation of how capital gains are treated when they are passed on after death.
Currently, when an asset is inherited, the market value at the time of the transfer is used to fix its base for any future capital gain calculation if the asset is liquidated. This is called a “step up” from the value of the asset when it was originally purchased by the deceased and has become a “loophole” target. As the White House fact sheet argues, “Hundreds of billions of dollars escape capital gains taxation each year because of the ‘stepped-up’ basis loophole that lets the wealthy pass appreciated assets onto their heirs tax-free.” This is not a reform that will only hit “the rich.”
The new tax rules would only exempt capital gains up to $200,000 for couples ($100,000 for individuals). The stated assumption is that middle class retirees who depend on capital gains for part of their income will not have much left to pass on. Yet this is not true. My parents were middle class. My father was a journalist, newspaper editor and communications executive, while my mother did not work outside the home. They were frugal and lived in the same modest house for over fifty years. They did spend down a substantial share of their savings in retirement, particularly during, by mother’s last years when she needed constant care. Yet, my sister and I still inherited well over the $100,000 limit on tax free capital gains transfers. And these funds have played an important part in our planning and sense of security.
The War Against Family Progress
It is the dream of most middle class parents that their children lead a better life than they did. Capital accumulation from generation to generation is vital to this hope. I certainly plan to leave my children a nest egg. It is very alarming that polls now show that most Americans (65% in an October Pew Research survey) fear that their children “will be worse off financially than their parents.” The Obama tax proposals certainly promote this fear.
I worked for several years in my first wife’s family business started by her father. It was an enterprise that spanned generations, as all his children were involved in running the operation. The left’s idea of inheritance is that there is no connection between generations in creating the wealth that is being passed on. Again, this is simply not true. The 2015 Federal estate tax exemption is $5.43 million per person. While some small business and farm families fall under this limit, many others do not. Does it make sense to force an enterprise to break up or be sold to generate the cash needed to pay a tax? The Small Business Administration defines a small business based on revenues of up to $21 million depending on type. The assets used to produce revenue are worth much more. Inheritance taxes make no economic sense and the supposed moral case for breaking up family wealth is illegitimate.
The campaign against capital gains is based on the left-wing notion that money made from saving and investment is somehow morally inferior to money made from “work.” Consider this statement from the Obama White House website, “Capital income taxes are also much lower than tax rates on income from work.” Since capital income is the result of saving and wise investment, this demeans what is normally considered a virtue. In the liberal-left view, the spend-thrift and the debtor, who only live for the moment and indulge in instant gratification, are on a higher plane that the prudent actor who plans for the future by putting away a nest egg, paying their way through life into retirement and helping their children by leaving them something after they pass on.
Why It’s Called Capitalism
On the macroeconomic level, of course, it is saving and investment that allows for expansion. It provides the funds needed to fund new production facilities and innovations. Capital creation and accumulation is how a society grows in income and capabilities. That is why the most successful system in the world is called capitalism. Indeed, for well over a century, there has been a close identity between GDP per capita and the amount of capital stock per worker in advanced nations. Wages depend on productivity, and productivity depends on capital.
The current tax system in the U.S. is set up to benefit the long-term investor. Short-term investment gains are taxed as ordinary income, while long-term investments are taxed at a rate lower than the top income rate. This is to encourage commitment and stability over mere speculation, which is the way it should be.
Liberals argue in class warfare mode that since only 36% of capital gains are earned by those making less than $90,000 a year, raising the rates will impact the “rich” much more than the middle class. Yet, this does not mean that the gains realized by members of the middle class are trivial or do not make up a substantial part of long-term planning for such things as retirement or college educations for their children. Saving for the future and counting on a healthy, growing economy to generate additional income is not only responsible behavior but clearly better than running up student loan debt or suffering reduced living standards after a lifetime of work.
Capital Is Already Double Taxed
The supposedly lower tax on capital gains and dividends is usually portrayed as an encouragement for savings and investment. But in fact, the total tax on capital is much higher than on ordinary income because the flow that produces the gains is taxed more than once. A capital gain generally reflects an increase in the earnings per share of the underlying corporation, which was already taxed at the corporate rate. Dividends are also paid out of after-tax income. Taxing capital income at any rate amounts to double taxation of the business income flow. And, of course, the savings that is used by individuals to acquire capital assets also comes out of after-tax income. The exemption being restricted accounts for retirement. But this money is still taxed when withdrawn and spent as ordinary income.
There had been talk that President Obama could find common ground with the Republican Congress in reducing the corporate tax rate which is higher in the U.S. than in any other major developed country. The U.S. rate is 35%, whereas the average for the European Union is 21.3%. But there was no mention of any such tax cut in Obama’s SOTU speech or on the White House fact sheet. Yet, the president in his speech stated, “middle-class economics is all about building the most competitive economy anywhere, the place where businesses want to locate and hire.” The only thing he then mentioned was improved infrastructure (ports, bridges, trains, Internet). He is right that infrastructure investment needs a higher priority in his projected 2016 Federal budget of $4.1 trillion. But this is support for business activity, it does not generate commerce nor does it offset the myriad actions of this administration that discourages or prohibits economic activity.
It has taken six years for the economic recovery to reach a point where the president could claim that the crisis is over. This has been the slowest recovery since the end of World War II; and is still not complete because of the low labor participation rate and large number of people who can only find part time work. It has usually only taken two years to restore employment levels because the underlying American system is strong. It can rebound from a hit, but the going is rougher if the hits keep coming as they have under Obama.
William R. Hawkins, a former economics professor and Congressional staffer, is a consultant specializing in international economics and national security issues. He is a contributor to SFPPR News & Analysis.