Tax policy has aided and abetted the rise of massive economic inequality in the U.S., a point highlighted in a recent article in the New York Times. The paper reported that last year the nation’s 400 wealthiest people paid a lower tax rate (federal, state and local tax rates combined) than any other income group — a drastic reversal of the situation several decades ago. Making the economy work for everyone requires correcting of our upside down tax system.
A bold, new tax plan from Oregon’s own Sen. Ron Wyden would do exactly that. He proposes reforming how the federal government taxes much of the income flowing to the richest Americans. Wyden’s proposal, “Treat Wealth Like Wages,” would reverse decades of mistakes in how the nation taxes capital gains, a key driver of inequality.
Capital gains are the profits from selling assets such as stocks, bonds, and real estate. These gains largely accrue to the richest among us, with 71 percent of gains flowing to people who made more than half-a-million nationally in 2017. Only 8 percent of capital gains accrued to people making less than $100,000.
Wyden’s proposal tackles two glaring inequities in how the nation taxes capital gains: what the tax rate is and when it’s paid.
The most straightforward inequity is that capital gains from investments are taxed at a lower rate than income from a paycheck. For capital assets held for more than a year, considered “long-term,” the tax rates range from 0 to 20 percent. Tax rates on wages, however, are taxed from 10 to 37 percent. For example, someone who earns $80,000 from wages would pay a 22 percent tax rate on their last dollar earned, while someone who earns $80,000 from long-term capital gains would only pay 15 percent
The second — less obvious, but fundamental — inequity is that capital gains are currently only taxed when someone sells the asset, creating opportunities for rich people with well-paid tax planners to game the system. Someone who makes their money from a paycheck must pay taxes regularly, but not so for someone who makes their money from capital gains. Taxes on capital gains income are not owed until the owner cashes in. Fortunes can build up over the years, with not a penny in tax being paid. This allows rich people to choose when to pay their taxes. They can wait until Congress cuts the tax rate on capital gains further, or sell assets off just before a tax increase.
Or they can completely avoid capital gains by never selling the asset. In that case, when the taxpayer dies, the capital asset passes on to their heirs as if brand new, stripped of any tax obligations. The heirs can then sell the asset and there would be no capital gains to tax. This massive loophole perpetuates a structure of wealth inequality.
And if that weren’t enough, Congress has created special tax loopholes that offer yet more opportunities to shrink or avoid taxes on capital gains. One of those is 1031 like-kind exchanges, a loophole that allows a taxpayer to “exchange” one asset, such as an apartment building, for another similar asset, and defer any taxes owed on the capital gains from the original property. Another loophole, recently put in place by Congress is the set of capital gains tax breaks that make up “Opportunity Zones”.
Sen. Wyden’s proposal would address a number of these flaws. First, capital gains income would be taxed at the same rate as wages, treating workers and investors alike. Second, assets would be assessed for capital gains and losses each year. This approach, known as “mark-to-market,” would prevent the rich from timing their capital gains to avoid paying their fair share. The mark-to-market rule would only apply to folks with at least $1 million in annual income or $10 million in eligible assets in three consecutive tax years, having no impact on middle class families. This excellent proposal could be made even stronger by tightening some definitions, as well as by eliminating some of the special tax loopholes for capital gains mentioned above.
Whichever way you slice it, the tax plan put forth by the senior Senator from Oregon would amount to a breakthrough for tax fairness. It is time to do as Sen. Wyden suggests and “Treat Wealth Like Wages.”