August 28th, 2019

The Shaky Case Against Wealth Taxation

Associated Press

We have the means to tax the assets of the super-rich, and it is high time we did so, especially when faced with inequality that rivals the Gilded Age.

Ever since Senator Elizabeth Warren (D-MA) introduced her proposed wealth tax, there has been a storm of criticism against it not just from predictable sources like the Tax Foundation or Fortune magazine, but also from Democrats like former Secretary of the Treasury Larry Summers. This criticism is misguided and should not prevent other Democrats from supporting Senator Warren’s proposal.

Under Warren’s wealth tax plan, the richest 75,000 American households would pay an annual 2 percent tax on all assets—net worth—above $50 million, and a 3 percent tax on every dollar of net worth above $1 billion. University of California, Berkeley, economists Gabriel Zucman and Emmanuel Saez, who study wealth inequality, say Warren’s tax would raise around $2.75 trillion over ten years. The revenue would be used to fund, among other things, universal child care for every child age zero to five, free tuition and fees for all public colleges, and forgiveness of 95 percent of student debt.

There are four major lines of criticism of the Warren proposal, and they are all wrong.

First, opponents have argued that based on the U.S. experience with the estate tax and European experiences with wealth taxes, the revenue estimates are too high. But the estate tax is notoriously loophole-ridden, whereas Senator Warren’s wealth tax has robust anti-avoidance features (and assumes a 15 percent avoidance rate). As for Europe, under European Union law European countries cannot prevent their rich citizens from moving themselves or their wealth to other European countries. The U.S. has taxed such expatriations since 2008, and because of tough laws enacted in 2010, is in a much better position to discover its rich citizens’ offshore assets than any other country.

Second, opponents have argued that some assets are too hard to value and track down. But the largest asset of the ultrarich in today’s society is not real estate or artworks, but stock in publicly traded corporations, often corporations that they have founded. Just taxing Messrs. Bezos, Brin, Page, and Zuckerberg on the untaxed value of their stock will bring in billions every year. The vast majority of wealth subject to the tax is in such financial assets; the owners of those assets are known to the SEC. One overdue, complementary reform would require identification of true beneficial owners of stock and prohibit the use of straws as illegal tax evasion. The tax would bring in trillions even if it completely exempts art or real estate.

Third, opponents have argued that a wealth tax is unconstitutional because it is a “direct” tax (which the federal government may not levy). Alexander Hamilton would have disagreed, since he imposed the first federal wealth tax on carriages and saw it upheld in 1796 by a unanimous Supreme Court, all of whose members were drafters of the Constitution. Whatever a “direct” tax is, it does not preclude taxing wealth.

Finally, opponents say that lesser measures such as raising the capital gains rate and eliminating tax-free transfers of property at death would have the same effect. But as long as we do not tax all increases in value as they occur (a much harder task than taxing wealth), we cannot raise the capital gains rate too much or we will deter sales. As for eliminating tax-free transfers, death by definition only happens once, whereas a wealth tax would be imposed every year. The super-rich all envisage shifting their wealth to tax-free foundations before they die, which is why we should tax them now while they are young. Besides, there is no reason why we should not have both a wealth tax and an improved income tax with no tax-free transfers at death.

The income tax was adopted over a century ago because state property taxes could not reach intangible assets like stocks and bonds, and federal consumption taxes (tariffs) were regressive. Today, we have the means to tax the super-rich on these assets, and it is high time we did so, especially when faced with inequality that rivals the Gilded Age and a president who cuts taxes on the rich and imposes tariffs on the poor. Senator Warren’s plan should be adopted, even if it fails to tax those Rembrandts.

Why Governors Have Flamed Out as Presidential Candidates

Cliff Owen/Associated Press

Former Colorado Governor John Hickenlooper and Washington Governor Jay Inslee both dropped out of the 2020 presidential race last week. Despite their practical experience, governors with an eye on the country’s top office face several handicaps in the current political climate.

For decades, governors dominated presidential politics. This year, they’ve turned out to be duds.

On Wednesday, Montana Governor Steve Bullock will officially miss the cutoff for qualifying for the next round of Democratic debates in September, falling short both in terms of polling and numbers of donors. Last week, Washington Governor Jay Inslee and former Colorado Governor John Hickenlooper dropped out of the race before suffering the same fate.

None of the three were exactly household names before the race began, but their failures follow the lack of success during the last presidential cycle by no fewer than ten current or former governors, including such putative heavy hitters on the Republican side as Jeb Bush and Scott Walker. “Governors have had a pretty good track record,” says Columbia University political scientist Justin Phillips, “but that all seems to have vanished.”

It wasn’t always this way. Between 1976 and 2004, Jimmy Carter, Ronald Reagan, Bill Clinton, and George W. Bush—governors all—combined to win seven out of eight presidential elections. Since that time, only one governor (Mitt Romney of Massachusetts) has gotten as far as winning a major-party nomination.

Governors face several handicaps in the current political climate. By the nature of the jobs they hold, which involve bread-and-butter government operations such as building roads and funding schools, governors remain less ideological and more pragmatic as a group than their rivals in legislative roles. Freezing in-state tuition is never going to sound as sexy as offering free tuition.

“The politics that governors engage in, or have to engage in, in order to succeed is not what’s appealing right now in our combative, polarized politics,” says Phillips, co-author of The Power of American Governors. In that book, Phillips and UC San Diego political scientist Thad Kousser show that governors may sometimes have to sign bills regarding hot-button issues such as abortion, Bible studies, or restrictions on transgender bathroom use, but they almost never raise such matters themselves.

That said, Inslee devoted his entire presidential campaign to the hot-button issue of the climate crisis, and highlighted his liberal policymaking in the governor’s mansion, including the creation of a public health insurance option. So there’s something more going on than just pragmatism not playing well in a polarized age.

Governors sit outside the swim of national issues obsessing not just Washington players but cable news and social media. Their remove from the center of the partisan storm limits their exposure. It also hampers their fundraising, especially on the Democratic side, where big donors are often motivated by a limited set of issues. In a politics that plays out nationally, chief executives in the states can find themselves permanently outside the conversation.

Attempts to capitalize on national issues can fall flat. Last year, Hickenlooper signed an executive order blocking any state agencies or funds from being used in support of President Trump’s policy of separating children from their immigrant parents. Asked at a news conference whether any state money was being used for that purpose, Hickenlooper had to concede, “Not to my knowledge.”

Governors simply have less flexibility, legally or in terms of logistics. “When senators are out of state, no one misses them,” says Larry J. Sabato, director of the University of Virginia Center for Politics. “When governors are out of state, it is noticed and they are often criticized. Heaven help them if a crisis occurs in the state while they are visiting the Iowa State Fair.” Most important, governors are at a severe fundraising disadvantage. While a senator such as Elizabeth Warren can kick-start her own presidential campaign by transferring $10.4 million from her Senate campaign account, governors don’t have the legal leeway to shift funds from their state accounts to a federal race.

None of the governors in the current field managed to hit the kind of partisan notes that might have distinguished them in a two-dozen-candidate field. Inslee brought additional attention to his centerpiece issue of climate change, but with any number of Green New Deal proposals floating around, he wasn’t able to claim it as his exclusive turf. More critically, he wasn’t an enduring figure within politics, known to a national audience. It’s hard in the modern age to start a presidential run from scratch, which is surprisingly the position governors find themselves in.

Bullock and Hickenlooper each sought to market their comparative centrism as a strength. They got no traction presenting themselves as alternatives to more progressive challengers or, for that matter, to the centrist standard-bearer, former Vice President Joe Biden. For the time being, at least, Biden has the support of more moderate Democrats pretty well sewn up.

According to Morning Consult, the most popular governors in the country are all Republicans in the otherwise blue states of Massachusetts, Maryland, New Hampshire, and Vermont. Moderation plays well at home, but gains them nothing on the national stage, as Maryland’s Larry Hogan found when he floated the idea of a primary challenge against Trump. In just the few days since launching his GOP bid, combative former Representative Joe Walsh seems to have garnered more media attention than the patrician protest campaign being pursued by William Weld, the moderate former governor of Massachusetts.

As late as February 2016, Gallup found that Americans viewed being a governor as the best preparation for the presidency, with 72 percent of respondents agreeing it was “good” or “excellent” training for the job. That year, of course, Donald Trump won the election, becoming the first president in U.S. history with no prior experience in government or the military. The outsider message peddled by governors such as Chris Christie and Scott Walker was no match for Trump’s shake-things-up shtick.

The country has to be in a certain mood to turn to a governor. Governors got nowhere in the early days of national politics, in part because the focus was on creating a national politics and culture. During the centennial year of 1876, Rutherford B. Hayes became the first sitting governor elected to the White House (albeit barely, while losing the popular vote), in the wake of the scandal-plagued Grant administration. He ushered in an era of governors with “clean hands,” reformers who promised to change the culture in Washington, including Grover Cleveland, Woodrow Wilson, and Teddy and Franklin Roosevelt, notes Saladin Ambar, author of How Governors Built the Modern American Presidency.

Governors went out of style during the Cold War, when the nation craved foreign-policy experience from the likes of military hero Dwight D. Eisenhower and fellow World War II vets and old Washington hands such as John F. Kennedy, Lyndon Johnson, and Richard Nixon.

Following Vietnam and Nixon’s downfall and disgrace with Watergate, the country was again ready to elevate a Washington outsider. Jimmy Carter’s promise of “a government as good as its people,” followed by Reagan’s complaint that Washington was the problem, not the solution, ushered in the recent era of gubernatorial dominance of the White House.

Both Clinton and the second Bush sought to shift their parties to the center. In Clinton’s case, wanting to show that Democrats could be tough on crime, he returned home to Arkansas from the campaign trail in 1992 to preside over the execution of Ricky Ray Rector, a condemned killer so brain-damaged that he saved the dessert from his last meal “for later.” Bush branded himself a “compassionate conservative,” touting his record working with Lieutenant Governor Bob Bullock and other Texas Democrats.

That kind of message no longer sells. That was apparent during Romney’s campaign, when he sought to distance himself from his own signature achievement as governor, a health care plan that served as model for the Affordable Care Act. “Romney had to get more conservative for his presidential run,” says Phillips, the Columbia professor. “That suggests governors are aware of this dynamic, that there’s not a big market for pragmatic, relatively moderate politics.”

David Koch’s Heirs Will Enjoy the Biggest Tax Loophole Nobody Talks About

Mark Lennihan/AP Photo

David Koch at the Economic Club of New York in 2012.

David Koch died late last week, just shy of 80 years old. Whole books have been written cataloguing his legacy as an industrialist and political figure, but to be brief, he leaves behind his stake in the country’s second-largest privately held company and a political network said to rival the entire Republican Party in scale. Everything from Texas oil pipelines to Dixie cups to the Tea Party owes its existence in some way to David Koch.

He also leaves behind a $50 billion estate, a gargantuan sum that made him one of the richest people in the world. In the past, that would have resulted in a massive inheritance for his heirs—but also a significant amount of revenue returned to the public coffers in the form of estate tax. If David Koch had died between 1941 and 1981, his estate (upon his wife’s death) would have been taxed at a rate of at least 70 percent after the first $10 million. Some back-of-the-envelope math would indicate that’s roughly $35 billion in tax revenue that could go toward any number of public services. (For reference, a 2013 estimate by the Department of Housing and Urban Development pegged the cost to end all homelessness in the United States at $20 billion.)

But thanks largely to a political climate David Koch and his brother Charles helped create, the federal government will never see anything close to that. Part of that is because of his libertarian network’s relentless campaign against the inheritance tax, rhetorically reinvented as the “death tax,” which became a major political cause célèbre, despite the fact that 2018 saw only 1,900 taxable returns from those who died. The top tax rate on estates has dropped from 55 percent to 40 percent since 2000 alone.

But in broader terms, there’s one massive tax loophole that has helped the estates of America’s billionaire class balloon to unthinkable sums, while getting taxed at rock-bottom rates. Thanks to a tax provision called step-up in basis, capital gains on inherited assets—stocks, properties, and more—are totally wiped out upon death. It’s a tax giveaway from Congress that may outstrip all the rest.

Put simply, step-up in basis is a tax provision that allows unrealized capital gains to reset to zero upon inheritance. When an investor parks money in stocks, property, and the like, and that investment gains in value over time, the gain is supposed to be taxed (though at a rate much lower than income tax rates, at just 20 percent) when sold. But if the asset is never sold, its gains never realized, and then passed to an heir, it will be reassessed at its current market value with those gains included. Its basis, therefore, “steps up,” and the capital gains taxes that should have been levied on it are dropped to nothing.

A simplified example: Let’s say an investor with a reasonably high-paying job put $10,000 a year into a distinctly average-performing bouquet of stocks. Done dutifully over a 35-year career, that would sum to $350,000 in contributions into the market all told. At the end of that 35-year period, compounded at our theoretical rate of return, the balance sitting in that account would be $2,710,244, with some $2,360,244 in capital gains.

Under the step-up in basis procedure, the inheritor of that account would have that $2.7 million in stock reevaluated at that level, with the entire tax burden negated. Capital gains tax that could have been recouped by the federal government would go to zero; so too would state and local taxes that might be levied on a sale. Say that the account owner was based in New York City: The combination of federal, state, and local taxes would have been $800,000 on that $2.7 million, leaving the inheritor with $1.9 million. With step-up in basis, the tax is $0.

That decision has a multiplier effect. If the heir holds onto the underlying asset, and it continues to produce an average rate of return, the annual payout on a $2.7 million principal is markedly higher than what you’d get on $1.9 million. The yearly difference in payout could be as high as 43 percent. The heir could also then use that asset to borrow against for a home loan or something else. And if they sold the stock, real estate, or other asset upon receiving it, they could pocket the entire $2.7 million, some $800,000 extra, in cash.

Imagine that scaled up by orders of magnitude. Because for people like David Koch, investments don’t happen in installments of $10,000 per annum; they happen in the tens and hundreds of millions. And as those assets see their basis stepped up upon inheritance, the amplification is colossal. Take the numbers presented above, and move the decimal point six places to the right. The result, as we’ve seen, is dynastic wealth on an unbelievable scale. “You get instances where the head of a family who’s on the Forbes list dies, and then all of a sudden their ten kids are all on the list,” noted Mark Mazur, Robert C. Pozen Director at the Tax Policy Center.

There’s no way to know exactly how much David Koch had taken advantage of this loophole, but it’s safe to assume he was well aware of it. It’s well known that the Waltons, the tycoons behind Walmart who make $100 million a day, position a majority of their holdings to avoid taxes in this very way.

Of course, as Congress generously provides for this loophole, it can also take it away. Even Larry Summers has called for eliminating step-up in basis. And there are plenty of sound reasons to do so, even beyond the obvious benefits of dynasty deterrence. Step-up in basis has been criticized on the grounds that it deters taxpayers from reinvesting capital gains earnings in other areas of the economy, and encourages nonproductive hoarding, known as the “lock-in effect.” And while some objectors have claimed that eliminating it would be needlessly difficult, or have to come in tandem with lower capital gains taxes, there’s no reason to believe that. “You can tax assets annually, tax them at death so you don’t get the tax-free step-up in basis, implement an actual inheritance tax,” Mazur told me. “There’s no shortage of things you can do.”

Step-up in basis is far from the only beneficial inheritance policy the Koch estate has reaped the benefit of. In 2010, Obama conceded to a Republican minority in the Senate, signing into law a tax cut to 35 percent on estates over $5 million. The Trump tax plan, after flirting with eliminating the estate tax, raised the ceiling on tax-free estates to over $11 million per person.

With Democratic presidential candidates turning their focus to wealth taxes rather than income taxes as a more effective way to combat runaway inequality, step-up in basis represents one of the more flagrant and easily rectified programs. It’s a huge giveaway that overwhelmingly benefits the very rich, while its positive-feedback nature amplifies wealth disparity. And while tax policy is decided by Congress, recent proposals from Senator Elizabeth Warren and Representative Alexandria Ocasio-Cortez have already started to reverse a long-standing trend in the conversation about the estate tax, which has been steadily shrinking for decades. As Democrats in Congress seek ways to overturn the Trump tax cuts, nixing step-up in basis could prove to be a quick and lasting fix for a more equitable tax policy.