Obama's State of the Union Is Filled With Sensible Bipartisan Tax Ideas.
Obviously, Conservatives Will Hate It.
By Danny Vinik
In the State of the Union Tuesday night, President Barack Obama will propose a new tax plan that will raise taxes on the rich and use the money to fund his free community college program and new tax breaks for the middle class. Republicans are not pleased. “The tax hike shows little understanding of where to find common ground with Republicans,” wrote Brendan Buck, the communications director for the House Ways and Means Committee. “Surely the White House knows a massive tax increase is not what the American people just sent a newly elected Republican Congress to do.”
Many Republican legislators echoed Buck’s message. But that message is wrong. While conservatives won’t like the entirety of Obama’s plan, it contains many ideas that they do like and have proposed over the past year. But because Obama proposed it, it’s dead-on-arrival.
To start, Buck’s reference to Obama’s plan as a “massive tax increase” is an exaggeration. It would raise $320 billion over the next decade, just a small fraction of the $40 trillion the federal government will collect during that span. As Slate’s Jordan Weismann writes, that’s “more than a rounding error, but not much more.” It’s certainly not a massive tax increase.
Regardless of the revenue, Republicans will reject basically any and all tax increases. Obama’s plan to raise revenue has three parts, the first two of which ought to appeal to conservatives serious about fiscal responsibility.
Create a new bank tax
Obama wants to impose a 0.07 percent tax on liabilities of banks with greater than $50 billion in assets. It’s similar to the bank tax that former House Ways and Means Chairman Dave Camp put forward in his tax reform plan last year. Instead of taxing bank assets, as Camp’s plan does, Obama’s plan would tax bank liabilities. This is a key, important difference. As Felix Salmon explained when Camp’s plan came out, “it’s not size that’s the real problem, it’s leverage, and it’s always good to give banks an incentive to raise more capital and less debt.” Tim Worstall, a conservative writer for Forbes, agreed with Salmon and argues that Obama’s new bank tax is a great idea and just needs a couple slight tweaks.
A bank tax will receive little support on Capitol Hill, certainly from Republicans but also from Democrats. Wall Street has immense power in both parties. But changing bank incentives to reduce risk—and thus lower the chance of a future bailout—should appeal to both liberals and conservatives.
Eliminate the “Stepped-Up Basis” loophole
Obama’s plan would also eliminate a big loophole for rich heirs. The key here is that capital gains tax—the tax people pay on investments—is only paid when the person sells the asset, not when it increases in value. For instance, if a person buys $5 million worth of stock and it appreciates to a value of $10 million in two years, the person pays nothing until they actually sell it. When they sell, they pay the capital gains tax rate of 23.8 percent (20 percent plus 3.8 Medicare tax imposed by Obamacare).
Many liberals already oppose the preferential treatment of capital gains (more on that in a bit). But there’s a major loophole for people who inherit investments: They only pay taxes on appreciation in the asset since they received it, not since it was purchased. For instance, if your father buys $5 million worth of stock and you inherit it at a value of $10 million, that $5 million in appreciation is never taxed. When you sell the stock, you only pay tax on how much it appreciated from $10 million. This is called “step-up” basis. While conservatives may want to lower the capital gains rate, it’s hard to think of any justification for this loophole.
Raise the capital gains tax rate
Finally, Obama proposes raising the capital gains rate from the aforementioned 23.8 percent to 28 percent. Republicans will certainly oppose this change on the grounds that it disincentivizes investment. It’s not really clear that’s true. In 2011, Jared Bernstein, the former chief economist for Vice President Joe Biden, compared real business investment over the past 80 years against the capital gains rate. He couldn’t find any correlation. But raising the capital gains rate goes against Republican orthodoxy, so it’s not something they will support.
Unlike in past years, Obama is not just raising money for deficit reduction. Instead, he wants to put the money towards helping the middle class. In particular, he would use the money to fund three tax cuts targeted at middle class households—all three of which Republicans should support:
Expand the Earned Income Tax Credit (EITC)
Under the current EITC program, childless workers receive almost no benefits compared to what working parents receive. Obama’s plan would substantially increase the credit available to childless workers. In addition, at the end of 2017, changes made to the EITC under the stimulus bill will expire. Obama’s new plan would also make those changes permanent.
Last year, Republicans, including Representative Paul Ryan and Senator Marco Rubio, proposed expanding the EITC so childless workers can benefit as well. Republicans and Democrats only disagree about how to pay for that expansion.
Create a second earner tax credit
One flaw with the tax code is that the first dollar of a second earner is taxed at the same rate as the last dollar of the first earner. That’s a lot simpler than it sounds. Let’s say you and your boyfriend each earn $20,000 per year. When you file separately, the first $9,075 is taxed at a 10 percent rate and the next $10,925 is taxed at a 15 percent rate. You each pay $2,546 in taxes, a rate of 12.7 percent. If you two get married and file jointly, the first earner’s taxes still face the same tax schedule. But the second earner’s tax schedule starts where the first is left off: his first $16,900 in income is taxed at the 15 percent rate and the next $3,100 is taxed at a 25 percent rate. Combined, the couple pays $5,856 in taxes, a rate of 14.6 percent. That penalizes marriage and disincentivizes the second earner from working.
To correct this flaw, Obama has proposed a credit of 5 percent of the second earner’s first $10,000 in income—a maximum of $500. It would be fully available to all couples earning less than $120,000 and partially available to couples earning between $120,000 and $210,000. Since it both promotes marriage and work, Republicans should support this. But as with EITC, the disagreement is on how to fund it.
Expand a tax credit for child care
Finally, Obama wants to nearly triple the Child and Dependent Care Tax Credit to $3,000 and allow parents of young children who earn up to $120,000 to collect it. This plan would make it easier for parents to work by making child care more affordable, giving it significant appeal to those on the right. Once again, Republicans and Democrats will disagree on how to fund it.
Obama’s plan has a few other features as well. It would consolidate a number of tax credit programs into the American Opportunity Tax Credit, which was created in 2009 by the stimulus. The goal is to eliminate confusion about the programs. Obama also wants to require employers with more than 10 workers to automatically enroll their employees on a tax-advantaged IRA program to encourage saving and provide money to small businesses to offset the administrative costs. IRAs would have a hard cap at $3.4 million, so the wealthy couldn’t use questionable tax strategies to amass huge amounts in their IRAs. (Mitt Romney’s IRA had over $100 million in 2012, despite the fact that annual contributions are capped at $5,500 a year.) Finally, the revenue generated from the plan would also offset the cost of Obama’s recently announced plan to offer some students two years of free community college.
Right now, the conventional wisdom is that the proposal is dead on arrival in Congress. “Do Obama's proposals have any chance of happening?” Vox’s Matt Yglesias rhetorically asked. “No. None whatsoever.” In the end, that will almost certainly be true. But in a normal legislative environment, it wouldn’t be. Instead, Democrats and Republicans would be able to reach a smaller compromise to, for example, expand the EITC in exchange for eliminating the “Stepped-Up Basis” loophole. Instead, Republicans hear the word “tax increase” and shut down any chance of compromise. It’s a sad statement on the legislative process that such a reasonable proposal has no chance to even receive a vote in Congress.
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