Now that President BidenJoe BidenThe Hill’s Morning Report – Presented by Facebook – Forget about comity in Congress Border surge scrambles Senate immigration debate GOP looks to measures barring trans athletes to rally voters MORE and Congress have enacted a $1.9 trillion COVID-19 relief measure, the president will soon provide details for the second item on his agenda, a major recovery plan. The package could include some of the tax increases on which he campaigned to pay for new spending.
Among other tax changes, the president has called for increasing personal income taxes on individuals earning more than $400,000 annually by returning the top personal income tax rate to 39.6 percent and implementing a variety of limits on existing tax breaks. Congress and the administration could achieve the same goals in a more straightforward way: require the rich to pay what we call a high-income tax (HIT) with no special breaks except a credit for charitable giving.
The HIT would equal 39.6 percent of a taxpayer’s adjusted gross income (AGI is the basic measure of income on which the personal income tax is calculated). The only break allowed against the HIT would be a credit equal to 28 percent of charitable giving. The very well-off would pay whichever is higher, the regular personal income tax or the HIT.
The HIT would exempt $400,000 of AGI, and this exemption would phase out for those with AGI between $400,000 and $600,000. In other words, those with AGI of $400,001 would be virtually unaffected by the HIT but a household with more than $600,000 in AGI would pay the HIT in full. To make it difficult to game the rules, the proposal would calculate the exemption using the taxpayer’s average AGI over several years. This proposal would simplify taxes by replacing the alternative minimum tax (AMT) and the $10,000 limit on federal income tax deductions for state and local taxes (SALT) with the HIT.
For the HIT — but not the regular income tax — this proposal would expand the definition of AGI to include capital gains on unsold assets during the final year of a taxpayer’s life. Currently, the tax code exempts capital gains on assets passed to heirs, which creates an enormous tax avoidance opportunity.
That is all the HIT would do. Compared to Biden’s personal income tax hike proposals, the HIT is not very complicated, particularly for very rich individuals (those with incomes exceeding $600,000) who would simply pay 39.6 percent of their AGI in taxes each year. But the HIT would solve many problems. Here are just a few:
First, high-income taxpayers subject to the HIT no longer would benefit from the preferential tax rates for capital gains and stock dividends. Biden proposes to eliminate these preferential rates for the rich, and the HIT would have the same effect. It makes no sense for working people to pay higher tax rates on their earned income than the wealthy pay on investment income they receive, often without lifting a finger beyond paying an investment manager to buy and sell.
Second, taxpayers subject to the HIT no longer would benefit from the huge deduction for business profits enacted as part of the Trump administration’s tax cuts. This 20 percent deduction for pass-through business profits mainly benefits the richest 1 percent. Biden proposes to phase it out for those with incomes exceeding $400,000. The HIT would accomplish the same thing.
Third, the HIT would replace the cap on state and local tax deductions as a better limit on tax breaks for the rich. The SALT cap, enacted as part of the 2017 tax law, was an obvious attempt to require residents of jurisdictions with higher state and local taxes (i.e., typically blue states) to pay for the tax cuts.
While Biden’s proposals do not address this issue, many congressional Democrats propose to simply repeal the cap and allow even the richest taxpayers to claim unlimited federal income tax deductions for SALT. This would drain away most of the income tax increases Biden proposes and most of the benefits would go to the richest 1 percent. Instead of allowing even the richest taxpayers to claim unlimited deductions for SALT, the HIT would phase out almost all deductions, but only for the very rich and without targeting any particular states the way the SALT cap does.
Fourth, the HIT would raise more revenue. Using the ITEP tax microsimulation model, we estimate that the HIT would raise $251 billion in 2022, while Biden’s proposed personal income tax increases would raise $137 billion in the same year. (Biden’s plan could raise less than half that amount if congressional Democrats amend it to repeal the cap on SALT deductions.)
The HIT raises more revenue partly because it is more aggressive in taking away tax breaks that the rich currently enjoy. For example, Biden proposes to limit the tax savings of each dollar of itemized deductions to 28 cents. The HIT effectively does the same thing for the charitable deduction by replacing it with a 28 percent credit, but it eliminates other itemized deductions for the very rich.
Finally, the HIT could be a foundation for future tax increases. For example, if lawmakers decide to enact tax rates that are higher than 39.6 percent, it makes sense to add those rates to the HIT. While the HIT is in many ways a moderate proposal that leaves the top tax rate no higher than it was before the 2017 tax law, it also lays the groundwork for bolder progressive tax reform in the future.
Of course, the HIT would not solve all problems. Some existing tax breaks allow the wealthy to manipulate their profits and losses so that the profits never appear in their income to begin with — as former President Trump
Donald TrumpBorder surge scrambles Senate immigration debate GOP looks to measures barring trans athletes to rally voters House GOP holdouts muddle Trump vaccine message MORE seems to have done for several years. Fixing that would require additional legislative changes.
Congress and President Biden also would need to enact additional proposals to address problems with other parts of our tax system, such as the corporate income tax and the estate tax. But the HIT would accomplish all the personal income tax increases that Biden proposes, and it would be simpler.
Steve Wamhoff is the director of federal policy at the Institute on Taxation and Economic Policy, and Matthew Gardner is the institute’s senior fellow.