The President’s Twofer

In the weeks leading up to the State of the Union address, President Obama has gradually laid out his vision for America. I am particularly impressed with his proposal to make two years of community college free for students who are willing to work for it. This program would help young adults from lower-income families get a needed start toward a four year college education or vocation training for a career.

Critics have argued it is easy to propose a new program without paying for it. Well, last Saturday, the president said how he will pay for it: raise taxes. What is great about his tax proposal is it is a twofer. First, it would raise needed revenue—$320 billion over 10 years—to pay for the policies that would help low- and middle-income families. Second, it would make the tax code fairer and help reduce the growth in the share of income going to the top 1 percent by increasing taxes on capital income—bringing taxes levied on income gained from wealth closer to income gained from working. The administration estimates that 99 percent of the impact of this proposal would affect the richest 1 percent and more than 80 percent would affect just the richest 0.1 percent.

The main tax proposal is changing how capital gains are taxed. The tax rate on capital gains and dividends is increased to 28 percent—the rate under President Reagan. Currently, the tax rate on capital gains and dividends is 20 percent plus a 3.8 percent surtax. The president’s proposal would increase the tax rate to 24.2 percent plus the 3.8 percent surtax.

In addition, the proposal removes a loophole—the “stepped-up basis” loophole—that allows the wealthiest taxpayers to escape paying tax on inherited assets. We at EPI have been pushing for this change for years. Currently, when assets are transferred, say in a bequest, no taxes are due on appreciated assets. For example, suppose an individual purchases $10 million in stock. That person would have to pay taxes on any realized capital gains when the stock is sold (if the stock was sold for $100 million then the individual would pay taxes on the difference between the purchase price—the basis—and the sales price or $90 million). But if the individual never sells the assets and passes on the $100 million of stock to an heir, no capital gains taxes are due on the $90 million gain. Furthermore, when the individual receiving the assets sells the assets, the basis is stepped-up to $100 million rather than $10 million. The president’s proposals would retain the $10 million basis for the heir (called carry-over basis) and taxes would be paid on any gains when the assets are inherited. In an era with a deeply eroded estate tax, removing this “stepped-up basis” loophole would help us tax large blocks of inherited wealth—essentially adopting some of Thomas Piketty’s ideas for pushing back against rising income and wealth inequality.