Two Americas, Two Tax Codes

Emory Professor of Tax Law Dorothy Brown raises important equity considerations in her NYT Op-Ed essay today:

WARREN BUFFETT knows there’s something very unfair about the American tax system. He’s often complained that while his 2006 tax rate (for federal income taxes and Social Security withholding) on $46 million of income was 17.7 percent, his secretary’s combined tax rate was 30 percent.

There are effectively two tax systems in America: one for the very rich and one for the rest of us. Income from stock dividends and capital gains, which makes up a disproportionate amount of the earnings of the very rich, is taxed at 15 percent. But the bulk of what the rest of us earn — wages and interest from savings accounts — is taxed at up to 35 percent. Though President Obama’s recent tax proposals are progressive and comprehensive, his reforms don’t do nearly enough to address this significant disparity.

Yes, President Obama’s plan would eliminate the loophole that has allowed hedge fund titans, whose income comes in no small part from management fees, to be taxed at just 15 percent instead of the ordinary income tax rate.

Families earning more than $250,000 and singles earning more than $200,000 would likewise see taxes on their wages and interest increased to a top rate of 39.6 percent from 35 percent. And the rate on both capital gains and dividends on the sale of stock would increase, but only to 20 percent from 15 percent. These changes lessen the unfairness in our tax system; they don’t eliminate it.

It's an important equity issue to consider, one I have mentioned repeatedly in my public finance class and at the beginning of our service-learning tax course.

And Professor Brown does not even address some of the less visible ADDITIONAL tax breaks for capital gains.

First, capital gains are not taxed at all until they are realized. If you put $100 into a saving account and let it grow at interest, the annual growth will be taxed as taxable interest each year. If you put $100 into a growth stock which grows in value over time, that growth will not be taxed until such time that you choose to sell it. The value of this tax deferral is considerable.

Second, if you do not sell the stock before you die, your heirs will be able to sell the stock without ever paying any capital gains tax on the gain in value that occurred during your lifetime.

Third, if you decide to donate the appreciated stock to an eligible tax-exempt charity (e.g., your alma mater, a museum, charity, etc.), then you may deduct the full appreciated value of the stock from your taxable income that year, even though you never paid income tax on the gain.

The low and moderate income taxpayers we serve at our VITA site get zero direct benefit from any of the tax breaks for capital gains and dividends.

Do they get any indirect benefits from these tax breaks? What's the rationale for these tax breaks? We'll talk about this in class tonight.