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Sunday, November 11, 2018

Tax Reform we need

Down with the ‘Stepped-Up Basis’
By Gerald E. Scorse, special contributor to Progressive Charlestown

The term “stepped-up basis” is shorthand for a tax loophole that lines the pockets of the haves while it picks the pockets of the Treasury. 

According to the Congressional Budget Office, the cost over ten years could reach $644 billion.

Let’s see how the well-off get handed hundreds of billions that should be going toward the good of all Americans.

The basis of an asset (stocks, real estate, fine art, etc.) is its price or fair market value when it’s acquired. Any increase over the basis becomes a capital gain. 

When holders dispose of assets, they’re taxed on those gains—except when the stepped-up basis steps in, and erases both the gains and the taxes.

It’s automatic: when assets are passed along to an heir, the value at the time of the transfer becomes the heir’s basis. Magically, all the accumulated gains vanish. With no gains, all the taxes vanish too.

The basis loophole is actually one tax inequity on top of another. First, capital gains are taxed at a far lower rate than wages. 

When this preferential rate isn’t preferential enough, the affluent simply hold on for the zero rate.  (“This is the thrill that pulses through the veins of the well-to-do when they discover there is no longer any limit on their power to accumulate.” The words are Thomas Frank’s, taken from his latest book Rendezvous with Oblivion.)

The loophole doesn’t apply to commonly-held retirement accounts such as regular IRAs and 401(k)s. Putting it another way, those hundreds of billions go lopsidedly to the wealthy—people with hugely appreciated assets, separate and apart from retirement savings.     

Full disclosure: The stepped-up basis is available to just about everybody. For tax years 2018 through 2025, it’s open to individuals with a net worth up to $11.2 million or couples with a net worth up to $22.4 million.

Anybody who calls for ending a law has to counter the thinking that led to it in the first place. Proponents of the stepped-up basis claim that it’s often not possible to accurately determine the original basis, especially for assets that could date back several decades.  

Our digital age has made this rationale more and more tenuous. In the large it simply doesn’t wash anymore.

In addition, Congress could always tailor a repeal to deal with holdings acquired long ago. 

Lawmakers faced a comparable situation in 2008, when they passed a bill requiring basis reporting for stock market capital gains. In that case they worked out various post-2008 schedules for different types of holdings. 

While Wall Street investors were always required to report gains honestly, the Internal Revenue Service now gets basis figures that provide a double-check. 

Over the long term, accurate reporting of capital gains by brokerage firms should approach the 99% level already achieved by employer reporting of workers’ wages and salaries.

Basis prices of other major assets should also be routinely reported. 

Realtors, for example, should be required to report to the IRS any home or property sale exceeding a specific amount; the same for major art galleries, antiques dealers and jewelers. Exceptions could be allowed, e.g., family heirlooms (provided they stay in the family and aren’t resold for tax-free gains).  

The two capital gains tax inequities (the stepped-up basis and lower rates) effectively increase income inequality and perpetuate wealth over generations. For this the Treasury pays dearly: according to the Congressional Budget Office (CBO), these tax breaks are expected to cost a combined $1.984 trillion from 2014 to 2023.

The same CBO report estimated the federal deficit for that decade at $1.932 trillion (excluding interest on the national debt). 

So if those two tax breaks were ended—just those two—the Treasury could gain enough revenue to pay for all federal programs over that period without running a deficit. (Of course behaviors could also change, lowering the Treasury’s pick-up. Even so, the prospect should warm the hearts of all fiscal conservatives and deficit hawks.)

Eliminating both breaks likely goes a break too far. In that case, Congress should start with the most egregious. It should shut down the stepped-up basis.

Gerald E. Scorse helped pass the bill requiring basis reporting for capital gains. He writes on taxes.