BEYOND THE NUMBERS
Critics of President Biden’s plan to help pay for investments in families by taxing income from wealth more like income from work often focus on the plan’s changes to top tax rates, ignoring that it would leave in place a massive tax benefit that wealthy households enjoy on their investments: the ability to defer paying tax on the rising value of their assets. It’s hard to overstate the benefits that deferral gives the wealthiest households, as a widely discussed ProPublica story shows.
The Tax Foundation, for instance, recently criticized the higher rates top earners would face on capital gains under the Biden plan. But the Tax Foundation itself wrote in 2019 that when you account for the value in delaying tax payments, effective tax rates on capital gains — that is, the share of their total capital gains income that a taxpayer would owe in taxes — would remain low under the Biden proposals because of deferral.
Capital gains (the increase in the value of assets such as stocks, real estate, or other investments) currently enjoy three tax advantages compared to income from labor, such as wages and salaries:
- They are taxed at lower rates, which top out at 23.8 percent for the highest earners (including a 3.8 net investment income tax imposed on high earners).
- They are only taxed when appreciated assets are sold, so wealthy people can defer paying taxes on a major source of their income simply by not selling those assets.
- They are not taxed at all when assets that have appreciated in value are held until the owner dies. Because of the “stepped-up basis” loophole, heirs pay no income taxes on any appreciation of assets that occurred before they inherited them.
The Biden reforms would address the first and third of these, by taxing capital gains at the same rates as labor income and eliminating the stepped-up basis loophole (with provisions to protect family farms). But deferral would remain, which is a significant advantage.
As the Tax Foundation explained in 2019, deferral “matters a great deal. This is because deferral allows a taxpayer to delay paying tax for years even while the asset appreciates and earns income.” Comparing a proposal from Senator Ron Wyden, which eliminated deferral, to President Biden’s campaign platform, which kept deferral, the Tax Foundation showed that the statutory tax rate on capital gains from a hypothetical investment (a $40 million asset earning 5 percent annually and held for 25 years) would be 37 percent under both plans but the effective rate under the Biden plan would be just 22 percent — versus 37 percent under the Wyden plan — due to the benefit of deferral.
“Policymakers should consider the advantage of tax deferral when evaluating tax plans on capital gains,” the Tax Foundation correctly concluded in 2019, because “Accounting for deferral reduces effective tax rates for proposals retaining this tax advantage.” However, a recent Tax Foundation piece on the Biden plan’s taxation of previously untaxed capital gains at death neglected this sound advice, failing to acknowledge the large gap between statutory and effective tax rates on capital gains due to deferral. (The Tax Foundation analysis also combines the Biden proposal with the estate tax, which, as we’ve explained, is a separate tax that effectively falls on a different individual: the heir receiving the windfall inheritance.)
The recent ProPublica reporting starkly illustrates just how large the advantage of deferral is for the richest Americans. For example, Warren Buffett’s wealth increased by $23.4 billion from 2014 to 2018. If those same gains in wealth — which should be considered annual income — had come from wages or were taxed each year at the same rate as labor income, he would have owed well over $1 billion in taxes each year, on average. Instead, because the gains came from stocks (and thus go untaxed while Buffett holds the stocks), he paid a tiny fraction of that amount: $23.7 million over those five years combined. While typical middle-income households pay annual taxes on the wealth they build through labor, billionaires like Buffett benefit massively from deferring taxes on the wealth they build through capital gains.
To be sure, those at the top would owe more under the Biden tax proposals, which would raise progressive revenue and make the tax code fairer. As a recent Tax Policy Center analysis explains, “Nearly all of President Biden’s proposed tax increases would be borne by the highest income 1 percent of households.” While the deferral tax break would stay in place under the Biden plan, eventually the accumulated income would be taxed when the asset holder dies. This makes the proposal a modest step toward ensuring that high-wealth households ultimately pay a fairer amount of taxes to support public investments that have benefitted them and their businesses greatly and that promote more broadly shared opportunity.