Paul L. Caron

Friday, March 13, 2009

Bartlett: Treat All Taxpayers Like The Treasury Secretary

Forbes:  A Strategy for Capital Gains, by Bruce Bartlett:

[T]here is a generally unknown upside to presidential appointments that may be worth a lot to certain individuals. Section 1043 of the Internal Revenue Code permits those appointed to high-level positions in the executive branch (not Congress or the Judiciary) a one-time tax-free capital gains rollover.

Individuals who must sell assets to comply with federal ethics laws are allowed to convert them into Treasury securities or shares in broad-based mutual funds. No tax applies to the transaction until the Treasury securities or mutual funds are sold. The underlying basis carries forward so that all accumulated gains are taxed unless they are held to death, at which point basis would be stepped up to market value.

This provision was extraordinarily valuable to Robert Rubin and Henry Paulson, both of whom had hundreds of millions of dollars in unrealized capital gains in Goldman Sachs stock. When they were appointed secretary of the Treasury, they were able to realize all the gains on their stock shares, saving them tens of millions of dollars in taxes, and diversify their portfolios at the same time.

What I have always found interesting about this obscure provision of the tax law is that it recognizes a principle that ought to apply to all taxpayers. That principle is that reinvested capital gains ought not to be taxed; they should be taxed only when consumed. The way we tax capital gains now, it is more of a transactions tax than a tax on income, preventing people from being able to diversify their portfolios and leaving them locked into assets on which they have large gains....

Barack Obama has asked Congress to raise the capital gains tax rate to 20% in order to restore fairness to the tax code. This will require congressional action, which will present an opportunity to again raise the issue of indexing.

Given Democratic control of Congress and widespread revulsion against the rich, who are viewed as having benefited disproportionately from George W. Bush's tax policies, it's highly unlikely that Republicans will be able to block a capital gains tax rise. But adding a provision to the tax code that limited the 20% rate to inflation-adjusted gains may be achievable.

Indexing can be presented as a matter of simple fairness as well as being consistent with economic theory and the tax treatment ordinary income. The income tax has been indexed to inflation since 1985, so indexing capital gains as well makes sense....

Many economists believe that the recent policies of the Federal Reserve and the Obama administration will lead to a resurgence of inflation a few years down the road. If this is true, then it's all the more reason for Republicans to push for capital gains indexing, rather than expend all their efforts on fighting a tax rate increase that they don't have the votes to prevent.

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Once again Congress (via the IRC) has allowed themselves special treatment, keeping it secret (unless you know where to look)while the massive must pay their fair share.
It proves the point that there are two rules, one for those who are so blessed to be appointed ans the rest of us !


Posted by: Deborah Snow | Mar 14, 2009 8:03:04 AM

I think it would be good if we treated all tax consumers like the tax payers! Why do I have to file a 1099 for my subcontractors, or collect 1099-misc on my dividends, when others get welfare, AFDC, food stamps, heating oil help, electrical subsidies and any number of political pandering tools without receiving an IRS Form 1099? As I understand it, Mr. TaxProf, you can even receive a 1099-G for RECEIVING unemployment payments. So... if you work AT ALL (even if fired!).. you have to be reported on but if you just beg you don't. Marks the future I guess.

Posted by: SenatorMark4 | Mar 13, 2009 4:02:15 PM

That might help make the tax code more sensible, but it would also make the average investor a little more short-term oriented. Right now, there's a huge difference between earning 15% compounded from one stock, versus earning 15% per year from one stock each year (or 15% annualized, pretax, from a stock a month or a trade a minute).

And it's probably politically untenable -- imagine giving even more fuel to the argument that hedge fund and managers are getting an unfair deal.

Posted by: TaxRascal | Mar 13, 2009 9:11:11 AM