The income side of fiscal policy (i.e. taxation) is always highly politicized.  The song never seems to change.  Republicans think everyone pays too much.  Democrats think everyone pays too little.  An oversimplification?  Maybe.

Nonetheless a basic understanding of the proposals independent of the emotionally-charged rhetoric can go a long way towards achieving Thomas Jefferson’s view that an “educated citizenry is a vital requisite for our survival as a free people.”

Quick note – at Apollo we’re occasionally accused of being pro-Republican so we’re compelled to point out as we’ve previously done that we’re apolitical.  Politicians are full of ____.  Democracy is broken.  Despite how we view ourselves as individuals the majority of the citizenry is uneducated, ill-informed, refuses to be self-responsible and thus poorly equipped to make intelligent, reasonable decisions.  Elections are therefore a glorified high school homecoming king/queen coronation where popularity (or more likely voting against instead of voting for a candidate) rules the day.  In short we aren’t pro/con either of the major parties so please keep this in mind as you rush to tweet, unfriend us, smash our windows, etc.

Whew!

With that out of the way let’s take a look at how the Trump and Biden proposals would impact different groups:

MIDDLE-INCOME EARNERS

Biden’s initial plan (released in April) has been updated to address COVID-related economics.  He is proposing a lengthy list of new or enhanced tax credits including:

  • The nonrefundable child tax credit would temporarily increase from $2,000/child (up to age 16) to a refundable $3,600/child (up to age 6) and $3,000/child (up to age 17).  Refundable credits are paid as refunds even if a person does not owe tax.  Pay no taxes yet get a refund…where do I sign up?!
  • The child and dependent care tax credit would increase from a maximum $2,100 for two or more children to $8,000.  As above the status would change from nonrefundable to refundable meaning a person who pays no tax would receive the credit in the form of a refund.
  • A $5,000 credit for informal caregivers.  Details have not been provided as to what makes someone an informal caregiver, if the credit is means tested and whether it’s refundable.  Seems like an area ripe for abuse.
  • First-time homebuyers would receive a $15,000 credit.  What’s more an additional refundable credit (i.e. received by people even if they don’t pay tax) would be available to ensure that renters would not pay more than 30% of monthly income for rent and utilities.  The incentive is clear…rent an unaffordable home/apartment and have the government pick up the tab beyond the 30% of monthly income threshold.
  • Childless workers age 65+ do not currently qualify for the Earned Income Tax Credit.  Biden proposes to make them eligible to receive the credit.

Trump has not released specific proposals.  General goals include:

  • Make permanent the temporary tax cuts under the Tax Cuts and Jobs Act (“TCJA”) signed into law in December 2017.  This would include the current lower income tax rates, expanded standard deductions, etc.
  • Reduce payroll taxes used to fund Medicare and Social Security.

The Tax Foundation analyzed the Biden proposals and calculated an after-tax increase for the bottom 20% of earners of 10.8% through 2025.  Under TCJA the bottom 20% of earners are likely to see an increase of 1%.  Don’t get lost in the numbers.  The bottom 20% pays little/no tax and is a net receiver of government funds (e.g. refundable tax credits).  In other words those paying little/no tax necessarily see higher after-tax incomes under Biden’s programs since he proposes to give money to people who pay little/nothing into the system.

HIGH-INCOME EARNERS

Biden’s proposals include:

  • Increase the top marginal income tax rate from 37% to 39.6%.
  • Lower the top of the 35% bracket / bottom of the proposed 39.6% (currently 37%) bracket so that it’s easier for people to find themselves in the top bracket.  Nominally it’s not a tax increase for those in the 35% bracket (i.e. the rate didn’t change) but realistically more taxes would be paid.  This is a prime example of where rhetoric twists reality.
  • Assess a new Social Security tax on incomes over $400,000.  Currently the 6.2% Social Security tax (paid by both employer and employee meaning a self-employed person pays 12.4%) is applied to income of up to $137,700.  Although all workers would continue to pay current Social Security taxes a hole would be created where incomes between $137,700 and $400,000 would not be subject to the new Social Security tax.
  • Limit deductions in three main ways for people with income of $400,000+.  First, cap the value of itemized deductions (e.g. mortgage interest, real estate taxes, state/local income taxes, etc.) at 28%.  In other words people in the 32%, 35% and proposed 39.6% brackets would find that every $1 that’s deductible would be reduced by $0.28 instead of $0.32, $0.35 or $0.396.  Second, the Pease Limitation would be reinstated effectively reducing every $1 of deductions by an additional $0.03.  Lastly owners of so-called pass-through entities such as S-Corps and LLCs would lose the 20% deduction enacted under TCJA.  How will Biden shelter his speaking fee income?

Trump’s proposals include:

  • Make permanent the provisions of TCJA as they relate to lowered tax brackets, expanded standard deductions, the 20% deduction for self-employeds, etc.

The Tax Foundation’s analysis of the Biden plan shows the top 1% of earners would see their annual after-tax income fall by 11.3%.  Again it’s important not to get lost in the numbers.  It’s rather easy for those of us who think of ourselves as the everyman/everywoman/everygendernonbinary to creep into the top 1%.

CORPORATIONS

Biden aims to increase the corporate income tax rate from 21% to 28%.  Taking more money out of corporate wallets?  Seems counterproductive when businesses fail (COVID or otherwise) and Uncle Sam is writing checks to the airlines, funding the Payroll Protection Program, extending unemployment benefits seemingly indefinitely, etc.

INVESTORS

Capital formation is the process of increasing machines, tools, factories, transport equipment, materials, electricity, etc.  They are used for the future production of goods and services.  In other words capital formation is the lifeblood for creating jobs and growing the economy.

Owners of capital seek profits.  No sense investing without a path for making money.  Active investors (i.e. entrepreneurs) and passive investors (i.e. owners of financial assets such as stocks and bonds) are therefore the people who need to benefit if society wishes to promote capital formation.

Here’s what Biden wants to do to discourage it:

  • Scrap the highest capital gains rate of 20% for profits exceeding $1,000,000 in favor of his proposed top ordinary rate of 39.6%.

Double the capital gains tax.  Wow!  Double wow!

DEATH, INHERITANCE and GIFTS

These areas may be the most controversial and least detailed of Biden’s plan.  Proposals include:

  • Reduce the estate tax exemption from $5,490,000 to the 2009 level of $3,500,000.
  • Eliminate the inflation adjustment.  The current $5,490,000 increases slightly each year.  The proposed $3,500,000 would stay fixed.  This is the same lack of thinking that sucked people into the Alternative Minimum Tax (“AMT”) black hole.  The thresholds in place when enacted in 1969 were fine and dandy but the lack of inflation adjustments meant over time more and more people paid AMT as incomes rose.
  • Increase the estate tax rate to 45% from 40%.
  • Here’s where Biden’s plan gets ugly.  Real ugly.  He is proposing to eliminate the step-up in cost basis.  It sounds benign but it’s a big deal.

Under current law at death the cost basis (i.e. purchase price) of an asset is reset at current market price.  Heirs may inherit an asset with massive embedded capital gains (the mythical “I bought Amazon when it IPO’d”) but for tax purposes the purchase price and current fair market value would be equal.  Capital gains taxes would be owed on the difference between date of death value and date of sale value if the asset is sold at a gain after inheriting.

Let’s look at an example.  Apple IPO’d at $22/shr but the split-adjusted price is less than $1.  In fact it’s $0.10/shr.  Apple’s FMV is currently $114/shr.  That’s a gain of $113.90/shr if sold.  Let’s assume 1,000 shrs are owned.

$114/shr x 1,000 shrs = $114,000

Under current law an investor who dies can pass $114,000 of value to heirs.  Cost basis is stepped-up from $0.10/shr to date of death FMV of $114/shr.

$114/shr x 1,000 shrs = $114,000 proceeds

$114/shr x 1,000 shrs = $114,000 stepped-up cost basis

Tax due is $0.

Under the proposed law eliminating the step-up in basis:

$114/shr x 1,000 shrs = $114,000 proceeds

$0.10/shr x 1,000 shrs = $100 cost-basis

$114,000 – $100 = $113,900 taxable gain to be taxed at, well, who knows?  Will it be taxed at the estate rate?  The ordinary income tax rate of the beneficiary?  Capital gains tax rates?  The almost doubled capital gains tax rate being proposed?

It’s not just investments.  The step-up would be completely eliminated.  Think about that when inheriting mom and dad’s house.  You know the one – they bought it 53 years ago for $8,000 and it’s now worth $700,000.  Big tax bill on its way.

A last little bit of salt in the wound is the IRS position that in the absence of evidence the presumption is that tax basis is $0.  How many of us remember what we ate for dinner last Thursday let alone prove what mom and dad paid for their house in 1967?

SUMMARY ECONOMIC IMPACT

The Tax Foundation’s General Equilibrium Model suggests Biden’s proposals will result in:

  • 1.62% decrease in Gross Domestic Product
  • 3.75% decrease in capital stock
  • 1.15% decrease in overall wages
  • loss of 542,000 jobs

These results are important as they illustrate that Biden’s proposals have nothing to do with growing the proverbial pie.  Instead he seeks to redistribute it.

Pro-Biden?  Anti-Biden?  Pro-Trump?  Anti-Trump?  Pro-nobody?  We all have our reasons.  One thing’s clear, however.  Tax and spend will be alive and well should Biden win the White House and the Democratic party take control of Congress.