PRIORITY

A Tax Code that Rewards Work

In America, our tax code should encourage and reward hard work. Let’s reorient the federal tax code to the twin goals of economic equality and economic growth.

John Hickenlooper wants to ensure America’s economy does more to reward work, reduce income inequality, and promote opportunity for young people and entrepreneurs. At the heart of his “Strategy for a Working America” is a determination to revise the federal tax code so it does more to reward work, and less to unduly favor those who earn their income from passive investment.

Two major tax-related initiatives designed to reorient the federal tax code to these twin goals of economic equality and economic growth:

  1. A major expansion of the Earned Income Tax Credit, with roughly a doubling of the existing benefit, and reforms to ensure that this refundable tax credit is fully available to working tax filers who do not have children living at home.
  2. Ending most aspects of the privileged tax treatment of long-term capital gains, so that these sources of income will be taxed as ordinary income in most cases; the reform includes ending provisions that now allow the wealthy to pass on stock portfolios and other assets with no long- term capital gains taxes at death.

The American economy over past decades has been a starkly divided picture. For working Americans, it has been a picture of relative stagnation. Real wages have barely increased since the mid-1970s, despite overall growth in the economy.

The picture is quite different for the best-off Americans. The share of American income going to the top 1% of Americans has now returned to levels that have not been seen since the “Roaring Twenties,” just before the Great Depression. [1] Since the 1990s, the gains for those at the top have been mostly driven by income derived from capital, rather than from wage gains.

According to former Treasury Secretary Lawrence Summers, if the United States had the same income distribution it had in 1979, the bottom 80% of the population would have an average of $11,000 more per family than they do today. [2]

Hickenlooper seeks to end this divided and inequitable picture. His “Strategy for a Working America” seeks to reward work and reduce historic income inequality with two major tax changes.

Increase and improve the Earned Income Tax Credit

First, the strategy would significantly increase and improve the federal Earned Income Tax Credit (EITC). The EITC — which is refundable and administered entirely through the tax code — has proved to be one of the country’s strongest, best-targeted, and most efficient ways to combat poverty and ensure a decent income for those who work.

Because of the importance of this program, as Governor, Hickenlooper proposed roughly a doubling of Colorado’s state match to the EITC.

Yet the federal EITC currently does not provide enough tax relief to ensure that all working households receive a decent income, above the poverty line. Part of the problem is that the credit is limited for households that do not have children living at home.

Hickenlooper’s proposal is broadly similar to the recently-introduced “Grow American Incomes Now” (GAIN) Act, introduced in 2017 by Senator Sherrod Brown and Representative Ro Khanna. As in GAIN, Hickenlooper’s proposal would

  • Roughly double the EITC for households with children.
  • Raise the maximum benefit for households that do not have children living at home, resulting in approximately a six-fold increase in benefits for the average childless recipient household.
  • Reduce the minimum qualifying age for workers not raising children in their home from 25 to 21 and increase the credit’s income limit.

The proposal would benefit a broad range of working households. Under the reform, the EITC would benefit childless couples with incomes up to $42,700 (in 2017 dollars), and married couples with a child with incomes up to $64,800.

According to analysis by the nonpartisan Center on Budget and Policy Priorities, this set of changes would have a dramatic effect on the incomes of working Americans. It would increase the incomes of 47 million working families and individuals, including 21 million who would become newly eligible for the credit. The average benefit across these individuals would be $2,800. [3]

In addition to reducing income inequality, expanding the EITC is a pro-growth reform. It will place more income in the hands of working families, who spend more of their income on consumption than upper-income households. This means the reform will help boost consumer demand, which is a key driver of economic growth.

Tax long-term capital gains as ordinary income in most cases

The second major tax change in Hickenlooper’s “Strategy for a Working America” would end the advantaged tax treatment of long-term capital gains. Currently, the federal tax code taxes ordinary income at rates of up to 37%; but taxation of income derived from long-term capital gains is capped at 21%.

This provision rewards those who benefit from passive investments (e.g., the rise in value of stocks, appreciation in value of artwork, etc.) more than those who draw their income from a weekly paycheck. It is one of the primary drivers of the country’s historic income and wealth inequality; nearly 80% of the benefits from lower taxes on capital gains go to the top 1%. [4] The advantaged taxation of capital gains is also one of the tax code’s key drivers of complexity tax avoidance strategies.

Hickenlooper’s proposal would:

  • Treat dividends and long-term capital gains as ordinary income for tax purposes. Long-term capital gains linked to small businesses, primary residences, and retirement accounts would be excluded.
  • Adjust taxable long-term gains for each eligible asset to account for inflation (as measured by the consumer price index) for the period over which the asset was held. In other words, a taxpayer realizing a $100 capital gain on an asset held for one year, during which inflation was 5%, would pay tax on $95.23 (= $100 / 1.05).
  • End the exclusion on taxation of capital gains at death and other transfers, which is one of the primary ways that upper-income households escape taxation on their gains. His proposal would value and tax such gains as ordinary income upon the death of the taxpayer and upon other transfers.

Hickenlooper’s proposal would not include the “mark-to-market” concept proposed by some as a reform of the taxation of capital gains, due to the complexities and enforcement difficulties this concept would introduce.

An analysis by Americans for Tax Fairness estimates that a set of reforms on the taxation of capital gains of this kind would likely raise $500 billion to $2.4 trillion in additional federal revenue over 10 years. [5]

[1] See for example: Chad Stone, Danilo Trisi, Arloc Sherman, and Roderick Taylor, “A Guide to Statistic on Historical Trends in Income Inequality” (Washington DC: Center for Budget and Policy Priorities, 2018); and Thomas Piketty, Emmanuel Saez, and Gabriel Zucman, “Distributional National Accounts: Methods and Estimates for the United States,” Quarterly Journal of Economics, Vol. 133, №2, May 2018, http://gabriel-zucman.eu/files/PSZ2018QJE.pdf

[2] Lawrence Summers, “Focus on Growth for the Middle Class,” Washington Post, January 18, 2015; https://www.washingtonpost.com/opinions/lawrence-summers-focus-on-growth-for- the-middle-class/2015/01/18/1d02a022-9dc7-11e4-a7ee- 526210d665b4_story.html?utm_term=.c2045c1aa8c5

[3] Chuck Marr, Emily Horton, and Brendan Duke, “Brown-Khanna Proposal to Expand EITC Would Raise Incomes of 47 Million Working Households” (Washington DC: Center for Budget and Policy Priorities, 2017), https://www.cbpp.org/research/federal-tax/brown-khanna- proposal-to-expand-eitc-would-raise-incomes-of-47-million-working

[4] Steve Wamhoff, “Congress Should Reduce, not Expand, Tax Breaks for Capital Gains” (Washington DC: Institute on Taxation and Economic Policy, August 2018).

[5] William Rice and Frank Clemente, “Fair Taxes Now: Revenue Options for a Fair Tax System (Washington DC: Americans for Tax Fairness, April 2019)

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