Tax Breaks (for the Rich) Are Forever

By James Kwak

This week I returned to one of my favorite topics: raising taxes, particularly on the rich. First I wrote an article for Medium about the single most obvious change that should be made to the tax code: eliminating the step-up in basis at death for capital gains taxes. If you’re not sure what step-up in basis means, or why it’s a ridiculous idea, you should read the article.

Then today I wrote an article for the Atlantic about why (a) killing 529 plans was a great idea in President Obama’s latest tax proposals and (b) why 529 plans are impossible to kill. Here’s the crux of the matter:

“If you’re poor, a 529 plan gives you nothing, since you don’t pay income taxes; the American Opportunity Tax Credit gives you $4,000 ($5,000 under Obama’s proposal) because you can take $1,000 of the credit per year even if you pay no taxes. If you’re in the ‘middle class’ (making at least $74,900 and able to save $3,000 per year per child), a 529 plan gives you $5,800; the AOTC gives you $10,000 ($12,500 under Obama’s proposal). If you’re in the upper class, a 529 plan gives you $26,300; the AOTC gives you nothing. Do I even need to write the rest of this article?”

My editor took out that last sentence, but I liked it so much I’m putting it back here. (Those number are based on some basic scenarios I described in the article.)

Every politician likes to say that he is in favor of simplifying the tax code, eliminating tax breaks for people who don’t need them, and helping the middle class. Only it just isn’t true.

12 thoughts on “Tax Breaks (for the Rich) Are Forever

  1. If eliminating the stepped up cost basis at death is the ‘single most obvious change’ to the tax code that you see and it is to the detriment of tax payer, who remain wildly overtaxed, you’ve lost the right to my attention.

  2. Carried interest does not count as the most egregious? Magically turn a 50% effective tax rate to a 20%. Oligarchs don’t pay taxes,(trusts, inheritances and offshoring and carved out loopholes) but when they do it is “carried interest” or capital gains. Make BILLIONS have an effective tax rate lower than a teacher or a firefighter!

    Pox also on many progressive economist who are always hung up on the ordinary income tax rate..which the oligarchs NEVER pay! Always worth remembering who pays the salaries of economist of all stripes at various “think tanks”..not people who pay ordinary income taxes.

  3. I think politicians are, by and large, in favor of simplifying the tax code, eliminating tax breaks for people who don’t need them, and helping the middle class. They just don’t think they could get away with voting for those things.

  4. From what I’ve read, the stepped up cost basis will hit both the rich (large stock capital gains) and the middle class (you now owe tax on the house Mom and Dad left you). Or can you explain why a $100,000 or so capital gain on real estate won’t occur / won’t hurt the middle class?

  5. On the Atlantic article, the expense rates on 529 plans vary greatly from state to state. I live in Georgia, and the highest expense option is 0.38%. The index fund is 0.25%. Vanguard’s S&P 500, one of the cheapest in the industry, is 0.17%. And I get a break on the 6% state income tax (on up to $2000 in contributions) and don’t pay the 6% on my investment returns.

    Using the $3000 example, I get $81,654 assuming 21% total tax rate in regular savings. I get $95,364 in the 529 plan (assuming 6.9% returns and contributions of $3,120 taking advantage of the tax break.)

    I suspect this also helps out with the FASFA for upper middle class families, as 529’s are treated more favorably than income. (I assume that adjusted income, including the federal tax credits, are the basis for the FASFA contributions; but I’m quite a ways from a child hitting college.)

    How about just capping contributions, assets, or making withdrawals taxable on people earning over $200,000 a year? As mentioned that would sweep in 70-80% of the tax avoidance by the super-wealthy, and leave a simple investment option for the middle class.

  6. @ThomasW – As James points out in his article, houses *already* have their own capital gains exemption. They don’t need an additional step-up exemption.

  7. Houses have a capital gains exemption, but from what I understand it must be your primary residence. I’m not sure this will apply to heirs (who probably didn’t live in the house). However, I haven’t investigated this area in detail.

    The other issue with the 529 plan change is it’s changing the rules part way through. Parents who do the “right” thing and save for college find they’ve just lost the benefits they’ve been expecting. Removing tax advantages to savings while promoting the tuition tax credits penalizes those who plan ahead and save for college.

    This type of change is a reason why I’ll never put money in a Roth IRA or 401K. There’s a good chance the government will start taxing Roth accounts (as they’ve taxed formerly tax-free Social Security) of retirees with moderate incomes. Regular IRA / 401K accounts are already taxed, making it harder to take more.

  8. I can largely agree with James’ argument that the step-up in basis seems to be a odd exemption, but he overlooks some practical issues. If there is tax to be paid on the increase in value, then the assets may have to be liquidated. This is a serious problem if the asset is a family home, farm, or company. Those tax regimes which do impose CGT at death have extraordinarily complex rules to handle the issue. Hardly a simplification of the tax code.

  9. Okay, let’s start with this economic FACT before we start taxing the current value of the house a daughter inherited upon the demise of her parents AFTER SHE TOOK CARE OF THEM FOR A DECADE OR SO WITHOUT PAY AND IS BROKE FROM DOING SO….AND WILL NEVER ENTER THE JOB MARKET AGAIN ACCORDING TO THE HR PARROTS OF THE RETHUGS…

    Then let’s ask the question – can the “Middle Class” be saved by the very people who economically DESTROYED it in the first place???

    “Shareholders” did only one thing for decades – that was to fire people and ship jobs to slave labor markets around the globe.

    Safe to say that “whistleblowers” were slammed down, over and over again, below the financial fortunes of the “shareholder’s” bookie, cocaine supplier and prostitute provider.

    Now, finally, a President who will elevate those shareholder supported jobs and businesses into the Middle Class hole that opened up by destroying whistleblowers….

  10. Excellent point Peter. If I were to step back from my original comment and comment on the ‘single most obvious change’, I mean if we’re really recognizing there’s a problem and committed to making a change, it can sometimes be instructive to bring the macro issue to a micro level. An example may be a spouse whose credit card obligations never seem to be met, and are constantly growing. The echo of this argument is how to pay them by cutting the groceries, etc… The micro answer is to look at the real problem rather than the symptom. Our tax spending is the ‘single most obvious’ problem. America has become a dog full of ticks… we’ve got to pick them off one by one.

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