Without More Work, Biden’s Tax Plans Don’t Compute

President Joe Biden’s tax proposals are an opening bid in what will likely be a protracted negotiation with Congress. It’s too soon to guess what the outcome will be. But as these talks proceed, lawmakers need to pay closer attention to the way the administration’s ideas hang together.

Changes to the tax code can’t be properly assessed item by item. What counts is the combined effect. This makes Biden’s approach of separate revenue-raising proposals, each tied to a particular spending plan, unwise. It would be better to discuss a single, comprehensive tax-reform package — all the more so because Biden’s ideas, taken together, aren’t mere tweaks to the code. They amount to something much more radical.

The president intends to pay for his $2.3 trillion American Jobs Plan and his $1.8 trillion American Families Plan mostly with taxes rather than additional borrowing, and he aims to collect the revenue from the highest-income households. His proposals to date include raising the top rate on employment income from 37% to 39.6%; the top rate on investment income (applied to earnings exceeding $1 million) from 23.8% to 43.4%; and the tax on corporate profits from 21% to 28%.

Biden also calls for a new treatment of capital gains that would make the higher rate on investment income much harder to avoid. Under current law, tax doesn’t apply to unrealized gains when the owner dies; the assets pass to heirs with their value, or “basis,” stepped up to current prices. The administration would regard gains above $1 million as realized at death, and thus close one of the most notorious loopholes in the current code.

The combination of a much higher rate on capital gains and the end of stepped-up basis shows that Biden and his team are alert to the way these proposals interact. Without the change in stepped-up basis, such a big increase in the capital-gains rate might raise little if any revenue, because deferring the sale of assets would be much more attractive than now. Abolishing stepped-up basis would be a substantial tax increase in its own right. Making that change and doubling the tax rate is a powerful double punch.

Other such interactions need to be examined more closely.

The U.S. taxes the income from capital at various points — first as profits, then as investment income and finally as estates. The combination of Biden’s capital-gains reform and the estate tax as it stands (40% is due on estates bigger than $11.7 million) would levy taxes of more than 60% on the biggest holdings. In some cases, that would be in addition to the 28% already paid on corporate profits. And this takes no account of the additional taxes on capital imposed by the states. In combination, these rates would be high by international standards and higher than anything the U.S. has seen for decades.

Granted, it’s easy to exaggerate the effect that such rates would have on saving and investment, and hence on economic growth and ordinary incomes. Calculations of lifetime tax liability probably aren’t uppermost in the minds of budding entrepreneurs. Most investment is financed from tax-exempt sources of one kind or another. Companies would likely find clever ways to pay less than the 28% Biden is advocating. And tax planners have developed numerous complex strategies for avoiding estate tax.

All of which underlines the need for reform. The current tax code offers too many opportunities for the rich to pay less than simple fairness demands.

Even so, the way piece-by-piece changes interact with each other and with the existing tax code requires the most careful attention. Prudent reform needs to strike a balance between fairness and incentives. A more connected approach might, for instance, marry a profits tax of 28% with full expensing of investment, to neutralize any disincentive effect and confine the tax to so-called above-normal profits or “rents.” For shares in companies that have already paid taxes on their profits, taxes on capital gains could be credited to avoid double taxation. If stepped-up basis is abolished, as it should be, the estate tax should be changed as well, to prevent extremely high taxes on big estates and the complex, wasteful maneuvers that will be undertaken to avoid them.

The tax code is all of a piece. The bolder the reforms — and Biden’s ideas are bold, all right — the more crucial it is for lawmakers to weigh their combined effects. As yet, this work has barely even begun.

Editorials are written by the Bloomberg Opinion editorial board.

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