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Bar News - March 18, 2015

Elder, Estate Planning & Probate Law: OPINION: Capital Gains Taxes and the Elephant in the Room


In 1979, my parents bought a run-down house and a sliver of land on the Severn River in Maryland for $75,000. “The Severn,” as we referred to it, was our weekend haven, less than an hour’s drive from our home in Washington, DC. On Friday nights we would pack up the car and head out, stopping for pizza at the local tavern before winding down the last half-mile of road, the canopy formed by overhanging trees blocking out the night sky. We followed our headlights down that dim tunnel until at last we emerged to see the stars overhead arcing down before us, meeting their perfect reflections in the still, dark water of Little Round Bay.

My father dreamed that he was building his family compound, where his children would bring his grandchildren back to spend summers with him and my mother. While I and my siblings swam, fished, canoed and ran through the woods, he would build decks, foundations, retaining walls. My mother sewed. It was a perfect escape for our young family.

But then my siblings and I got to middle school, and weekend sports began to intrude on family life. In high school we spent even less time at the Severn, and then we went off to college, one by one, settling far from my parents’ home in Washington. The Severn fell into disuse, then disrepair; my father’s construction projects lay unfinished.

For nearly 25 years, my father hung on to the property, though even he had stopped going there regularly. While his inability to let it go was due largely to his emotional attachment, his chief stated reason was that he did not want to pay the capital gains tax – several tens of thousands of dollars - upon a sale. His plan, for more than two decades, was to hang on to a property nobody was using just so he could leave it to his children when he died, when we would inherit it tax-free. Only after repeated vandalism convinced him that the Severn was at least as much a liability as an asset did he agree to sell.

In an economist’s view of the world, there are only two ways to make money: Trade your labor for wages, or own capital and charge other people to use it. “Capital” is what economists call stuff that makes other stuff; accountants add to this, significant, nonperishable property like a residence. For example, machinery that makes cars, or shoes, or 3-D printers is capital. Also, money that you have saved, and can therefore lend to or invest in a business, is capital. Own a home, or a rental property, or shares in a mutual fund, or even just a savings account? You own capital.

When capital goes up in value, and you sell it, you have taxable income, called a “capital gain.” The US tax rate on wages tops out at 39.6 percent, but the highest tax on capital gains (which include dividends from financial assets like stocks) for assets held longer than one year is only 28 percent, with most gains taxed at 20 percent. This leads to the anomaly observed by Warren Buffett (most of whose income comes from investments rather than labor); that he pays an effective 17.4 percent tax rate on his income, while his staff (including his secretary) pays an average of 36 percent.

In his recent State of the Union address, President Barack Obama proposed increasing tax rates on capital gains and eliminating the “step-up” in basis upon death. The proposed rate increases can be summed up in “the Buffett Rule”: if you make over $1 million a year in income (including from capital gains), your tax rate can’t be lower than 30 percent.

We can debate the right size of government and the level of taxation necessary to support it. But as long as we’ve chosen to tax labor at up to 40 percent, we shouldn’t let capital slip by at a much lower rate. We want people to work, right? And eliminating the basis “step-up” – the incentive to hold non-productive property until death just to avoid paying capital gains taxes – would free capital up to move to better uses.

But the debate over capital gains taxes distracts from the elephant in the room of economic policy: we need to broaden the debate about sharing the wealth of the economy beyond arguments over taxation.

Redistributive taxation, even if the rich and powerful would sit still for it, is increasingly insufficient to spread the fruits of the American economy fairly. “Productivity,” the measure of how much stuff can be produced by a single laborer, has been growing relentlessly since the industrial revolution. More and more of the stuff we buy is produced by machines, and profits flow to the owners of those machines, while more human laborers become obsolete.

Advances in computing and robotics, combined with cheap oil, reliable global transport, and ever-better telecommunications are accelerating this trend, with no end in sight. Redistributive taxation can’t keep up with the concentration of wealth that results from technological change.

We need to come up with new principles to determine what entitles a human to a share of the world’s wealth. In America, broadly-shared prosperity since World War II has allowed us to focus on growing the pie, rather than asking “what entitles someone to a slice?” The default answer for workers has been “a capitalist is willing to pay you for your labor.” But since the 1980s, not only has the share of wealth going to owners of capital rapidly increased while the share going to labor has fallen faster than John Henry’s hammer, but more and more workers have found their labor unneeded by the modern economy.

If we’re headed toward a future where most of our stuff is made by robots, we’re going to have to face the question of just distribution head-on. Let’s hope we have a good answer.

Donald H. Sienkiewicz

Donald H. Sienkiewicz is an attorney at the Estate Preservation & Planning Law Office in Milford. He can be reached by email or at (603) 554-8464.

Supreme Court Rule 42(9) requires all NH admitted attorneys to notify the Bar Association of any address change, home or office.

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