Home > Uncategorized > How to fix costly and unjust US tax system – FT.com

How to fix costly and unjust US tax system – FT.com

December 19, 2012 Leave a comment Go to comments

Here are some issues the Obama administration and Democrats and Republicans in the US Congress should consider given the magnitude of prospective deficits and the extraordinary good fortune of those at the top of the income distribution.

Why do current valuation practices built into the tax code make it possible for investment partners to end up with $50m or more in entirely tax-free individual retirement accounts when the vast majority of Americans are constrained by a $5,000 annual contribution limit?

A simple calculation shows that the US estate tax system is broken. Assets that are passed to relatives or other personal relations are often badly misvalued relative to what they cost on an open market. The total wealth of American households is estimated at more than $60tn. It is heavily concentrated in very few hands.

A conservative estimate given the lifespans of Americans would be that 2 per cent ($1.2tn) is passed down each year, mostly from the very rich. Yet estate and gift taxes raise less than $12bn, or 1 per cent, of this figure each year.

If a family’s home rises in value by more than a $500,000 exclusion over the course of its dwelling, then it pays capital gains tax on the difference between the value now and the value at purchase. But real estate investment operators, who sell properties whose value is measured in the hundreds of millions if not the billions of dollars, are able to take tax deductions for “depreciation” on their properties. And they are then able sell these properties at an appreciated price while avoiding capital gains tax through what is known as a “like kind exchange” – but is in fact a sale.

Why should international companies be able to locate the lion’s share of their foreign income in small, low-tax jurisdictions such as Bermuda, the Netherlands and Ireland, and avoid paying taxes?

There are sound arguments for a preferential rate on capital gains. But is there any real justification for allowing those who do not need to sell their assets to finance retirement to avoid capital gains taxes entirely by including them in their estates?

These tax rules, which permit the taxes of the most fortunate Americans to be far less than commensurate with their good fortune, have the virtue of being relatively comprehensible. There are many others, involving issues such as derivative accounting, pooled interests and leveraged leases, that are neither easily explainable nor easily justified.

The failure to tax capital gains at the point of death costs the federal government about $50bn a year. Since its removal would both raise money in the future, and induce earlier and greater realisations of capital gains in the short term, its removal would likely add well over $500bn during a 10-year period. I believe it is plausible to raise $1tn over the next 10 years by going after provisions that cause what adds to wealth and spending not to be regarded as income.

It has been observed that the greatest scandals are not the illegal things that people do but the things that are fully legal. This is surely true with respect to a tax code in urgent need of reform.

The writer is Charles W. Eliot university professor at Harvard and a former US Treasury secretary

via How to fix costly and unjust US tax system – FT.com.

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