(Forbes) If you tuned in to one of the initial Democratic debates this past summer, you were greeted by a stage more over-stuffed with diverse personalities than a country-western variety show. Kamala and Elizabeth and Yodelin' Zeke! Biden and Beto and Butterball Jackson! Cory and Mayor Pete and Big Shirtless Ron! To make matters worse, the quality of the content wasn't much better than what you'd find on Ya Hoo!, with each candidate reduced to shouting over one another in a desperate attempt to provide a memorable soundbite.
In recent weeks, however, the field has mercifully been winnowed to twen....wait...that can't be right...there's still twenty? Fine..now that the field is down to twenty, it's time to start taking (most of) the remaining contestants seriously.
And when I say "take them seriously," I am of course limiting my focus to their tax policies, because I don't pretend to know the best way to provide universal healthcare, or defeat Isis, or prevent every American from hoarding a small arsenal in their unlocked sheds. I do, however, know a bit about taxes, and tax policy is going to be a huge part of the 2020 election.
To this point, President Trump's signature legislation remains the Tax Cuts and Jobs Act (TCJA), the sweeping reform that unfolded at the tail end of 2017. The TCJA will serve as a 2020 battleground because of its two most notable characteristics, which one would think would be mutually exclusive:
How can both of these things be true? Here's a little secret...there's only one thing people hate more than NOT getting a tax cut, and that's getting a cut, only to find out that your richer friend got a bigger one.
And that's the reality of the TCJA: while Joe Sixpack fared pretty well under the new law, Joe's boss did substantially better, which explains why less than 40% of the country approves of the President's tax bill. The remaining 60%, well...they think the bill was a giveaway to the rich, and they ain't happy about it.
As 2020 approaches, Republicans will choose to keep the focus on the first of the two characteristics of the TCJA, arguing that the bill cut taxes on most Americans (it did), boosted the economy (the jury is still out), and simplified the tax law (it most certainly did not).
Democrats, on the other hand, have latched onto the latter characteristic, continuously highlighting the windfall to the rich and promising to correct this perceived injustice. Doing so will not exactly require the assistance of a master strategist; after all, if people hate the TCJA because it gave breaks to the rich, it would follow that any proposal that substantially increases taxes on the wealthy should be quite popular. And if the past few months are any indication, this logic will hold true.
It all started when Congresswoman Alexandria Ocasio-Cortes casually threw out the possibility of returning the top tax rate to the 70% standard it last reached in 1980. Now, if I've learned nothing else from three seasons of Stranger Things, it's that people love anything rooted in 80's nostalgia, even if it doesn't make a whole lot of sense. This same principle holds true for AOC's tax plan, because it was met with an approval rating among voters of 59%, despite the fact that a 70% rate on income over $10 million is largely a symbolic gesture rather than a true revenue raiser, because those earning that much either a) generate their earnings from capital gains, which are taxed at preferential rates, or b) have the wherewithal to hire people like me to make sure their income never meets head-on with a 70% marginal rate.
Soon after, Senator Elizabeth Warren, a leading candidate for the Democratic nomination, informally introduced a proposal that would have once been unthinkable: an annual tax not on the income of the rich, but rather on their wealth. While there are no shortage of legal, political, and administrative hurdles to a wealth tax (which we'll address when we turn our attention to Warren's now-formalized proposal) nearly 61% of voters polled about the wealth tax favored the idea.
Other candidates were clearly taking notes, because as more formal proposals have begun to trickle out from the remaining candidates, it's become clear that they are unified in their goal to use significantly higher taxes on the rich to pay for everything from the Green New Deal to student loan forgiveness to adding a second free Slurpee day 11/7.
There's a lot to keep track of, so over the next few weeks (read: months), we are going to use this space to break down the tax proposals of many of the remaining candidates, and ultimately, create a nice little side-by-side comparison relative to current law. But before we do, one important caveat:
Don't shoot the messenger.
If you don't like Bernie's top rate or Warren's wealth tax or Biden's plan for a 40% tax on "squares" (probably), remember that I didn't write these plans, so please do me a favor and save the angry emails for your kid's middle school soccer coach.
With that settled, we're going to start with Bernie Sanders, the Vermont Senator who is making a second spirited run for the White House.
Candidate: Bernie Sanders
Oh boy. Not this again. Back in 2016, I wrote about Sanders' tax plan for Forbes, and I'm still dealing with a mild case of PTSD from the comments to that article. Needless to say, Sanders is a polarizing figure: to some, he represents the best way forward for a country that has been too profoundly divided between the have's and have-not's; while for others, he is a purveyor of empty promises who won't rest until America is turned into a socialist wasteland.
Whatever your thoughts on Sanders, we can all agree that he's got a lot of ambitious plans, whether its expanding Social Security or providing Medicare and schooling for all. And these things cost money. Lots and lots of money. As a result, Sander's tax proposal will have to raise quite a bit of revenue. Here's how it would shake out, in comparison to current law:
Top Rate On Ordinary Income
Current Law: As part of the TCJA, the top rate on ordinary income -- things like wages, business income, and interest income -- was reduced from a high of 39.6% to 37%. Of course, the U.S. tax system is a progressive system, meaning we pay higher rates as our income increases. Under the current structure, those rates begin at 10%, and then climb to 37% via the following steps: 12%, 22%, 24%, 32%, and 35%. It's also important to note that there is an additional 3.8% surcharge that applies to the "net investment income"of certain high-income individuals -- things like interest income or income from a business in which you don't actively participate (more on this later) -- meaning the top rate on these forms of income can reach a high of 40.8%.
Sanders' Plan: Sanders would retain the bottom six brackets and then amend or add four more: the 35% rate under current law would become 40% for many taxpayers, and then there would be additional rates of 45%, 50%, and 52%, with the final rate applying to income over $10 million. But...Sanders would also impose a 4% "income-based premium" at each level that he claims would raise an additional $3.5 trillion over ten years, and would be used to help provide free health insurance to all. Thus, while a taxpayer's tax burden may increase, the idea is that their overall household expenditures would presumably decrease, if the cost of healthcare declines by more than the increase in the tax burden.
The difference between current law and Sanders' plan can be summarized like so (for a SINGLE taxpayer):
| Income | Current Rate | Sanders Rate |
| $0 - $9,525 | 10% | 14% |
| $9,526-$38,700 | 12% | 16% |
| $38,701-$82,500 | 22% | 26% |
| $82,501-$157,500 | 24% | 28% |
| $157,501-$200,000 | 32% | 36% |
| $200,001-$250,000 | 35% | 39% |
| $250,001-$500,000 | 35% | 44% |
| $500,001-$2,000,000 | 37% | 44% |
| $2,000,001-$10,000,000 | 37% | 54% |
| over $10,000,001 | 37% | 56% |
In addition, it appears Sanders would retain the 3.8% net investment income tax, which would drive the top rate on interest or passive business income to 59.8%.
Top Rate on Long-Term Capital Gains and Qualified Dividends
Current Law: Long-term capital gains (think: the sale of stock held more than one year) and qualified dividends are currently taxed at a high of 20%, though most American's pay 15%, with those in the 10% and 12% brackets paying 0%. Of course, you have to tack on the aforementioned net investment income tax of 3.8%, so the rate reaches a high of 23.8%.
Sanders' Plan: The rates would remain the same for those earning less than $250,000, but for everyone in excess of that amount, capital gains and dividends would be taxed at the same ordinary rates reflected above, meaning the rate could jump from a high of 23.8% to 59.8%. It is not clear, however, if the 4% surtax described above would apply to capital gains and dividends, so the rate could "drop" to 55.8%.
The treatment of capital gains is likely to be a huge talking point as 2020 nears. On the one side, many Republican senators are urging the President to further reduce the tax burden upon the sale of property by indexing the cost of that property for inflation. It makes economic sense: if you purchased stock in 1978 for $100,000 and sell it today for $140,000, under current law, you've got $40,000 of gain to deal with. But when you adjust the $100,000 you spent in 1970 for the impact of inflation over the past four decades, in real dollars, you LOST a boatload on that sale.
There are several hurdles the President would face in doing so, however, ranging from legal questions over whether he has the authority in the absence of Congressional action to controversy over what other items in the tax law would also need to be indexed in the name of fairness. The biggest problem, however, is one of optics given the public perception of the TCJA: approximately 85% of all capital gains are recognized by the wealthiest 2% of taxpayers, meaning any unilateral reduction to capital gains taxation will be viewed by voters as one more gift to the rich. Fearing such a reaction, earlier this week President Trump tabled any further discussion of implementing an indexing plan.
The Democrats, of course, have their own plans for capital gains, precisely because 85% of all gains belong to the rich. We will see that nearly every candidate will follow Sanders' lead and greatly increase the preferential rate on gains. But will it work? Because here's the thing about gain from sales of property as compared to income from wages -- you control the timing of the income. If the tax rate climbs too high, you simply don't sell the property. You borrow against it, live off the debt proceeds, and wait until you die so you can pass the property on to your heirs (more on stepped-up basis later).
As a result, Democrats will need to take a more ambitious approach if they intend to tap into the trillions of untapped capital gains throughout the country. To that end, Senator Ron Wyden -- who is NOT running for President but who is in line to lead the Senate Finance Committee should Democrats take back that chamber in 2020, and thus would be a major force in designing tax policy -- fired the opening salvo this week, publishing a report that recommends "mark-to-market" taxation for the wealthiest taxpayers. Under such a plan, those taxpayers would be required to value their holdings each and every year, and pay tax on any net increase each year, regardless of whether they sold the property.
The proposal is a departure from the long-standing principle that income must be realized before it can be taxed, and like a wealth tax, poses serious administrative and valuation challenges. Regardless of its viability, Wyden's approach reflects the line being drawn in the sand over the treatment of capital gains, and from a broader perspective, the best way to tax the rich.
Payroll Taxes
Current Law: If you earn money through wages or are self-employed, you pay payroll taxes. In the employer-employee context, the employer and employee split a 12.4% tax on earnings up to the Social Security wage base, which in 2019 is $132,900. For ALL wages, the employer and employee split a 2.9% Medicare tax. If you're self-employed, you're on the hook for the full 15.3% (though you do get to deduct half of the taxes on your return) unless, of course, you're smart enough to form an S corporation and take advantage of a 60-year old opportunity in the law to avoid payroll taxes that we'll discuss shortly. Finally, as part of Obamacare, those who earn more than $250,000 (if married, $200,000 if single), are subject to an additional 0.9% payroll tax.
Sanders' Plan: As we will see throughout this exercise, the Democratic candidates are not limiting their sources of additional tax revenue to the income tax. Sanders, for example, would seek to ensure the ongoing solvency of Social Security by requiring employers and employees to split the 12.4% Medicare tax again once earnings exceed $250,000. It's a steep price to pay, but from my perspective, if paying more into Social Security makes it even 1% more likely that my parents won't be forced to move in with me because their funds died out, well, I"m ready to do my part.
In addition, Sanders' plan would impose a new 7.5% payroll tax on employers. To protect small businesses, the first $2 million in wages paid would be exempt from the tax.
Itemized Deductions
Current Law: Taxpayer are entitled to deduct the greater of 1) the standard deduction, or 2) the sum of the itemized deductions (things like mortgage interest, medical expenses, state and local income and property taxes, and charitable contributions). The TCJA nearly doubled the standard deduction (from $6,350 to $12,000 for single taxpayers, $12,700 to $24,000 for married couples), while limiting or eliminating certain itemized deductions, a confluence of changes that decreased the number of filers who will itemize from 30% in 2017 to 11% in 2018.
While certain itemized deductions are subject to limitation -- for example, the deduction for state and local income and property taxes is capped at $10,000 -- there is no longer any overall limitation on a taxpayer's itemized deductions as there was prior to 2018.
Sanders' Plan: Sanders takes a page from a long-standing proposal by former President Obama to cap the maximum benefit of itemized deductions at 28%. Thus, under the Sanders proposal, a taxpayer could pay 59.8% on their last dollar of income, but receive a deduction of only 28% on their last dollar of itemized deduction.
S Corporation Payroll Tax Opportunity
Current Law: First things first: it's not a "loophole." It's just the law. It's been this way for 60 years.
Back in 1959, the IRS stated that income earned by shareholders of an S corporation is not considered self employment tax for purposes of the 15.3% in payroll taxes we discussed above. As a result, if you operate a business, you have a choice:
First, you can operate a business directly, without an S corporation, and say you earn $2 million...all of the income will be subject to self-employment tax; the first $132,900 at 12.4%, and the full $2 million taxed at 2.9%.
Or.....you could set up an S corporation, have the $2 million paid to the corporation, and pay yourself a $100,000 salary. You'll pay 15.3% on the $100,000 salary, but the remaining $1.9 million can be distributed to you without the imposition of payroll taxes. Not a bad deal.
Of course, the IRS can argue that your $100,000 salary was not high enough, and recharacterize some of your distributions to income and collect the payroll tax. But pay yourself "reasonable compensation" and the rest comes out without payroll taxes; not by virtue of a sneaky "loophole," but rather a well-worn and widely-known subtlety of the law.
Sanders' Plan: Sanders plan would subject all S corporation income to self-employment tax, though it does not state that in any coherent fashion. As with the 28% maximum benefit of itemized deductions, this is a change that was long-proposed by former President Obama -- and even made a brief appearance in the House bill that eventually became the TCJA -- but has yet to become law.
Estate Tax
Current Law: When you die, if the value of your assets exceeds a threshold, an estate tax is due. The TCJA increased the exemption amount to $11.4 million ($22.8 million for a married couple), with any excess subject to a 40% rate. When your assets are passed through the estate to the beneficiary, the beneficiary takes the assets with a "stepped-up basis" equal to their fair market value. Thus, if they were to receive an appreciated building worth $10 million and sell it the next day for that price, no gain would arise.
Sanders' Plan: Sanders has long itched to take aim at the estate tax. His latest plan calls for 45% on assets valued between $3.5 million and $10 million, 50% on assets valued between $10 million and $50 million, 55% on assets valued between $50 million and $1 billion, and 77% on any value in excess of $1 billion (all thresholds doubled for married couples). In addition, Sanders would eliminate the "stepped-up basis" rule upon death. More specifically, death would become a realization even, meaning the deceased would pay tax on the appreciation at the time of death. This would accelerate collection of the tax when compared to simply eliminating the step-up, as the IRS won't have to wait for the heirs to sell the assets to tax the gain.
Corporate Tax
Current Law: The hallmark of the TCJA was the reduction in the corporate rate from 35% to 21%. That's a 40% decrease, which definitely didn't help the narrative that the bill was largely a giveaway to Big Business.
Sanders' Plan: Oddly enough, Sanders has not formally stated his preference for the corporate rate, though rumors are he would favor a return to the 35% rate in place in 2017.
What's New and Different?
For each candidate, we'll take a look at something they are proposing that is outside the realm of the normal tax rate increase or limit on deductions. Come to think of it, for some candidates, EVERYTHING might be new and different. In the case of Sanders, aside from surcharges and employer-side payroll tax increases, he would embrace the once-taboo notion of an annual wealth tax.
It would work a bit like the estate tax, only you don't have to be dead to pay it, so if there's a silver lining to be found, that's it. Each year, similar to Wyden's mark-to-market tax, your net worth will be computed -- using a method and manner that absolutely no one has contemplated to this point. If the value of your assets exceed $21 million, you'll pay 1% on the excess.
As mentioned briefly in the introduction, the problems with a wealth tax are many, starting with the administrative hassle of valuing assets alluded to above. The bigger issue, however, is there is doubt as to whether a wealth tax is constitutional under Article 1, Section 9, Clause 4, which provides that any "direct tax" -- a term that has remaining undefined since the late 1700's and thus has caused no shortage of constitutional consternation -- must be allocated among the states in accordance with the relative population. Because this wealth tax would most certainly NOT be allocated among the states, but rather would be imposed directly on each individual, if it were be determined to be a direct tax, it would not be constitutional. This is a fascinating issue; one I've spent far too much time researching over the past few months, and one that I'm itching to write an article about. But have you ever read the comments section on ANY article interpreting the constitution? There are hordes of people who have devoted their life to understanding every word on that parchment, and they like nothing more than to tell you how wrong you are when your interpretation differs from theirs. Hard pass.
We'll revisit the wealth tax issue when we get to Elizabeth Warren, because hers is quite a bit more ambitious than Sanders'.
Summary
All told, Sanders' plan would raise in excess of $16 trillion in revenue over the next ten years. By way of comparison, the Tax Cuts and Jobs Act was slated to reduce revenue by $1.5 trillion. So this is a plan of a much higher order of magnitude, but when you're offering the types of social programs that are the foundation of the Sanders platform, that money has to come from somewhere. It will be interesting to see how the cost of Sanders' plan compares to the other candidates' plans, but for that...we'll have to wait until next time.
