Thread by @dashching

Thread: the host of unproductive tax shelters for exploiting lower tax rates on capital gains is one of many good reasons to tax capital gains at rates closer to the rates on income from work. Tax shelters like these benefit only the wealthiest (& their tax advisors).

Capital gains from the growth in value of wealth are taxed at a much lower rate than the top rate on income from work -- and the rate on capital gains is *zero percent* if a person holds onto an asset that’s gained in value until their death.

(The 0% tax rate on the growth in value of assets that are held until death is also known as “stepped-up basis.” To see how it works, see: cbpp.org/research/feder… by @ChuckCBPP @jacsamoby Sam Washington @_George_Fenton.)

Diagram from Batchelder and Kamin’s paper; red/green scribbles mine.

The very low/0% cap gains rates are the red targets for filers/tax advisors. Getting what would otherwise be salary or other types of income into those bullseyes = large tax savings. papers.ssrn.com/sol3/papers.cf…

Big gaps in tax rates are fertilizer for tax shelters.

@lenburman says it best: forbes.com/sites/leonardb…

(I had trouble picking just one of the many pithy quotes from Len on this issue.)

Shelters using low capital gains tax rates run the gamut from lawful ones (protected by fierce lobbying, e.g. carried interest) to gaming that stretches or crosses the line of what’s lawful. They all try to change the character of as much income as possible to get lower rates.

A couple of examples of how that’s done/been done (and if I missed your "favorite," please chime in!):

Good/bad old carried interest (yes, it still exists) relies on treating as much of a private equity fund manager’s compensation as possible as low-taxed capital gain (rather than higher-taxed wages for management services). See taxpolicycenter.org/briefing-book/… by @TaxPolicyCenter:

Here's a whole menu of “planning” opportunities to try to ensure income gets into lower-taxed capital gain rates: spe1031.com/Exchange-Basic…. (Like-kind exchanges are another aspect of this – but for another thread.)

"Basket options," another hedge/quant fund scheme, was the subject of a Senate investigations hearing before the potential for pure tax evasion led the IRS to try to crack down.

hsgac.senate.gov/subcommittees/…

nytimes.com/2015/07/09/bus…

More recently: SPAC founder shares. bdo.com/getattachment/…

It’s hard for the IRS to keep up with shelters that push the boundary between lawful and unlawful. Their response to basket options & arguably SPACs was a bit behind the shelter explosion – & not exactly surprising given a decade of deep cuts to the IRS. nytimes.com/2021/03/10/opi…

Some of these shelters are very creative! But that creativity ultimately doesn’t result in innovation, new businesses, products, investments or anything else valuable in the real economy – they just shuffle income from a high-taxed category to a lower-taxed one.

It’s a difficult to know how much income that shows up as "capital gain" is (say) labor income. But in a parallel space, research suggests that 3/4 of profits that wealthy households receive as pass-through "biz" income is really labor income: nber.org/system/files/w… @omzidar

Getting on top of unproductive shelters requires closing down the source: the rate gulf between the taxation of income from work and the lower taxes for capital gains.

As noted, this is just one of the good reasons to equalize rates on capital gains and labor income for the most well off. @ChuckCBPP & the @CenterOnBudget team (as well as my past self) have you covered on the others:

https://twitter.com/ChuckCBPP/status/1385622577352224773