House vote on $3.5 trillion budget raises odds of higher taxes on rich

The prospect of higher taxes for wealthy Americans drew closer on Tuesday as House Democrats passed a $ 3.5 trillion budget.

This framework forms the basis for the Democrats to write formal laws that can be passed without a Republican vote. The Democrats have called for higher taxes on the rich and corporations, as well as stronger enforcement from the IRS to fund their agenda.

The House of Representatives vote sets the stage for a political showdown in the coming weeks as Democrats try to get the biggest safety net addition in decades, spending more on education, paid vacation, childcare, health care and climate initiatives.

On August 11, the Senate legislature also passed the budget according to party lines. A Senate framework outlining budgetary initiatives offers few details on specific tax policies relating to the rich, saying only that it seeks “tax equity for high-income individuals”.

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However, according to tax experts, the richest Americans are likely to face higher taxes on their normal income, capital gains from investments, and valued assets inherited from heirs.

The plan would also “ban” new taxes for families earning less than $ 400,000 a year, small businesses and family businesses.

At the same time, the spending plan can also provide tax breaks for some wealthy people in high-tax countries. It suggests that the Democrats offer “relief” to the current $ 10,000 cap on state and local tax deductions.

The Democrats are aiming to pass laws through a process called budget reconciliation, which would allow the bill to be passed by simple majority. But full support is not guaranteed and the Democrats have wafer-thin majorities in both chambers. In the Senate, a defector could lower the chances of the bill. Senator Kyrsten Sinema, a moderate Democrat from Arizona, reiterated this week that she would not support a plan costing up to $ 3.5 trillion.

“At this point, we’re dealing with Monopoly money,” Bill Hoagland, a senior vice president of the Bipartisan Policy Center, told CNBC about the budget. “If we actually start putting rubber on the road, it will be a lot more difficult.”

Taxpayers earning more than $ 500,000 paid about 70% of total individual income taxes collected that year, Hoagland said, citing tax return data.

Income tax

Raising the upper marginal income tax rate to 39.6% from its current 37% is the most likely way the Democrats intend to raise taxes for the rich, according to experts.

“I think the Democrats would say, ‘There we were before that [2017 Tax Cuts and Jobs Act] We didn’t vote for, “” Ryan Abraham, a director at Ernst & Young who sits on the firm’s Washington Council, told CNBC. “That’s not too much to ask.”

The Democrats would essentially speed up current policies – the top ordinary income rate is expected to return to 39.6% after 2025 under the Tax Cuts and Jobs Act.

As a result, the average tax rate of those who earn $ 500,000 to $ 1 million a year would rise to about 31% (up from 27%), according to Hoagland. It would rise to 32.5% (from just over 30%) for those with incomes greater than $ 1 million, he said.

The change would generate $ 131 billion in federal revenue by 2026, according to an estimate released by the U.S. Treasury Department in May.

Increase in capital gains tax

The top tax rate on long-term capital gains is also expected to increase.

The Biden government proposed raising this maximum rate to 39.6% – the same as the proposed maximum normal income rate – for those who earn more than $ 1 million a year. (Combined with a surcharge of 3.8% on the net investment income, the top tax rate would be 43.4%.)

Wealthy individuals get a large portion of their annual income from investments – meaning that raising taxes only on wages may not tax their total income as effectively as Democrats would like, according to experts.

I would expect some increase that gets closer to the individual rate. But not up to the individual tariff.

Bill Hoagland

Senior Vice President of the non-partisan Policy Center

Individuals with annual incomes greater than $ 1 million get about 40% of income from investments, according to the Tax Foundation, compared to just 5% for those who earn less than $ 50,000 a year.

However, some experts are skeptical that Democrats will be able to raise the interest rate on long-term capital gains (owed on investments held for more than a year) to 39.6%.

“I would expect an increase closer to the individual rate,” said Hoagland. “But not at all up to the individual tariff.”

Wealthy lands

The Democrats are also likely to seek to change the passing of cherished assets from the wealthy to the heirs.

For example, the White House proposed that, with a few exceptions, impose capital gains tax on death.

“That would be a much bigger change than just changing the rate of capital gains,” said Abraham of the proposed policy.

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Currently, the increase in the value of an asset on the death of an owner is not taxed. The asset is given a step-up basis, meaning it is transferred to the heirs at its current market value, which clears the capital gain. The heirs could then sell the asset free of capital gains tax.

(Super-rich fortunes owe federal inheritance tax of 40% under applicable law on values ​​greater than $ 11.7 million for individuals and $ 23.4 million for married couples.)

According to an estimate by the Treasury Department, capital gains tax reforms would raise $ 322.5 billion in a decade.

Tax enforcement

The Democrats also watch out for tax compliance to generate income from households making more than $ 400,000 a year.

Undervalued incomes, especially among the wealthy, are the main contributor to what is known as the tax gap, according to a Treasury Department report released in May.

The Treasury Department estimated the gap (the difference between tax paid and tax owed) at $ 584 billion in 2019. About 80% of the gap comes from “opaque sources of income” such as partnerships, condominiums and rental properties, which are primarily aimed at the rich, the Treasury Department said.

The Biden government requested more third party reporting to the IRS to improve tax compliance.

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