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Moderates winning on tax debate

For months, wealthy U.S. taxpayers and corporations have been living with the specter of higher taxes under the Biden administration. It is a pretty good bet that taxes will go up, but not as much as you might expect.

Throughout the week, Democrats in the House and the Senate have been horse-trading over the amount of spending, versus the amount of taxes, necessary to pay for President Biden’s $2.3 trillion budget plan. Republicans are already on record that they will oppose any new tax hikes at all.

Since the Democrats hold such a slim majority in both the House and the Senate, any legislation will need to accommodate both moderates and progressives within the party in order to pass. The battle between the progressives and the moderates has already started.

It appears that Senate progressives, like Bernie Sanders and Elizabeth Warren, along with House liberals, such as Alexandria Ocasio-Cortez, will need to temper their expectations on how high the corporate tax rate (and other taxes) should be raised. Draft legislation, released this week, indicated that the corporate tax rate, which is at 21%, may rise to 26.5% (on anything over $5 million in income) and not the 29% that was first suggested in the president’s initial proposals.

As for individual tax rates, there is some on-going discussion among moderates who might want to raise the top bracket for wealthy individuals and married couples by $50,000, or so. The original idea was that those individuals earning over $400,000 per year (and married couples earning over $450,000) would be taxed at 39.6%, up from 37% starting in 2022.

However, the key battle still-to-be waged is over changes to the capital gains tax. Under current law, people who die with unrealized gains don’t pay capital-gains taxes. Their beneficiaries do pay, but only on gains dated after the prior owner’s death, and only when they actually sell those assets. The Biden plan would treat a death in the same way the IRS treats a sale, that is, a capital gains tax would automatically be applied.

The initial proposal would also increase the capital gains tax from 23.8% to 43.4%. The House Ways and Means Committee has suggested limiting the capital gains tax to just 25%, which does not sit well with progressives.

Capital gains taxes are a sore point for many (but not all Democrats), who have complained for years that the present tax laws unfairly benefit the wealthiest Americans. Not so, say others. Moderates argue that there are plenty of small family businesses and farms that would be devastated by these changes.

The Biden proposal would offer a $1 million exemption to everyone and would allow farm and business owners to defer taxes as long as their businesses remain family-owned. A new Senate Finance Committee proposal would ease the capital gains hit by raising the per-person exemption to $5 million, and up to $25 million for family farms.

Then there is a group of Senators and Congress-people (regardless of whether they are progressives or moderates) from New Jersey, New York, and other high-tax states that are insisting that they won’t back a budget deal without a relaxation of the limits on the state and local tax deduction, the so-called SALT tax passed in 2018 by Republicans. Progressives are just as insistent that the lion’s share of these benefits would accrue to the rich and not the middle class. A compromise might be found in capping any SALT tax breaks to a specific middle-class income bracket.

As you can imagine, this debate is not over. I expect it will take at least two more months before a compromise will be hammered out between the opposing wings of the Democrat Party. Investors can be almost certain that taxes will rise for some, but the sting will be lessened to some degree.

Fortunately, the chances of compromise are quite high, especially when one considers the stakes. The expansion of the U.S. social safety net, the critical need for a new climate policy, and the fact that mid-term elections are not that far away indicate a deal will get done.

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