As most readers will know, there is a bit of a battle going on in DC right now. Nope, not between Democrats and Republicans, but between factions of the same party. I am, of course, talking about the infrastructure, spending, and tax plan that they are trying to get passed. After being critical of the previous regime’s tax rate reductions in the Tax Cuts and Jobs Act of 2017, it would be hypocritical to profess any complaints about the higher tax rates currently proposed in the Biden tax plan (you can read our analysis of the TCJA here, here, and here). As an admitted fiscal conservative, I may differ from other fiscal conservatives in that I am less focused on tax rates themselves (don’t get me wrong – I don’t like taxes either) but instead on how the taxes are spent. I also feel it important that government spending, which is really taxpayer spending, is in line with tax receipts so that our children and children’s children don’t have a day of reckoning to pay for our recklessness. Unfortunately, whether the corporate tax rate is 21% or 26.5%, spending far outweighs revenue. More damaging, the rate of increase of spending far outpaces the rate of increase, and any possible rate of increase, of tax revenue. This is not a new phenomenon, with the gap growing late in the GW Bush’s second term and accelerating thereafter.
Rather than argue about tax rates, which largely will have a marginal impact on the economy or the deficit (especially in light of proposed spending), instead let’s dive into understanding specific components of the same tax bill which will have little impact on tax revenue but will have very direct impact on us as taxpayers.
Please understand that the situation is still dynamic with reconciliation between the president’s, the House’s, and the Senate’s plan still ongoing. The aim of this Insight isn’t to complain about what is in the proposal, but rather to (hopefully) galvanize readers to pay attention to what is going on and reach out to their elected officials with their concerns. In most cases nothing is more important to elected officials than reelection, so hearing concerns from their constituents really does impact support for bills coming across the House or Senate floor.
The following four items are, frankly, insane:
- Bank account disclosure – Included in all drafts of the plan are the requirement for banks to report all accounts (and activity) with balances over $600 to the IRS. The excuse for this requirement being included in the tax plan is that rich people don’t pay their fair share of taxes because they are hiding income and therefore not including it in their tax calculations. By giving the IRS access to all these bank accounts, the IRS will be able to inspect all activity and determine if there is activity that should be taxed that currently isn’t. First off, I don’t believe the low effective tax rate of the “rich” is because they are stealing. Sure, there may be some here and there that aren’t being truthful, but the rich have bookkeepers and accountants handing this stuff for them, and it is rare that you will find licensed professionals who will lie and put their profession at risk. Additionally, the rich don’t need to hide income by not reporting the money coming into their bank accounts. Over the years and decades congress has created tax loopholes large enough to drive trucks through in order to serve their special interests. Smart taxpayers follow the laws and take advantage of these provisions. How do I know? I have done it myself. I have bought solar panels (which was a 33% tax credit in the year of installation) and invested in shallow oil wells (100% deduction in the year of the investment). I wouldn’t say I am rich, nor all that smart. If I am doing it, you had better believe people smarter and with more tax resources than I are certainly doing it, and in considerably more detail.
But that isn’t the biggest issue with this insane proposal. How many rich people only have $600 in their account? Very few. More importantly, how many non-rich people don’t ever have $600 in their account? Again, very few. Anyone working full time at minimum wage paid every two weeks has $600 in their account every time they get paid. This isn’t an attempt to intrude on the lives of the rich. It is an attempt to intrude on the lives of everyone.
Not only that, while this is being promoted as a way to stick it to the rich, it adds a considerable amount of operating expense to the banks to comply with the reporting requirements. That expense has to be offset somewhere, most likely through increases in the cost of accounts. A free account going to $25/month isn’t going to impact the lives of the rich, but it will certainly impact the lives of a lot of non-rich, whether or not they qualify for the reporting. Instead of soaking the rich as is the stated purpose, the true outcome would be a detriment to the non-rich. It is either hypocrisy or ignorance.
There has been discussion about raising the $600 minimum to $10,000. This certainly reduces the damaging impacts of the provision, but again, how many rich people only have $10,000 in an account, and how many non-rich have more than $10,000 in an account? This is still a provision targeting far more than the stated boogey man.
- Self-Directed Retirement Accounts – As most readers know, the current tax code allows for taxpayers to have self-directed retirement accounts. There is no minimum amount required to have such an account and the annual custodian fee is minimal. A huge benefit to the self-directed retirement accounts is that it allows taxpayers to invest in asset classes beyond what is offered by Wall Street (accreditation qualifications still apply). Risk return profiles are often considerably better for these non-financial market investments, allowing the eventual retirees to retire in better shape than they otherwise would have. Many of our investors use this tool to great effect. The current tax proposal not only eliminates the ability for self-directed retirement accounts to invest in non-traded assets (so call alternative investments), it requires that all nontraded assets currently held inside the self-directed accounts be liquidated within three years. First off, why? There is considerable consternation about American’s inability to fund their own retirements. What is the benefit of taking away a tool that assists in providing for better retirement prospects for taxpayers that wants to take advantage of it? Second, even if there really is a tax reason (I can’t find one) for eliminating the self-directed benefits, what is the purpose of penalizing taxpayers that have played by the rules and set up these accounts? I know from our substantial list of investors using self-directed accounts that many people use their self-directed IRAs to invest in non-liquid investments with lock up periods longer than three years. They will be forced to either face large investment penalties to liquidate these investment positions, or they will be get hit with tax penalties for not doing so. It is a no-win situation.
Other than the initial tax penalties for not liquidating alternative positions, which is a drop in the tax revenue bucket, this part of the tax proposal has very little long term tax impact. If the changes are not tax related to justify the higher proposed spending, what is the purpose? Either it is bitter grapes from those not willing to do the work to set up these accounts (yet another example of governing to the lowest common denominator), or Wall Street has seen the amount of retirement funding being used in nontraded assets and wants to get its paws on those funds. I find the first hard to believe. I find the second much easier to believe, meaning Wall Street is again flexing its lobbying power and has captured writers/supporters of this part of the tax plan in its special interests grasps.
I don’t have a self-directed retirement account so won’t be directly impacted if this provision makes it through into the final version of the bill, but a large percentage of investor and Insight readers do, and they/you all will be directly affected. And yes, these changes to self-directed accounts apply to private debt investments as well.
- Electric Vehicle Tax Credit – Included in the plan is a large $12,500 tax credit for purchasing an electric vehicle. While I am not in favor of the government providing incentives for specific actions, we are way, way past the point of the tax code being more generic and non-biased in nature. But as far as incentives go, this is probably a good one. The issue here isn’t in the credit, it is that the credit only applies to cars built by union labor. If a car isn’t built by union labor the credit drops to $8,000. Look, I get it that Trump took a considerable amount of the union vote from the party in power and this is a way to buy those votes back, but one of the things I disliked most about Trump’s presidency was how much he played favorites. This is a blatant attempt to do the same.
Additionally, as the United States has lost its export competitiveness in just about everything other than innovation, this sort of favoritism is a penalty on small and cutting edge/nimble companies. Small companies aren’t union. Nikola, Lucid, Sila, Faraday, and Fisker are just a few examples of cutting-edge EV companies that will be hit with an effective $4500 selling price increase per vehicle. And that doesn’t even include Tesla, an innovative gorilla who has changed the world and sped up EV absorption by decades versus what it would have been had we only had the sorry options that the Big 3 were selling us. In fact, if we look further, four out of the top five and seven of the top ten manufactures/sellers of electric vehicles are non-union. There is considerable irony that as part of this policy meant to reduce greenhouse gases, the companies that are doing to most to reduce greenhouses gases in this arena will be penalized.
- SALT – One thing that our previous Insight’s critique of Trump’s tax plan thought was positive was the changes to the State and Local Tax (Salt Deductions). In a nutshell, the amount of state income and property taxes that could be written off against income on the federal return was reduced. Since people with more income (state income taxes) and more stuff (property taxes) were the ones directly impacted by this change, this was truly a tax changes borne on the backs of the more fortunate among us. Since that time, lawmakers have been trying to get the SALT reductions repealed. The loudest voices in this effort are from the same areas that most strongly voted for the current administration. It is highly hypocritical to be working so hard to raise taxes on the rich while at the same time trying to repeal policy that raised taxes on the rich.
As of the time of this writing, to the best of my knowledge, the SALT repeal is not included in any of the three proposals. However, there are strong and insistent voices that continue to push the repeal and many pundits have the expectation that it will be added into final versions of the bill just prior to passage to keep constituents happy without providing time for the inconsistency in policy to be exposed. Disgusting.
Other provisions to understand:
- The afore referenced rate increases to corporate, personal, and capital gains tax rates
- Tax surcharge on anyone making over $10 Mil/year (CNBC)
- Increased inheritance tax rate and reduced pass-through limit (Forbes)
- Top real estate income rate increase by 16.8% (Wall Street Journal)
- Real estate capital gains rate increase by 11.8% (Wall Street Journal)
- Elimination of the stepped-up basis provision at death (Wall Street Journal)
- Increased capital gains rate on top of increased inheritance tax rate
- Twenty-two tax credits created or made permanent
- Excise tax on pharmaceutical drugs (Tax foundation)
- Elimination of Roth conversions for wealthy, though not until 2032 (CNBC)
History has shown us again and again that major changes to the tax code have not only a long-term impact on the economy, but often an almost immediate and sizeable impact. For example, the real estate tax changes in the late 1980s led directly to the S&L implosion and a US recession (and to the long-term benefit of Wall Street through commercial mortgage-backed securities). The most asinine of the changes in the proposal may not have sizeable impact to the economy, though they will certainly have sizeable impacts to many individuals’ personal economies, while other changes will impact the broader economy. When taken in conjunction with the increased spending that is also included in the proposals, it is almost impossible that there won’t be short, medium, and long term impacts. But standing here today it is difficult to know exactly what those changes might be.
About the Author: Forrest Jinks is CEO of Altus Equity Group Inc and a licensed real estate broker. Forrest has decades of experience as principal in a variety of alternative investment segments including real estate (residential rehab, in-fill development, multi-family, office and retail), debt, and small business start-up (online marketing and site retail). He can be reached at email@example.com.