Back to General Resources

House Ways and Means Tax Gap Hearing

House Ways and Means Subcommittee on Select Revenue Measures                                              

Funding Our Nation’s Priorities: Reforming the Tax Code’s Advantageous Treatment of the Wealthy

Wednesday, May 12, 2021

Witnesses 

  • Adam Looney, Professor, Executive Director of the Marriner S. Eccles Institute for Economics and Quantitative Analysis, University of Utah
  • Jason Oh, Tax Law Professor, University of California Los Angeles School of Law
  • Harry L. “Hank” Gutman, Chief of Staff (Retired), Joint Committee on Taxation
  • Chye-Ching Huang, Executive Director, New York University Tax Law Center
  • Chris Edwards, Director of Tax Policy Studies, Cato Institute

Opening Statements
Chairman Mike Thompson (D-Calif.)
In his opening statement, Thompson said the American Rescue Plan provided the backbone of critical relief and now Congress needs to consider how the tax system is impacting efforts to foster a fair economic recovery. He said this hearing will examine how the tax system works differently for the well-off than the middle class and the bulk of gains have been concentrated with the wealthiest. Thompson said those at the top grow richer, but the middle class remains stagnant. He said our tax system favors financial assets and dynasty trusts over working families, which will not support the investment we need to build a more prosperous future. He said tax advantages that favor the wealthy lead to wasteful tax avoidance and are neither productive nor fair. Thompson said in considering advantages seen by the wealthy, it is important to keep in mind how the tax system affects working families and small businesses. In addition to tax advantages, he said they also know the wealthy are able to plan ahead and evade tax through underreporting and overstating their deductible expenses. He said this leads into another area of concern which is the disproportionate auditing of tax returns across income levels. He concluded that tax laws need to be fair on paper and enforced fairly, and added that Internal Revenue Service (IRS) enforcement will be closely examined by the Subcommittee during the month of June.

Ranking Member Adrian Smith (R-Nebr.)
In his opening statement, Smith questioned what the primary purpose of our tax code should be: creating equal outcomes or subsidizing behaviors where we see a public good and punishing when we do not. He said our tax code exists primarily to collect sufficient revenue to fund the government in a fair way for taxpayers. Smith said he believes the federal tax code does a good job of meeting those goals through the Tax Cuts and Jobs Act (TCJA). Before the pandemic, he said the Department of the Treasury saw the largest amount of revenue from taxes and the 2021 revenues are expected to be even higher. Smith said the tax code is fair, progressive, and incentivizing constructive economic activity. He said TCJA was groundbreaking for bringing back profits from abroad, and that its reforms put an end to the exodus of U.S. companies overseas, created anti-abuse rules to prevent zero-tax income in tax havens, and positioned American companies to compete and win in the global economy. Smith said the real reason for this hearing is to offset the cost of the infrastructure package and that the Majority believes individuals are not paying their fair share. He said doubling the capital gains tax would be a major “revenue loser” and would be counterproductive during this time in the economy. Smith said his concern is with family operated small businesses who could be hurt by these tax proposals. He said exemptions for family businesses will not help or raise revenue, and said Congress needs to empower families and businesses to succeed on their own and not force them to rely on Washington.

Testimony
Adam Looney, Professor, Executive Director of the Marriner S. Eccles Institute for Economics and Quantitative Analysis, University of Utah
In his testimony, Looney said wealth and income are increasingly heavily concentrated in the U.S., and that the top one percent hold more than about a third of total wealth. He said there have been several changes in the tax system that contribute to these trends: the tax system’s increasingly generous treatment of inherited wealth, reductions in tax rates on corporate and business income owned by wealthy taxpayers, and the favorable treatment of capital gains on investments and other assets disproportionately owned by wealthy taxpayers. He also added that about 58 percent of wealth of the top one percent is composed of the stock of public companies or private businesses. Looney said in short, the tax system provides favorable tax treatment on assets for the wealthy, and does less to reduce inequality in income and wealth than it has in the past. He suggested scaling back reductions in the tax rates that apply to corporate and pass-through business, eliminating the exclusion of capital gains held until death (“stepped up basis”), raising the tax rates on capital gains and eliminating tax expenditures for specific capital gains, and funding enforcement to ensure taxes levied are actually collected.

Jason Oh, Tax Law Professor, University of California Los Angeles School of Law
In his testimony, Oh said he hopes to discuss several features of the income and estate taxes that limit the revenue collected from the wealthiest Americans, followed by possible reforms for raising taxes on the wealthy and increasing the overall progressivity of the tax system. He listed three key points to note: 1) the income tax does not effectively tax the wealthy, arguing the realization requirements play a big role; 2) the tax system can be made more robust through several reforms: repealing stepped-up basis, shifting to mark-to-market for more assets, and increasing the capital gains rate; 3) these reforms work better in a package and some options for reform are more effective than others given the legislative uncertainty about how long reforms will last. Oh said that what matters is the overall progressivity of the tax system. He said he is skeptical if the Supreme Court would uphold an annual wealth tax, but supports several programs in President Biden’s proposal like making the Child Tax Credit (CTC) permanent, expanding access to childcare for low-income families, and increasing Medicaid funding.

Harry L. “Hank” Gutman, Chief of Staff (Retired), Joint Committee on Taxation
In his testimony, Gutman said he believes that tax-free step-up in basis should be repealed and replaced by a regime in which death and lifetime transfers are income tax realization events, so when an individual dies owning property that has appreciated in value, tax would be payable on that gain rather than forgiven as it is under current law. He continued with a few reasons why step-up in basis should be repealed: 1) it creates vertical and horizontal inequity; 2) it creates an artificial impediment to sales that would normally occur and therefore distort capital flows; and 3) it results in a revenue loss of $218 billion for 2020-2024. He said a realization regime causes a forced sale of assets, and whatever regime is proposed must address legitimate concerns of family businesses and farms. Gutman said requiring a sale of some of those assets would adversely affect these individuals. He said other concerns that need to be addressed are the lack of basis records, interaction with the Estate Tax, and transition relief. He concluded in saying it is worth consideration that both Democratic and Republican Treasury Departments have identified “step-up” as a problem but have not enacted permanent solutions.

Chye-Ching Huang, Executive Director, New York University Tax Law Center
In her testimony, Huang noted the menu of tax breaks for income from wealth leads to wasteful tax avoidance, sheltering, and even evasion and tax breaks for income from wealth can lead to wasteful tax avoidance. She added that wealthy filers can also use pass-throughs to avoid and evade top rates on labor income. Huang said low- to moderate-income workers have a very different experience of the tax system than the rest. Huang said there is 95 percent tax compliance on wage and salary income for typical workers, but that wealthy filers get their income in ways that do not require reporting. She said it is a problem that the IRS lacks resources and tools to detect and act on non-compliance by high-wealth filers. Huang said workers, families, and infrastructure are far higher national priorities than retaining tax breaks for the wealthy. She said the U.S., relative to the size of its economy and in comparison to most other developed countries, invests less in areas such as reducing child poverty, securing paid leave, and other investments that support economic opportunity and mobility. She also urged that the Earned Income Tax Credit (EITC) and CTC boosts be made permanent.

Chris Edwards, Director of Tax Policy Studies, Cato Institute
In his testimony, Edwards said President Biden’s taxes would be a mistake as state governments can fund these proposed activities themselves through, for example, their own gas taxes. He pointed to paid family leave programs, arguing that states already fund this themselves and that there is no need for federal intervention. He said increasing the corporate tax rate would undermine infrastructure investment, and that the “green way” to fund infrastructure should instead be user charges such as gas taxes and airport passenger charges. Edwards said the TCJA provided equal percentage tax cuts to income levels across the board. He said President Biden’s Families Plan that claims to be “tax reform that promotes work not wealth” suggests a misunderstanding of the role of wealth in the economy. He said keeping wealth in the market economy benefits everyone as it supports operations and investments of businesses which then employ workers and generate GDP. Finally, Edwards expressed his opposition to increasing the capital gains tax, noting that many other Organisation for Economic Cooperation and Development (OECD) countries have lowered their corporate rates and seen increases in revenue.

Question & Answer
Inequality
Thompson asked about the difference between income inequality and wealth inequality, saying the EITC does a good job reducing income inequality on an after-tax basis but questioned if the tax system makes a dent in wealth inequality as well. Looney said policies like the ETIC and CTC have increased over time and dramatically boosted incomes of low- to moderate-income households. He said for the higher end of taxpayers who earn much of their income from their wealth and businesses, their tax rates have gone down over time with reductions in capital gains and state tax rates which has just further expanded their wealth and increased overall inequality.  

Thompson asked how it could be possible for the top one percent to have a lower tax rate than those in the middle. Oh said the wealthy who own a lot of appreciated assets can decide how much salary to pay themselves. He said the amount of ordinary income they see is in their control and then they can borrow off their assets which makes it possible for this class of taxpayers to pay taxes at very low rates.

Estate Tax
Thompson asked for suggestions on how to help small businesses and farms and ensure they do not suffer an income tax incident at the time of death. Gutman said there are two options that would provide for deferral of income tax until the property is sold. First, he said to value the property using estate tax rules which would be a special use valuation that allows the property to be valued at its actual use rather than its highest, best use. Gutman said the second solution is a carry-over basis, and either solution would directly address the liquidity concerns raised.

Wealth Tax
Rep. Ron Estes (R-Kans.) asked why other European countries have abandoned an annual wealth tax. Edwards said there used to be more than a dozen countries who used to have a wealth tax but they found the administration burdens were too high and the wealthy began moving their assets offshore.

Capital Gains Tax
Smith asked about the potential negative impacts of capital gains tax increases and what other solutions might be. Edwards said economists have estimated the revenue maximizing rate to be 28 percent, so pushing it higher makes no sense as it would risk a lot of damage to the economy. He also added that every OECD economy has had a lower capital gains tax rate. Edwards said there is an argument that capital gains are “not properly income” and that this issue goes along with concerns around the estate tax at death. He suggested repealing the estate tax and then taxing on a carry-over basis when the asset is sold.

Rep. Suzan DelBene (D-Wash.) asked about the importance of fixing how capital income is taxed. Oh said taxation of the wealthy is heterogeneous and confusion arises when lumping everyone together. He said there are some people in this group paying their taxes at 37 percent and some paying less than 10 or 15 percent, and that fixing how capital income is taxed is crucial.

Preferential Capital Gains
Rep. Tom Rice (R-S.C.) asked for reasons to have a preferential rate on capital gains. Edwards said assets grow with inflation, so tax on capital gains is artificial. He agreed with Rice that it would encourage more investment, more productivity for workers, more competition, and is crucial for startup businesses and innovation. Edwards said increasing the capital gains rate would damage all of these areas.

Rep. John Larson (D-Conn.) asked for thoughts on preferential treatment of capitals gains and requiring employers to distribute their stock to employees. Oh said it is an interesting idea to encourage stock ownership across a broader group but there are some design issues that would need to be addressed because employees’ wealth would be tied up with their employer. Edwards said he agrees there is a diversification problem but generally likes the idea of employees being part of the capital system.

Tax Evasion and Loopholes
Rep. Lloyd Doggett (D-Texas) asked who benefits from corporate tax breaks and what Congress can do to address corporate tax loopholes. Huang said the top one percent of taxpayers see most of these benefits. She said they have not seen any wage growth above trend since those tax cuts were put into place. Huang added that permanent corporate tax cuts were paid for through cuts to healthcare and increased taxes on housing. She said raising the corporate tax rate would be a way to mitigate this.

Doggett asked how partnerships are used for tax avoidance and what can be done. Looney said partnerships are intended to be flexible in their financial structures and used by taxpayers to enter into complicated financial arrangements, but are also often used to facilitate tax avoidance. He said they allow taxpayers to shift income into forms of income that achieve lower tax rates or defer that income. He added they are also incredibly complicated to audit.

IRS and Auditing Returns
Rep. Linda Sanchez (D-Calif.) asked how disparity in auditing rates affects inequality and if more tax revenue would be seen with higher audit rates for wealthy individuals. Huang said that while lower income communities have been audited at relatively the same rate over time, the audit rate for the wealthy has continued to drop. She said there would be cuts in the tax gap if high income filers were more proportionately audited.

DelBene asked how the decrease in IRS funding impacted audit rates and if increasing funding would help improve compliance and close the tax gap. Huang said the audit rate for high income filers has dropped significantly because the IRS has lost staff who can conduct complex audits. She said it is crucial to include multiyear long term funding increases for the IRS as it would help rebalance audits and enforcement so the high-income taxpayers “get some of the effort they are due.”

Mark-to-Market
Rep. Gwen Moore (D-Wis.) asked what the consequences would be from not using the three tax policy solutions as a package and if a mark-to-market regime should be a concern. Gutman said mark-to-market would measure your gains and losses on assets every year and you would be subject to tax but it would eliminate the realization requirement. He said some have proposed accrual taxation and believes it is an interesting concept particularly if it is limited in its scope to marketable assets, but that it gets more problematic with non-marketable assets.

Rep. Stacy Plaskett (D-U.S.V.I.) asked how a mark-to-market system would work during a recession when asset prices fall. Oh said it is important to design a rule that does not allow for unlimited deductibility because people will want to understate the value of their assets. Oh said it might be best to stick with mark-to-market for publicly traded assets.

Policy Suggestions
Rep. David Schweikert (R-Ariz.) said if the purpose of this tax discussion is “having cash in the bank,” he suggested having a discussion around cutting government subsidization of the extremely wealthy. Edwards said there is a problem on the spending side which is not only bad for the economy but also the climate. He said there are high end tax loopholes to get rid of like the municipal bond tax exemption which is slanted to the wealthy and distortionary. He also said opportunity zone break also creates a lot of unfairness. Another suggestion Edwards made was reducing Social Security benefits that go to the wealthy.

Rep. Kevin Hern (R-Okla.) asked what tax policies the committee should consider. Edwards said a reduction in the capital gains tax rate down to 15 percent and said he is not in favor of subsidy policies.

For more information on this hearing, please click here.