This week bore witness to political jockeying between the centrist and progressive wings of the Democratic party. The objective: to reach a mutually agreeable framework to fund Joe Biden’s multi trillion-dollar infrastructure, climate, and social spending initiatives.

Ideas included limiting business loss deductions, a surtax on income over $10 million, a corporate minimum tax, tax on stock buybacks, and more.

One proposal is a wealth tax on unrealized capital gains of the wealthiest Americans. Iterations of this proposal have been worked on by Elizabeth Warren (D:MA), Bernie Sanders (I:VT), and Senate Finance Chairman Ron Wyden (D:OR).

Negotiations are fluid; though House Ways and Means Chairman Richard Neal (D:MA) contends the proposal is “dead.” That would be a good thing. Of all the tax proposals recently floated in Washington, a wealth tax is the most suboptimal. It is destructive to all Americans, not to mention, potentially unconstitutional.

Implementation Issues

Taxing unrealized capital gains is a horrific idea. It would not raise anywhere near the projected amount of revenues - the wealthiest Americans would spend millions on lawyers to save billions on taxes. What it would do is hamper the greatest engine of innovation anywhere in the world, the American entrepreneur, thereby thwarting economic growth and stifling job creation. Said The Economist, “Because this tax would apply only to securities traded on public markets, with different rules for stakes in privately held firms, it would deter entrepreneurs from floating their companies on the stock exchange. That would ultimately be bad for investment and the incentive to innovate.”

Another idea would be to apply a wealth tax on private investments. This would be fiendishly hard to implement and cause major dislocations across various private marketplaces, neutering investment, and innovation.

Consider the following: Entrepreneur X owns an interest in a start-up valued at $100. Six months later, the company’s prospects have improved, and the firm successfully raises a round of funding at $1000. Under the proposed wealth tax, Entrepreneur X would be taxed on the $900 increase in value of the start-up even though she has not sold her stake. This creates a litany of problems. How would Entrepreneur X satisfy her tax liability if she did not have ample cash on hand? Furthermore, a need to hoard cash for unrealized tax liabilities would be a grossly suboptimal use of funds. Those monies could otherwise be put to work investing in other entities, generating economic growth, jobs, and perversely, tax revenue.

At TQC, we believe in a progressive tax code. People who earn more should pay more. However, a progressive tax code must be applied thoughtfully. We agree with the position taken by many on the right who argue against excessively high marginal tax rates. A disproportionate number of people who would bear the burden of marginal tax rates over 50%, proposed by some politicians on the left, are responsible for creating a disproportionate number of jobs in America.

We must be careful not to impose a marginal tax so burdensome that it takes away job creators' economic incentive to offer employment opportunities for working Americans. That is suboptimal for all Americans.

It is imperative to keep in mind: most higher-earning people in the United States already do pay significantly more in taxes, as they should.

We align ourselves with many on the left who argue that although marginal tax rates are higher for the wealthy, it is unjust that some extremely rich individuals (and corporations) can take advantage of loopholes in the tax code to cut their tax rate to a level lower than what working-class and middle-class Americans pay, in some cases to 0%.

At TQC, we do not begrudge those individuals (and companies) for utilizing the existing tax code to reduce their tax bill; any rational person would do so. That said, many regressive loopholes in the tax code should be closed or curtailed. Without debate, they disproportionately help the very wealthiest Americans. Very few working-poor, middle-class, and even higher earning Americans benefit from these carve-outs. We believe that is regressive and unfair.

The IRS

Democrats and Republicans certainly have divergent principles regarding tax policy. However, if there is one thing about taxes that they should both agree on, it is this: The Internal Revenue Service is woefully underfunded. This is a serious problem. The primary blame falls on our elected officials.

Unsurprisingly, for most lawmakers regardless of party affiliation, directing resources to rectify the problem is not high on their respective priority lists. After all, allocating money to the IRS will not garner politicians many votes.

The Quintessential Centrist believes in a progressive tax code. People who earn more should pay more. However, a progressive tax code must be applied with levelheadedness and proportionately. We agree with the position taken by many on the right side of the aisle who argue against excessively high marginal tax rates. A disproportionate number of people who would bear the burden of all in marginal tax rates over 50% and / or be subjected to “wealth taxes” proposed by politicians on the left, are responsible for creating a disproportionate number of jobs in America. We must be prudent so as not to impose a marginal tax so burdensome that it takes away job creators' economic incentive to offer employment opportunities for working Americans. That is suboptimal for all Americans. It is important to keep in mind: most higher earning individuals in the United States already do pay significantly more taxes, as they should.

We align ourselves with many on the left side of the aisle who argue that although marginal tax rates are higher on the wealthy, it is unjust that certain rich individuals can use the tax code to their advantage and lower their tax rate to a level lower than what working class Americans pay, in some cases to 0%. Hedge Fund managers, Family Office principals and Private Equity partners are typically wealthy individuals. By utilizing “carried interest,” they can reinvest profits back into their respective entities vs. paying ordinary income tax on short-term capital gains. Real estate investors often use 1031 exchanges to roll proceeds from property sales into new physical assets thereby shielding their gains from income tax. At TQC, we do not begrudge those individuals for utilizing the existing tax code to lower their tax bill; any rational person would do so.

It would be an understatement to assert that the United States Tax code is mired in complexity. Its sheer verbosity and length (4 million words across tens of thousands of pages) is testament to its convolution. The code is so granular, complex and cumbersome that it takes dedicated accounting and legal professionals years of diligent study to master the various opacities of it. After weeks of due diligence, TQC was at best able to skim the surface in assessing and appreciating all the nuances of a tax code so large, it is bigger than the Holy Bible. No such irony because perhaps only God himself can fully comprehend it.

When laws are overly cumbersome and complex, it typically means that those with money and influence, especially the political kind, can exploit them. Again, we find nothing nefarious in paying as minimal an amount of tax within the confines of the law. However, an individual who is compelled to pay an attorney over $1,000 an hour to study page 328, paragraph 3, line 5 of a tax code, is likely to have earned a significant enough income whereby they rely on complex legal maneuvers to shield those earnings from the Internal Revenue Service (IRS).

Here are but a few of the most egregious and regressive loopholes in the U.S. tax code that we feel are unfair to the vast majority of salaried, tax paying individuals across various tax brackets.

Step Ups:

"Step-ups" allow those lucky enough to inherit stocks, bonds, real estate and certain closely held businesses to avoid paying tax on these securities or assets. Instead of paying taxes on any gains from the time the assets were originally purchased, the “step-up” (in cost basis) allows the beneficiary or heir to use the current market value of the given asset. Therefore, if the beneficiary sells any of these assets, they are taxed on the difference between the price at which they inherited them at and the value they received from selling them. Scratching your head? Here is a back of the envelope example of how this works. In 1982, the stock price of IBM traded between ~$5 and ~$10 per share. Let’s assume an Investor X purchased 10,000 shares of IBM for $7 or $70,000, tucked them away and held the shares until they died this week. The closing price of IBM on Friday, March 15th was $139.43. Beneficiary Y inherits the shares, and then sells the stock for the current market price of $139.43. He smiles when $1,394,300 dollars appears in his brokerage account. Instead of paying taxes on the difference between the price Investor X paid for IBM and the price Beneficairy Y sold IBM for, because of the “step-up,” the heir pays nothing and keeps the entire $1,394,300 for himself. Here is another simplified example, this time using real estate. Let’s assume Real Estate Investor X purchased a piece of property for $1,000,000 and held it for 15 years, until her death last month. During the tenure of her ownership, she leased the site to a tenant. Upon her death, the property passed onto her daughter. The property is now worth $1,750,000. The daughter decides she does not want to be a property owner and liquidates it for its current market value of $1,750,000. Instead of paying taxes on the difference between the price Investor X paid for the property and the price her daughter sold it for, because of the “step-up,” her daughter pays zero tax and retains the entire $1,750,000 herself.

A remarkable event took place in Washington last month; Congress passed a substantive piece of bipartisan legislation. In fact, prior to the passage of the SECURE (Setting Every Community Up for Retirement Enhancement) Act on May 23rd, by a margin of 417 to 3 in the U.S. House of Representatives, the only notable piece of recent legislation that was enacted with the blessing of both parties on the hill was the First Step Act, a sensible prison reform bill, signed into law by president Trump on December 21st, 2018. The SECURE Act still needs to be reconciled and voted on by the Senate; but the consensus is that some form of the bill will easily pass.

We commend Congress for passing a bi-partisan bill, an extraordinarily rare feat during this hyper-divisive time. Unfortunately, our lawmakers, the majority of whom have accomplished few things consistently but fail the American people by absolving their responsibility to work together, have failed their citizens yet again. This time, Congress let their constituents down by perversely doing exactly what they’ve been rightfully lambasted for not doing: working cohesively to pass meaningful legislation.

In its current form, the “SECURE Act” is disadvantageous to the tens of millions of working Americans and small business owners who contribute to Individual Retirement Accounts (IRAs). But before we delve into the reasons why, it would behoove us to frame why IRAs, while sometimes used by wealthy Americans, are often a preferred retirement vehicle for small business owners, the self-employed, and working Americans that do not have access to 401k's. For the sake of simplicity, we will focus on the two most commonly used IRAs: Traditional IRAs and ROTH IRAs, named after the deceased Delaware Senator and World War 2 Veteran William Roth, who spearheaded the effort to create the retirement product that has benefited millions of working American's and their heirs.

Each year, single individuals are allowed to contribute up to a fixed amount of money into IRAs. For the tax year 2019, IRS rules dictate that individuals can contribute up to $6,000 ($7,000 if you are over 50 years old). Although similar, there are two important differences between a Traditional IRA and a ROTH IRA. The money contributed to a Traditional IRA is tax deductible, whereas contributions to a ROTH IRA do not qualify for a tax deduction. However, while Traditional IRAs are tax deferred until redeemed and then taxed as ordinary income (the theory being, at retirement, the account holders' tax bracket will be lower than it was when they were working) ROTH IRAs grow and are cashed out tax free.