Sufficient But Not Ample: Are the Tax Reform Proposals Fair?

January 31, 2015

by Michael G. Goldstein, EVP Corporate Strategies

Life is not fair, but the opportunities to succeed are there.

Merriam Webster Collegiate Dictionary defines the word “fair” as “sufficient but not ample”. I bring this up because we are going to hear that word a lot when tax reform revisits our newspapers and airwaves. Taxes must be made fair and everyone must pay his/her fair share. At least that is what we are told every time reform is raised. So what exactly is fair?

Is it fair that Bill Gates founded Microsoft and I did not? Is it fair that Princeton accepts less than 7 percent of all of its applicants for admission? Is it fair I did not make the US Olympic team even though I had the desire to do so? The answer to all these questions is, of course not. Some people are geniuses, some high school students work harder than others, and some athletes are blessed with limitless talents.

In sum, life is not fair, but the opportunities to succeed are there. This gets me to two of the many elements of the president’s tax proposals. One has already burst into flames and the other quietly sitting on a shelf is waiting to be activated. Our tax code requires self-reporting and taxpayers rely on the good faith of our legislators to not repeal a provision that they once offered as an incentive just because it becomes popular and too successful. I give you the 529 plan a very popular program that is now viewed as utilized by people who make more than $200,000 a year in other words the so called “rich “. The 529 program has accrued a massive amount of assets and this piñata is begging to be smashed at least from the perspective of the tax code draftsmen. When that news hit that this sacred benefit was in the cross hairs many politicians became apoplectic. Suddenly hard working non-rich taxpayers were expressing dismay at this reversal and the suggestion evaporated.

Most on The Hill say that the current tax revisions are dead on arrival but that doesn’t mean they won’t go away. The shelf life of a tax proposal is long and it waits patiently for the next shift in power. Once the idea is put on paper it can rise like a phoenix. This now leads us to the next proposal that may not go away so easily-- the limit on IRA accumulations. It is suggested that no IRA shall have more than $3.4 million in assets. A senior administration official previously stated that wealthy taxpayers can currently “accumulate many millions of dollars in these accounts, substantially more than is needed to fund reasonable levels of retirement saving.” The position is that $3.4 million is enough to finance $210,000 per year in retirement benefits---although it is anybody’s guess as to how this number was determined perhaps by legislative legerdemain. By contrast the president will receive a pension of $191,300, plus expenses, plus secret service, plus, plus, plus. Apparently the poster child for IRA accumulation is former Massachusetts Governor Mitt Romney who some have questioned how he could accumulate $100 million in an IRA—one word: “investments.”

Governor Romney used money in a 401(k) to invest in various opportunities at Bain Capital—which, by the way, were also offered to the employees at Bain. When the governor departed Bain he rolled over the 401(k) to an IRA. These benefits in his IRA will be taxed on distribution (which he must take at age 70 ½), will be subject to estate tax, and will be subject to income tax when his beneficiaries receive the IRA distributions. Many of us won’t have that opportunity for that rate of return experienced by the governor but what about a smart individual investor who has a couple of homeruns in a 401(k) portfolio (e.g. buying Apple at $7.00 a share) that is then rolled over into an IRA. Is it fair to punish that person with a new adjustment to the IRA rules?

Preparing and passing tax legislation because something is perceived not to be “fair” creates unintended consequences. A cautionary tale began in 1969. Some members of congress were incensed that 200 millionaires paid no income tax because their income was derived from tax free municipal bonds. In order to prevent this from ever happening again the Alternative Minimum Tax was developed. Congress neglected to index for inflation when passing the AMT provision. How well did that work out? As of the close of tax reporting in 2013, 3.9 million taxpayers with income from $200,000 to $500,000 were ensnared in the AMT trap. That sure is a lot of millionaires.

I also believe that our biggest problem when it comes to taxing the rich is how the rich are defined. I suggest we raise all Congressmen’s salaries to $1,000,000 per year a little bit more than a .220 hitter in professional baseball. In this way we ensure that the rich will always be anyone making more than a million dollars a year. Just a thought.

Published on LinkedIn January 31, 2015