Editorial

Obama takes on income inequality with his tax proposal

Fixing taxation of inherited wealth can narrow the gap between the richest Americans and the rest of us

President Obama's first big tax proposal to the new Republican-controlled Congress would sharply increase the amounts paid by the heirs of wealthy Americans in order to fund more tax breaks and education programs for those with low and moderate incomes. It has about as much chance of becoming law as his new proposal for tuition-free community college, which is to say, virtually no chance at all. Yet the president is right to focus on inherited wealth as one way to help narrow the widening gap between the wealthiest Americans and the rest of us.

As with all things in Washington, Obama's proposal is leavened with politics as well as policy. It's designed to appeal to working-class and middle-class voters, the same group Republicans are courting as they look to the 2016 elections. Those voters' fortunes have languished over the past several decades, as productivity gains haven't translated into meaningful increases in wages. Although there's no simple fix, part of the solution is to make it easier for those on the lower rungs of the economic ladder to climb up. Obama's proposal aims to do that in part by cutting taxes on low- and moderate-income workers.

There's broad support for that approach, and particularly for expanding the earned income tax credit for the working poor. The hard part is finding a politically acceptable way to pay for it. Obama's tax cuts would cost $175 billion over 10 years, which he would more than offset with $320 billion in new revenue. The centerpiece is a controversial proposal to end a major tax break for heirs to large estates. Under current law, heirs pay no capital gains taxes on the assets they're bequeathed, no matter how much the value has increased since they were first purchased. Instead, if and when they sell the property, they pay taxes just on the change in value since they took possession. Obama's proposal would require beneficiaries to pay taxes on all capital gains since the assets were purchased, and to do so as soon as they obtained the property. Spouses, family homes, small businesses and small estates would be exempted. The president would also raise the tax rate on capital gains from 23.8% to 28% for those in the highest income bracket, including couples with incomes of at least half a million dollars.

The administration contends that the tax increases would be felt by only a sliver of the population, namely, the relatively few Americans with large estates and sizable capital gains. That group has captured a disproportionate share of the growth in wealth in the United States in recent decades, as the typical investment portfolio has burgeoned in value while median incomes have stagnated. One downside of Obama's efforts to confine the sting of his tax plan is that it is maddeningly complex, exacerbating what is already one of the worst features of the federal tax code.

Yet the tax break for inherited assets is bad policy, encouraging people to hold on to investments long after they should have sold them. As a result, it ties up money that could be invested in ways that promote more economic growth. Even lawmakers who don't think income inequality is a problem should oppose tax breaks that provide the wrong incentives.

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