A Closer Look at a Tax that Needs a Fix

By: Victor Normand
Published: November 2012

The health care reform proposal submitted by Richard Nixon in 1974 had many similarities to the current law.  Although his plan required no new taxes, it is very possible that Congress might have included a tax had deliberations ever progressed.  The current law actually did not include the 3.8% tax on investment income including capital gains until the eleventh hour, literally just hours before the final debate.

The National Association of Realtors (NAR) in their analysis estimates that only 2% to 3% of all home sellers will be affected by this law.  NAR does not support the tax, but their analysis is incomplete by the omission of a historic perspective.  This writer will argue that the tax provision in the new health care law is flawed and should be amended so that it remains a tax on significant gains by higher income taxpayers.

Let’s speculate that President Nixon’s health care reform had become law in 1974.  Now let’s further speculate that a 3.8% tax similar to the current tax was part of that law.  Once laws are passed, particularly social legislation along with taxes codified in support of those laws, they are very hard to change.  The constituency for any such program develops rapidly as its benefits are enjoyed, and the constituency continues to expand over time as does the programs dependency on a dedicated revenue stream.  So, where would we be today if such legislation with its tax provision had become law?

As it relates to real estate, the current law has two key benchmarks.  The first is a capital gains exclusion from the tax, which is set at gains of $500,000 or less.  The second is an adjusted gross income (AGI) threshold of $250,000 below which the new tax does not apply.  Both of these amounts apply to taxpayers filing a joint tax return.

I am not sure how these amounts were arrived at, but we can relate them to median home prices and median family income for the purpose of comparison.  The ratios for the nation in 2010 when the law was passed are as follows:

 

                       Median Existing Home Price         $173,000       =  .35

                        Capital Gain Exclusions              $500,000

 

Median Household Income              $48,340      = .19

                           AGI Threshold                          $250,000

 

In 1974, the median existing home sale price was $32,000, and the median family income was $9,902.  In this hypothetical situation using the above ratios, the capital gain exclusion would have been set at approximately $91,500, and the AGI threshold at approximately $52,100.  And arguments would probably have been written about how reasonable these limits are and about how few households would actually be affected by this tax.  Would we hold the same opinion 38 years later?

Would a 3.8% tax on capital gains or investment income above $91,500 for tax payers with AGI above $52,100 be acceptable today?  Thirty-eight years may seem like a long time, but really, is it?  Consider the Alternative Minimum Tax and the percentage of middle income tax payers affected by it today who were never intended to be affected. Let’s not make the same mistake again.

If the exclusion is fair and the AGI threshold reasonable, let’s keep it that way.  The amounts should be indexed to inflation so that we are not creating an unintended tax burden for our children and grandchildren.  Or, is it possible that Congress intended there to be an automatic tax increase every year that does not require a vote thanks to inflation?

Forward this newsletter to your Congressman or Senator and see what they have to say.