Fun with tax projections

Earlier JLM noted the just-enacted enlargement of the kiddie tax. Apparently Congress was concerned that substantially appreciated assets would be handed off to the children of the wealthy, who could sell them next year at a 0% tax rate on the gains. The strategy still works well this year, when those kids have a 5% tax rate, but next year would be even better. There's something so compelling about the phrase "totally tax-free gains," isn't there?

The solution wasn't to eliminate the 0% tax rate, it was to extend the kiddie tax all the way up to 24-year-olds, if they are students. So don't be thinking you can avoid high taxes on your capital gains just because you are in grad school! And it doesn't matter whether that stock you own was a gift or if you bought it out of your own babysitting money in high school--when you sell it, use your parents' marginal tax rate to compute your tax liability.

Do the college students that you know own a lot of stocks? Didn't think so. So how much money will this tax change raise? $1.4 billion over the next ten years. That's chump change in the tax revenue arena, but let's think about this for a minute. According to the Joint Tax Committee's estimates (get them here) this change will increase revenue by roughly $150 million a year for the next ten years. That implies college students as a group will be realizing $1 billion per year in long term gains! Seems a little high to me. If the typical sale is 1/3 gain, 2/3 return of basis, that means $3 billion worth of stock sales. Every year. For ten years. Because those students are going to school with $30 billion in their pockets.

I don't think so. Please prove me wrong if you can.

But wait, there's more. Faced with a tripling of their capital gain tax rate next year, college students and their parents will be hearing from their tax advisors that they should sell assets this year, nail down the 5% rate and pay the tax, even if they plan to repurchase the stock to hold for later years. A very large number of shares will be sold based upon this advice, a large number of capital gain realizations will be accelerated, and more tax payments will be pushed into this calendar year.

The total volume of expected tax receipts from the accelerated sales, again according to the Joint Tax Committee?

Zero dollars.

That's the number you necessarily get when you insist that tax changes won't change taxpayer behavior, and tax revenue has to be estimated on static models, not dynamic ones. There has never been a better example of the foolishness of this policy.

One more curious item in the projections. I suspected that these calculations were less about new revenue coming in and more an estimate of revenue losses that theoretically would have occurred if asset shifting became more common, losses that now may be avoided. But if that were true, we would see a big change in the tax revenue model after 2010, when the 0% tax rate expires. That's not the case—in fact, the revenue enhancement is larger in the last five years of the projection window than in the first five!

In the face of this punitive new tax, do the estimators really believe that assets will continue to be shifted to the students, and they will continue to sell rather than wait until they are out of school? Apparently so.