We need to ‘broaden the base’ to get rates ‘DOWN’: American Action Forum president

Key Concepts

• Unrealized Capital Gains: The increase in the value of an asset (like stocks or real estate) that has not yet been sold.
• Haig-Simons Income Definition: An economic framework defining income as the sum of consumption plus the change in net wealth over a period.
• Step-up in Basis: A tax provision that adjusts the cost basis of an inherited asset to its fair market value at the time of the owner's death, effectively exempting the appreciation from capital gains tax.
• Supply-Side Economics: An economic theory advocating for lower taxes on capital and income to incentivize investment, production, and economic growth.
• Consumption Tax: A tax policy that focuses on taxing what individuals spend rather than what they earn or save, intended to encourage capital formation.

---

1. Main Topics and Key Points

The discussion centers on the debate over whether to tax "increases in unrealized capital gains" as a method to broaden the tax base and lower overall income tax rates.

• Art Laffer’s Perspective: Laffer argues that taxing the increase in unrealized capital gains is consistent with the Haig-Simons definition of income. He proposes using the revenue generated from this broader base to significantly lower top marginal income tax rates (targeting 25% or lower). He views the current "step-up in basis" at death as a loophole that allows wealth to escape taxation indefinitely.
• Larry Kudlow’s Perspective: Kudlow strongly opposes taxing unrealized gains, labeling it "confiscatory." He argues that capital is often taxed multiple times (corporate and personal levels) before it even reaches the point of a capital gain. He advocates for a supply-side approach: lowering capital gains taxes to 15%, indexing them for inflation, and reducing corporate rates to 15% to stimulate growth.
• Doug Holtz-Eakin’s Perspective: Holtz-Eakin disagrees with Laffer’s focus on taxing capital. He argues that the tax code should prioritize taxing consumption to protect incentives for saving and investment. He maintains that taxing the return on capital is detrimental to long-term economic growth.

2. Methodologies and Frameworks

• The Haig-Simons Framework: Laffer cites this as the gold standard for a "comprehensive income tax." The formula is: Income = Consumption + Change in Wealth. Laffer argues that because the change in wealth (unrealized gains) is part of this equation, it should be taxed to allow for lower rates elsewhere.
• Supply-Side Strategy: Kudlow and Laffer both agree on the goal of "low rates and a broad base." However, they disagree on the definition of that base. Kudlow emphasizes that "you can't have capitalism without capital," arguing that taxing capital directly hinders the very investment needed for growth.

3. Key Arguments and Supporting Evidence

• The "Growth" Argument: Kudlow and Holtz-Eakin argue that taxing capital is anti-growth. Holtz-Eakin asserts that for long-run economic expansion, consumption should be the primary target for taxation, not the returns on investment.
• The "Fairness/Base" Argument: Laffer argues that the current system is inconsistent because it allows massive wealth to pass through generations without ever being taxed due to the step-up in basis. He believes that by closing this "loophole" and taxing the annual increase in wealth, the government can afford to lower rates for everyone, which would ultimately stimulate the economy.
• Inflation Indexing: There is a rare point of consensus: both Laffer and Kudlow support indexing capital gains for inflation, ensuring that taxpayers are not taxed on "paper gains" caused solely by rising price levels.

4. Notable Quotes

• Art Laffer: "I don't want to tax unrealized capital gains. I want to tax increases in unrealized capital gains which is an income item... that's all it is."
• Doug Holtz-Eakin: "You want to maintain the incentives to save and investment and tax the return to capital is not that incentive."
• Larry Kudlow: "Remember what Jack Kemp said many years ago, you can't have capitalism without capital. If you're going to tax away the capital, it's not going to be good."

5. Synthesis and Conclusion

The debate highlights a fundamental tension in conservative economic thought. While all participants agree on the necessity of lower tax rates to drive economic prosperity, they are divided on the "base" of the tax system. Laffer advocates for a purist application of the Haig-Simons income definition to achieve a broad-based, low-rate system. Conversely, Kudlow and Holtz-Eakin prioritize the protection of capital, arguing that taxing the growth of assets—even unrealized ones—is a direct assault on the capital formation required for a healthy, growing economy. The discussion concludes with a consensus on the desirability of lower rates and inflation indexing, but a persistent disagreement on whether taxing unrealized wealth is a viable or moral path to achieving those goals.