Former Vice President and presumptive Democratic nominee, Joe Biden has recently unveiled what he affectionately calls “the care-giving economy”, a $775B plan to build thousands of new child-care facilities and boost Medicaid home and community services for the elderly.
The proposal comes as the COVID 19 pandemic has taken a heavy toll on nursing homes and caused many schools and day care centers to close for months in an effort to control the spread of the virus. The plan would add 3 million jobs in the care and education sectors, including 150,000 health workers in underserved communities.
If elected, Biden would pay for this plan by increasing taxes on real estate investors with annual incomes of $400,000 or higher, and making high-earners comply more fully with existing tax laws. While this may not be intended, the proposal reignites an old controversy on a capital gain tax loophole that has so lavishly rewarded real estate investors compared to their peers who own stocks or other assets. For example, if you own a stock that has appreciated over time and sell it; you owe the IRS a portion of the profit that you’ve earned over time. The difference between the purchase price and the value of the stock at the time of the sale is called a capital gain and it is immediately taxable. But if you had invested in real estate instead, section 1031 of the IRS code allows you to defer the tax if you plan to re-invest the proceeds of the sale into real estate. This exception is known as “like kind” exchanges and, the rationale for it was to encourage and enable the real estate sector to invest in more housing without having to rely heavily on credit. However, studies have long shown that most investment in real estate consists in repurchasing already existing assets, rather than building new units and that investors have creatively used section 1031 as a mini tax heaven by constantly rolling it and thereby indefinitely postponing the tax bill.
If passed into law, Biden’s proposal would eliminate this loophole and distribute the capital gain tax burden more equitably. But there is a more plausible justification for ending this “fiscal privilege” and it has to do with the process of value creation in the real estate industry. While capital investments do play a role, it is widely documented that the lion’s share of the appreciation in real estate is attributable to land values. In large metro areas such as New York City, land values account for nearly 70% of the rise in the value of real estate. This value is not created by what the landlord or the investor does on his property, but by what is around the property i.e., the infrastructure and other vital public services, all paid for by the community. To tax away all or part of this unearned increment to care for the community as Biden intends to, would be one modest but sure step toward implementing Henry George’s land tax.