Why Can't the Middle Class Invest Like Mitt Romney?

Christmas came early for the New York Times. On December 19, the paper’s editorial page ran a guest essay under the clickbait headline: “Mitt Romney: Tax the Rich, Like Me.”

Progressives went head over heels over Romney’s apparent Damascus-style conversion to the gospel of redistribution. “Tax the Rich! Welcome to the coalition, Mitt,” boasted Iowa state rep and former Democratic Congressional candidate J.D. Scholten. “Man, have we come a long way from the ‘47 percent’ comment of 2012,” glowed MS Now’s Ali Vitali. “Me and my old rival Mitt Romney finally agree on something,” declared former Clinton administration Labor Secretary Robert Reich. 

To paraphrase the old journalistic saw, it’s what’s in the headline that matters more than what’s in the story. Such is the case at least with Romney’s mea culpa for the super-rich. The policy proposals from the former GOP presidential hopeful point in a different direction than the eye-grabbing “Tax the Rich” header might suggest. Romney doesn’t call for raising marginal tax rates on high income-earners, or lifting the corporate tax rate, which Congress slashed from 35 to 21 percent in the 2017 Tax Cut and Jobs Act, or jacking up capital gains rates.

Instead, Romney takes aim at tax loopholes that allow the wealthy to shield long-term investment gains from taxation. Although it’s not Romney’s intention, his piece raises a legitimate question: Why can’t middle-income Americans pay effectively no taxes on investments like the wealthy do? 

Romney’s big idea for raising taxes on the rich is to eliminate a concept known as “stepped-up basis.” While the phrase sounds esoteric, basis is one of the most important principles in tax policy. It refers to the original value of an asset that’s sold later. If the original value is adjusted upward — so-called stepped-up basis — the profit is lower when the asset changes hands, resulting in less taxes. 

Romney complains that the tax rules allowing for stepped-up basis on inherited assets let the rich skirt paying capital gains taxes. This is because if a rich person owns shares of a company that increase in value from, say, $1 million to $100 million, no capital gains are paid when those shares transfer at death. The basis of the stock is reset, or stepped up, for the heir’s benefit. If they sell shares, they pay only on gains realized since they inherited the shares. The huge price run-up during the original owner’s life is never taxed. 

Rich or poor, we’re all entitled to stepped-up basis when we die. Romney’s point isn’t that we should repeal stepped-up basis for everyone. He wants to nix it only for mega-estates with over $100 million in assets. 

But Romney’s proposal begs the question: Why don’t we instead make it easier for all Americans to shield ordinary investment gains through stepped-up basis outside of the inheritance process? 

As Romney suggests in his piece, the wealthy benefit from stepped-up basis because, unlike most people, they do not need to sell assets during their lifetimes to pay for big-ticket expenses such as a home purchase, a child’s college tuition, or retirement. 

Tellingly, Romney uses the hypothetical example of Elon Musk purchasing Tesla stock and passing it on to his heirs at a much higher value. Nobody believes that Elon would have to unload some of his Tesla shares to make ends meet while he’s alive. The rest of us? Not so much. 

Federal tax law indeed has some user-friendly ways for the non-rich to avoid investment taxes. Roth IRAs and 529s are notable examples. The former allows taxpayers to pay zero capital gains on money they invest for retirement, which is even better than stepped-up basis. (When the tax rate is zero, basis doesn’t matter because the asset owners pay zero percent on any gain.) Likewise, 529 owners get tax-free treatment for money invested to pay for school tuition, and now for job-training and professional credentialing under the One Big Beautiful Bill Act.   

But why don’t ordinary Americans get an effective capital tax rate of zero on other long-term investments? Along with stepped-up basis on mega inheritances, Romney criticizes 1031 exchanges. This provision allows taxpayers to pay no capital taxes on the sale of real estate investment properties. Every day homeowners also get a tax exclusion that shields up to $500,000 of profit on home sales, and can currently write off $40,000 per year in property taxes on their homes. For residential real estate, the list of tax giveaways is long. By contrast, low- and middle-income Americans who buy equities outside a Roth IRA, 529 account, HSA, or other tax-deferred program receive no capital gains relief that these investments generate. 

This makes no sense. The number one problem with tax policy is not, as Romney contends, that it benefits the rich at the expense of the poor. The U.S. tax system is  more progressive than Europe’s. The top 1% of U.S. taxpayers contribute 40 percent of total income tax revenues while earning just over twenty percent of the nation’s total income. America’s wealthiest are paying their fair share. 

The real issue with the tax code is its preference for politically-favored industries. Case in point: taxpayers get to write off the first $500,000 of gain on their homes, but get no exclusion on long-term stock market gains. Likewise, there’s no such thing as a 1031 exchange when ordinary investors exchange one ETF for another. 1031s shield investment gains for real estate only, not stocks. 

The result: tax policy discourages broad-based wealth creation. Since 1995, stock returns have outpaced real estate gains by more than sevenfold. But Americans get to write off a half-million dollars of real estate gains while households earning $250,000 are hit with a 23.8 percent tax on investment gains on stocks and ETFs. This produces a pathological outcome. Over time, buying shares in America’s world-class companies produces the best returns by a wide margin. Yet the tax code encourages deploying capital according to what’s politically popular, not what makes money.  

Investment data show the importance of tax policy in investment decisions. According to the Federal Reserve, 61 percent of Americans are invested in tax-preferred retirement accounts, compared with only 35 percent who own securities outside of retirement accounts. Equalizing the tax treatment of retirement and non-retirement investment accounts would encourage more Americans to grow their net worth by holding long-term equity positions. 

An easy fix is to bring the capital gains tax treatment on stocks more in line with real estate, where taxpayers can write off $500,000 of profit on a home sale, provided they have lived in the home for two of the past five years. Tax policy shouldn’t preference short-term stock speculation under any circumstances. A reasonable policy would allow those who continuously own a stock or ETF for 10 years or more to get stepped-up basis. 

Such a policy would allow more Americans, who can’t hold onto investments until they die, to receive the same tax treatment that the heirs of the Musks and Romneys of the world receive when they inherit a mega-estate. 

More importantly, it would direct more capital to America’s profit-maximizing companies and make ordinary retail investors much wealthier.

Michael Toth is the research director of the Civitas Institute.