Steven Pearlstein: The tax deal that Trump's ego can't refuse

US president-elect Donald Trump. Photo / Andrew Harnik

In recent weeks, I've suggested several deals - involving infrastructure, health care and devolution to the states - that moderate Democrats in the Senate could strike with a Trump White House to forestall the even worse policies that will surely comes from the House of Representatives, where the Republicans' Tea Party faction remains in control.

Here's another: acquiesce to the elimination of the federal estate tax - a long-sought goal of the Republicans - but do it in return for the elimination of a loophole that now allows the wealthy to avoid paying taxes on capital gains.

One of the biggest loopholes in federal tax code allows people to hold on to their stocks, bonds, real estates and artwork until they die, and then pay no taxes on the appreciation of those assets above the price originally paid for them - what's known as the capital gains tax, which currently is set at 20 per cent.

For most of the wealthiest Americans, most of what they inherit is capital gains.

To give you a rough idea of how big a loophole this is, consider that the federal government takes in only about US$20 billion (NZ$28b) from the estate tax each year.

Although the rate is higher - 40 per cent - the reason the tax raises so little is that the first US$11 million (NZ$15m) is exempt from taxation for married couples.

As a result, of the 2.6 million Americans who die each year, only the wealthiest 5,000 or so actually have to pay the dreaded "death tax."

In comparison, the "death loophole" to the capital gains tax costs the Treasury about US$50 billion (NZ$72b) a year. What that means is that, even if you exempt the first million or two in "unrealized" capital gains, taxing capital gains at death would make it possible to eliminate the estate tax while still raising the same amount of annual revenue, or even more.

The politics of this deal is particularly attractive.

Donald Trump could declare a great bipartisan victory for himself, the American economy and other successful 'job creators'.

Donald Trump could declare a great bipartisan victory for himself, the American economy and other successful "job creators." And those Democrats who broker the deal will be forever immunized from specious yet predictable Republican charges that they hate the rich and begrudge their success.

The only people who would be unhappy with this deal would be the liquor distributors, oil drillers, hedge fund managers and other scions of family fortunes who have spent hundreds of millions of dollars in campaign contributions to buy Republican support for an end to taxes on inherited wealth.

As it happens, during the campaign Trump's own proposal to eliminate the estate tax included a little noticed provision to exempt only the first US$10 million (NZ$14m) from capital gains taxes - anything over that would be subject to the tax.

But he also included a provision that the tax would not have to be paid until the inherited assets - the stock, the bonds, the family-owned businesses, the real estate, the yachts, the art - were sold by the heirs. Democrats could demand that Trump dump the unlimited deferral as the price of their support.

The art of dealing with Trump is to offer him a deal his ego can't refuse. It's not a whole lot more complicated than that.

For Democrats, this is a win-win strategy.

If Trump accepts it, he will be able to claim a great political victory while Democrats can take satisfaction in having preserved a tax on inherited wealth and preserved US$20 billion (NZ$28b) to finance vital government operations. The proposal also has the advantage of boosting economic growth over the long run by freeing billions of dollars in capital that is now locked in to existing investments simply to avoid ever paying capital gains taxes.

And if Trump refuses the deal or is unable to bring along the Republican Congress, then Democrats will have a simple, clear message about "crony capitalism" and "tax loopholes for billionaires" to use to confront every Republican at every town hall meeting and in every tweet and television commercial between now and 2018. If Democrats can't turn that to their political advantage, they don't deserve to win elections.

The art of dealing with Trump is to offer him a deal his ego can't refuse. It's not a whole lot more complicated than that.

Pearlstein is a Washington Post business and economics writer. He is also a professor of Public Affairs at George Mason University.