Will Obama’s ‘middle-class economics’ hit inherited art?

Proposed tax reforms could make the rich feel less well-off—and less likely to spend on art

Corinna Kirsch

President Barack Obama has proposed a series of tax-code reforms that, if approved by the US Congress, could have a major impact on the art trade. His budget proposal focuses on “middle-class economics” and aims to shift tax breaks from the wealthy to the less well off. “Let’s close the loopholes that lead to inequality by allowing the top 1% to avoid paying taxes on their accumulated wealth,” Obama said in his State of the Union address on 20 January. His tax package aims to generate as much as $640bn in tax revenues over the next ten years.

One proposal is to close a loophole that enables beneficiaries to avoid paying fees. Art, among other inherited items, currently enjoys special protection because of the “stepped-up basis” loophole, which means that heirs do not need to pay capital gains tax on assets. For example, if a family member inherits a work originally bought for $1,000 and sells it for $100,000, he or she need not pay income tax on the $99,000 gain. (Income tax is separate from estate tax, which heirs do have to pay.)

If passed by Congress, Obama’s proposals “would have an enormous impact on collectors’ heirs”, says Donn Zaretsky, a lawyer at John Silberman Associates. The president wants the transfer of appreciated assets, including art, to be subject to capital gains tax, essentially treating gifts like a sale. Any increase in an object’s value between its purchase by a collector and his or her death would be taxed at a top rate of 23.8%, which Obama wants to raise to 28% for households with a shared income of more than $500,000).

“Without the more favourable tax treatment, [art] would become a less attractive investment vehicle,” says Kate Lucas, a lawyer at Grossman. Others, however, see reason for optimism, including the Wall Street analyst George Sutton of Craig-Hallum Capital Group, who believes that increased death taxes would encourage more people to sell during their lifetimes. “This would be a good thing for the supply side of the market,” he says.

A ‘haunted-house’ market

More generally, though, the tax proposals could result in the rich feeling less well-off than they have in recent years. This, in turn, could affect the art market, which has been benefiting from the increase in the number of super-wealthy people since the economic crisis of 2008. Since the recession, the number of people in the US with more than $1m in assets (excluding property) has grown to four million, and their combined estimated wealth is around $13.9tn, according to the latest annual World Wealth Report by Capgemini and RBC Wealth Management. Meanwhile, sales of art grew around 25% in value to an estimated €18bn between 2012 and 2013, according to the latest report by the economist Clare McAndrew for the European Fine Art Foundation (Tefaf).

The tax reforms proposed by Obama are intended to curb the growth of the wealthy at the expense of the less well-off. This may be democratically sound, though rich art collectors are unlikely to embrace the policies—especially since they come at a time of increasing volatility in the financial markets. Dan Loeb, the founder of the hedge fund Third Point, which is the largest shareholder in Sotheby’s, wrote to investors last month, calling 2015 a “haunted-house market”, where “a new scary event lurks around each corner”, and saying that he planned to be more cautious.

However, the wealthy need not panic about tax hikes just yet. The House and Senate budget committees will consider and make revisions to the president’s budget proposal by 1 April, and the majority of tax experts think that there is only a slim chance of its being approved by the Republican-controlled Congress. “These proposals have approximately zero chance of passing in Congress,” Donn Zaretsky says.

Appeared in The Art Newspaper Archive, 266 March 2015