Citing inequality and the perception that the wealthy don’t pay their fair share of taxes, Joe Biden made two promises during his presidential campaign: he would not raise taxes on anyone making less than $400,000 a year in income, and he would ensure that the top 1.8 percent of the population, as well as corporations, pays up. Hence the administration’s infrastructure and social-spending legislation raised a significant portion of revenues from changes in tax rates for the wealthiest individuals—raising the top marginal tax rate from 37 percent to 39.6 percent, adding a surtax on capital gains for those making more than $1 million in income, and raising corporate tax rates from 21 percent to 28 percent. But after objections from Senator Kyrsten Sinema last week, these proposals ran aground.
Now a replacement proposal seems to be gaining traction: the billionaire tax, which appears to be targeted at the several hundred people who own more than $1 billion in assets or have had income of more than $100 million for three consecutive years. The intent is to tax unrealized gains on their assets each year.
Congress has an amazing capacity to write bad tax legislation, but this proposal sets a new standard. First, it’s micro-targeted. As a general rule, broad-based taxes—those affecting most people—are more likely to deliver predicted revenues than those that affect a narrow subset of the population. The billionaire tax is about as narrowly focused as tax law gets. One may have little sympathy for the 700 or so billionaires affected by these taxes, but one should also recognize that these individuals also have the most resources to minimize the effect of these laws. An army of tax lawyers, accountants, and investment vehicles is being created while the law is written, and that army may also be providing input on its actual form.
Next, the proposal seeks to tax capital gains and losses. The basis used for computing taxes can have implications for revenues from the tax code, ranging from sales (with value-added and sales taxes) and income to capital gains. Sales taxes will yield more predictable revenue for the government than income taxes, which will yield more stable revenues than capital-gains taxes. Capital gains come from stock-price changes, which are far more volatile than income earned by taxpayers. That income, in turn, changes more on a year-to-year basis than the value of the assets someone owns. California’s tax revenues, for instance, are significantly more volatile than Florida’s because the Golden State taxes capital gains as ordinary income.
The new feature of this law is its attempt to tax unrealized capital gains on assets. This raises two practical problems. First, liquidity: if the billionaire tax will apply to such assets as real estate and fine art and not just to stocks and bonds, it will be hard for the individuals being targeted to sell their holdings in the open market and get enough cash to pay, since these non-traded assets are often illiquid. Taxpayers owning non-traded assets will need appraisers to revalue these assets every year. That’s great for the appraisal business, but it’s almost guaranteed to create a hotbed of litigation around the appraised values. Second, despite a decade of rising stock and bond prices, assets can still stagnate or drop in value for extended periods. Some have talked airily of being allowed to claim unrealized losses as deductions, but how exactly would that work? And given legislators’ estimates that this tax will deliver about $200 billion in revenues, what are their assumptions about how the market will do over the next decade? Stocks and bonds have had a good run, but history suggests that extended bad times are inevitable. In the 2000s, stocks declined over the course of the decade; if that happens again, the billionaire tax may generate no revenue at all.
The proposal will also have side effects for other tax revenues. If paying the billionaire tax changes the tax basis for assets—as it should, since they are being marked to market and taxed—then when these stocks are ultimately sold, less in capital-gains taxes will be collected. If this proposal represents an attempt to circumvent the current inheritance step-up windfall, it does not fix the core problem. It would mean the billionaire tax merely moves forward the collection of taxes in time.
Ultimately, this is a wealth tax—albeit on incremental, not total, wealth. The administration’s effort to avoid using the words “wealth taxes” to describe this proposal is sophistry. Put simply, this proposal favors people with inherited wealth who are invested in non-traded assets and mature businesses and hurts people invested in publicly traded equities in growth companies, many of which they have started and shepherded to success. If that is the message that the tax law writers want to send, they should have the decency to be up front about it.
The history of tax law is a history of unintended consequences. The problem with this law is that the consequences are entirely predictable and mostly bad. You and I, though we are not in the billionaire’s club, will face them. If there is a billionaire tax on unrealized gains, some or even many of these billionaires will have to sell portions of their asset holdings to pay taxes due, pushing stock prices down. If you are an investor with a preference for founder-run companies because they have fewer conflicts of interest, you may see founders reducing their holdings sooner at these companies as a consequence of this law. I’m not sure how privately held businesses will be treated for computing the billionaire’s tax, but if the law contains a carve-out for these businesses or non-traded assets, some rich founders may well choose to take their companies private again.
For those who view the tax code as an instrument to deliver pain, the only consolation prize will be that punishment is being meted out to those who “deserve” it the most. That is a booby prize. Democratic lawmakers face a tough task, but good intentions about improving the safety net do not excuse the writing of tax laws that prove inefficient at collecting revenues, ineffective even in their punitive intent—and potentially dangerous for the rest of us.
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