Ron Wyden (D–Ore.), chairman of the Senate Finance Committee, has released the text of his proposed “Billionaires Income Tax Act”. It’s a mere 107 pages, a trifle over 20,000 words, and I’ve felt no impulse to do more than browse through it. The Wall Street Journal summarizes the high points, and I’ll summarize its summary, supplemented by dipping occasionally into the bill itself:
Senator Wyden aims to tax unrealized capital gains as they accrue, a huge change from present law, which taxes gains only when taxpayers realize them in sales, exchanges or other taxable transactions. Commentators have noted how tricky it is to tax gains that may prove transitory (asset values go down as well as up) and will often be hard to calculate (many assets don’t trade in liquid markets). Senator Wyden has made an effort to overcome these formidable difficulties, which is why his bill is novella length.
The tax would be imposed on anyone who, for three consecutive years, had net worth of over one billion dollars or adjusted gross income of over $100 million. Once a taxpayer fell into this disfavored class, he would remain in it until his net worth fell to $500 million or less and his AGI to $50 million or less and remained below those levels for three consecutive years. These thresholds are not indexed. We can thus anticipate, especially as Bidenflation takes hold, that the 700 “billionaires” reportedly subject to the new tax will eventually have lots of company, albeit probably not (we hope!) as much as the 155 individual taxpayers who initially had to pay the alternative minimum tax; their number grew to 5.1 million.
There would be two distinct regimes, one for assets that are traded on established markets, such as shares of public companies, and one for nontraded assets.
The net increase in fair market value of traded assets would be taxed annually at the maximum long-term capital gain rate (20% plus a 3.8% Medicare tax). In the first year in which an individual became subject to the tax (2022 for a Bezos, Musk or Zuckerberg), he would be allowed to spread payment over five years.
A net decrease in the value of traded assets could be carried back for up to three years to offset past gains and obtain a refund of capital gain taxes previously paid. The loss could also be carried forward indefinitely to offset future realized or unrealized capital gains and $3,000 a year of ordinary income. (When the limit on the ordinary income offset was increased from $1,000 to $3,000 in 1970, it wasn’t quite so nugatory: the equivalent of about $22,000 today.)
Gains on nontraded assets would be taxed only when realized, as under current law, but the definition of “realization” would be expanded to include gifts, bequests, transfers to irrevocable grantor trusts and various other transactions that ordinarily aren’t taxable (with an exception for transfers to spouses). Also, the tax rate would increase above 23.8% as the asset’s holding period increased, up to a maximum of 49%.
Those are the basics. The rest of the 107 pages are devoted to closing every loophole and work-around that Senator Wyden’s staff could imagine. You may be sure that by next Monday Mark Zuckerberg’s tax lawyers will have devised half a dozen schemes that are beyond the imaginative capacity of Congressional staffers, spurring yet more pages of statute in the future.
A couple of economic effects of this tax structure are predictable and will have an impact well beyond the small circle of ultra-wealthy targets.
First, the taxes assessed in 2022 will be gargantuan, which is why payment will be allowed over five years. After 2022, if the economy doesn’t fall into permanent stagnation (a scenario that shouldn’t be ruled out; President Biden’s policies could usher in a period that will make Japan’s lost decade look like exuberance), entrepreneurs will continue to found companies that grow from almost nothing to multi-billion dollar valuations in a short space of time. Even with five years to pay the tax, the 2022 and later billionaire cadres will face urgent needs for cash. They may avoid the tax for the moment by refraining from taking their companies public, a strategy that will make it harder to raise capital for further expansion and will also increase their eventual tax rate. Alternatively, they may go public and begin selling their personal stock holdings to raise money to cover tax liabilities. The latter course will exert a steady downward pressure on the stock price, to the detriment of other stockholders and the company’s future prospects.
Second, government revenue from the tax will fluctuate convulsively. The three-year loss carryback means that a broad stock market decline, like the one in 2008, could lead to multi-billion dollar tax refunds to men like Jeff Bezos at the very time when the federal fisc was most severely strained. Conversely, stock market booms will produce high but short-lived revenue streams, which, unless legislative habits alter radically, will be drawn on to establish programs whose expenditures will continue and swell after the boom has faded. California, which relies heavily on capital gains taxes to fund its government, illustrates how hard it can be to budget rationally when income is unforeseeable.
From a lawyer’s point of view, the most interesting question about taxing unrealized gains is whether it is permitted by the Sixteenth Amendment. If not, that is, if unrealized gains are not income within the amendment’s meaning, any tax levied on them is subject to the Constitution’s requirement that direct taxes be apportioned among the states by population (Art. I, sec. 9, cl. 4). The question is interesting enough that I’m going to ponder it longer before offering a definitive opinion. Here are a couple of preliminary observations:
The starting point should be Merchants’ Loan & Trust Co. v. Smietanka, 255 U.S. 509 (1921), in which the Supreme Court held that realized capital gains are “income”. The decision’s originalist analysis strongly implies that income arises only as the result of some act or transaction. Id. at 520. A later case, Helvering v. Bruun, 309 U.S. 461 (1940), refined that concept by holding that it was constitutional to tax the gain a landlord realized when he recovered real estate whose value had been increased by the tenant’s improvements. This case has been cited for the proposition that realization isn’t a necessary component of “income”, but that hardly seems consistent with what the Court itself said:
Here, as a result of a business transaction, the respondent received back his land with a new building on it, which added an ascertainable amount to its value. It is not necessary to recognition of taxable gain that he should be able to sever the improvement begetting the gain from his original capital. If that were necessary, no income could arise from the exchange of property; whereas such gain has always been recognized as realized taxable gain. [Id. at 469 (emphasis added)]
As an interesting sidelight, the legislature of my home state of Washington recently enacted a tax on realized capital gains. The state’s Supreme Court held long ago that income taxes violate the state constitution, unless the rate of tax is completely uniform. Culliton v. Chase, 174 Wash. 363 (1933). A lawsuit challenging the new tax is moving forward. The state doesn’t deny that the tax isn’t uniform. (It exempts gains on various classes of asset, such as personal residences, whose taxation would have led to legislators' donning coats of tar and feathers.) The argument in defense of the statute is that taxes on realized gains aren’t taxes on income. Meanwhile, Senator Wyden argues that unrealized gains are income. One must twist one’s mind into knots to be a true progressive these days.