How to tax the ultrarich? With the Democrats’ once-expansive policy agenda shrinking under the pressure of impossibly slim congressional majorities and sagging approval ratings, hopes of overhauling the tax system or reversing the Trump tax bill appear all but lost. But there may be space to introduce a new form of taxation designed to affect not just the wealthiest Americans, but a specific stratum of them — the ones that don’t pay taxes very frequently under the current system.
President Joe Biden, in his proposed budget released this week, took a swing at a “billionaires tax,” a kind of supercharged capital-gains tax that would impose a minimum 20 percent tax on those whose net worth was over $100 million on income that comes from all sources, including unrealized capital gains. In order to get around questions of constitutionality, it would function essentially as prepaying capital-gains taxes against their eventual realization.
This comes on the heels of a raging debate in the Democratic Party over how, exactly, to get the ultrawealthy to pay more in taxes. Part of the problem with taxing the superrich is that they tend to generate little taxable income and instead accrue wealth by the appreciation of their assets. They can furthermore borrow against these assets, generating cash flow to spend without paying taxes.
“The level of ultrawealth has exploded as knowledge that we’re not taxing those gains has taken off,” said David Gamage, an Indiana University law professor and former Treasury Department official.
Liberal law professors, economists, policy wonks and elected officials have been trying to address this set of issues for years, not settling on a single approach. Two legal scholars who wrote an influential digest of ways to tax the very rich are now in the Biden administration. A prominent scholar of inequality and taxation, Danny Yagan, is the chief economist of the Office and Management and Budget, and Natasha Sarin, a tax scholar who has done research on how much tax revenue can be gained with a better-funded and more effective Internal Revenue Service, is a senior Treasury official.
And there is no shortage of ideas in Congress. Sens. Elizabeth Warren (D-Mass.) and Bernie Sanders (I-Vt.) have proposed a wealth tax (which may run into constitutional issues); Senate Finance Chairman Ron Wyden (D-Ore.) has proposed a capital-gains tax that would affect unrealized gains every year (which Democratic West Virginia Sen. Joe Manchin was iffy on).
But why the focus on the very, very wealthy? The White House estimates that about half the revenue from the tax will be generated by billionaires. In short, this is a tax designed to hit as few — and as wealthy — people as possible.
“Capital gains are an untapped revenue opportunity: the super wealthy (families with net worth in excess of $50 million) currently hold $8 trillion in unrealized (untaxed) capital gains,” Yagan — alongside University of California, Berkeley, economists Emmanuel Saez and Gabriel Zucman — wrote in a paper before he joined the White House.
The wealthy make money differently — and that makes it harder to tax
“Tax experts have generally known that mega-millionaires and billionaires mostly escape the income tax system for most of their wealth for a long time,” Gamage said.
They can then pass these assets on to their heirs after death, at which point the unpaid capital-gains taxes are zeroed out thanks to the “step-up in basis,” or “stepped up basis,” which allows estate beneficiaries to rest the value of an asset without paying taxes on its past appreciation.
“If you hold gains for a long time and give those gains to your kids, the current system doesn’t tax them at all. That’s a clear gap in the tax code,” said Owen Zidar, an economist at Princeton University.
When the investigative news organization ProPublica was able to get its hands on leaked tax data from some of the wealthiest people in the country, it exposed just how tax-resistant they could be. For George Soros, Michael Bloomberg, Elon Musk and Jeff Bezos, just to name a few, federal taxation was hardly an annual occurrence despite massive gains in their wealth. The report generated outrage, but what these wealthy individuals were doing is well within the legal tax code.
Zucman, who, with French co-authors Thomas Piketty and Saez, is one of the leading scholars of the very, very wealthy, has estimated that 10 of the wealthiest Americans would pay $215 billion in taxes under the Biden plan.
“I think the general understanding and agreement among almost all of us is that taxes on capital income have really come down over recent decades. People have been looking at taxing capital more to address that while inequality has been going up,” said Zidar.
Making a new tax is hard
The Biden administration’s approach is, admittedly, a complex and narrowly targeted one. But that may reflect the difficulties of translating an issue that typically polls well and Democrats like to run on — taxing the rich — into actual policy.
Traditionally, when it comes to taxing the wealthy, Democrats have looked to raise existing taxes — income taxes, capital-gains taxes and corporate taxes. Biden’s tax plan that he campaigned on included elements of all of three of these, including reversing some of President Donald Trump’s 2017 tax reform. At least so far, these proposals have not survived contact with Congress — and specifically Democratic Arizona Sen. Kyrsten Sinema. And the recent proposal would address a kind of income that the current tax system struggles to identify and tax.
There are two major issues for taxing unrealized capital gains. One way of doing so is to tax wealth — the difference between assets and liabilities — directly. This approach may run into a constitutional issue — the 16th Amendment, which allows for the direct taxation of individual income, is specific to incomes. While the scope of taxing power is hardly a settled issue, a direct wealth tax would face, at best, legal uncertainty in its implementation. The second issue is more practical.
Realized capital gains — the money that individuals earn when they sell an asset for more than what they bought it — are relatively simple to assess. Unrealized capital gains would require the Internal Revenue Service to do the tricky work of trying to value private businesses. According to estimates provided by Yagan, Saez and Zucman, among those with net worth over $100 million in the U.S., almost three-quarters of their unrealized capital gains come from either real estate or shares in private businesses.
But, some tax experts argue, taxing unrealized capital gains is the key to getting the ultrawealthy to make taxation more than an occasional event.
After all, higher income taxes hit only those who pay income taxes, and while those who pay the highest rates are wealthier than average, they’re hardly the whole universe of the ultrarich.
“There are some small number of mega-millionaire and billionaire who have primarily salary incomes, those folks would not be affected by this,” Gamage said. “This does not focus on mega-millionaires and billionaires who are paying high tax rates, it focuses primarily just on mega-millionaires and billionaires who are paying low taxes under current law.”
Thanks to Lillian Barkley for copy editing this article.