Senator Ron Wyden (D-OR) has released details of his proposed tax on billionaires, which would function as a mark-to-market tax on the accrued capital gains of the wealthiest Americans. This proposal, though more limited in the number of taxpayers affected than past mark-to-market proposals, would be more expansive in that it would effectively account for unrealized capital gains retroactively as well as prospectively. That, along with the significant administrative issues inherent in determining tradable vs. non-tradable assets, potential economic harms, and looming questions of constitutionality, make this an inadvisable tax proposal.
The tax would fall upon any taxpayers making more than $100 million in annual income or with a net worth of over $1 billion for three consecutive years. Once a taxpayer meets these conditions, they are subject to the tax until they drop below $50 million in annual income and $500 million in net worth for three consecutive years. Wyden estimates that it would affect roughly 700 taxpayers.
Under the proposal, affected taxpayers would see their tradable assets, such as stock in publicly-traded companies, “marked to market” each year. That means taxpayers would pay tax on the on-paper gains in value such holdings enjoyed. The first year the tax is in place, affected taxpayers would have to pay tax on unrealized gains going back to when the asset was first acquired, likely leading to significant tax bills. Because this will lead to massive initial tax bills for the very wealthy, affected taxpayers would have five years to pay this initial hit.
For non-tradable assets, such as real estate, affected taxpayers would not have to pay tax on annual unrealized gains. Instead, when these assets are sold, affected taxpayers would face an additional interest charge, or “deferral recapture amount,” on top of the capital gains tax. This would be equal to the Applicable Federal Rate (AFR) plus one point.
Like other mark-to-market proposals, this version entails significant drawbacks. Major administrative concerns, such as defining “tradable” vs. “non-tradable” assets, remain unresolved or are subjected to administrative discretion. Though there is an attempt to define the terms, assets that do not strictly fall under the definition of “tradable” can be defined as such by the Secretary of the Treasury if they so choose.
That would likely lead to a significant investment bias towards non-tradable assets. There is little reason for the tax code to treat stocks and mutual funds more aggressively than privately held business interests, yet the wealthiest investors would be incentivized to put their savings towards the latter over the former. This could lead to less investment in traditional publicly-held companies and more investment in more volatile assets like art or non-fungible tokens.
And while Wyden makes an effort to address concerns about how taxes on unrealized gains would lead to successful entrepreneurs being forced to liquidate their controlling interest just to pay their tax bill, concerns should remain. Under his proposal, entrepreneurs could treat up to $1 billion of tradable stock in a single corporation as a non-tradable asset, preventing them from having to pay tax on unrealized gains.
Nevertheless, the potential to have to pay tax on unrealized gains for a rapidly-growing start-up could lead to successful start-up unicorns delaying their IPOs. And even with the ability to designate stock in one business venture as non-tradable, successful entrepreneurs could also face the same concern should they launch a second or third successful venture.
And even with the five-year allowance to pay the initial tax bill, billionaires would likely have to liquidate large amounts of their stock holdings to pay taxes on accumulated gains. Mark Zuckerberg, for example, owns about $125 billion worth of Facebook stock alone, all of which are capital gains. Subjected to the 23.8 percent long term capital gains tax rate, Zuckerberg’s Facebook holdings would be liable for about a $30 billion tax bill. Even stretched over five years, this would require Zuckerberg to sell large amounts of Facebook stock in ways that could potentially be destabilizing to the company.
To a progressive, that may well be the point. But for a billionaire to have to flood the market with that many shares, let alone a few hundred of the country’s wealthiest business owners, will create major market disruptions. Not only could it tank the market as stock prices drop and investors panic-sell, so many high-value shares being sold at once would also suck away investment capital from other areas of the market.
One final irony: Wyden’s proposed treatment of capital losses, though handled better than it perhaps could have been, is illustrative of the hollowness of progressive complaints about loss deductions. Wyden would allow taxpayers with unrealized capital losses to either carry forward the losses to offset future gains, or carry them back to offset past mark-to-market taxes paid. Whether this would lead to billionaires receiving refund checks from the government for past taxes paid or paying little to no tax in years with gains due to carried forward losses, progressives would doubtless be as upset as they are when net operating loss deductions cause low corporate tax bills.
Investors would also have a stronger incentive to engage in loss harvesting. As losses appear to be unlimited, investors close to the threshold to qualify for the billionaire’s tax would have an incentive to try to reduce their annual income through buying up unproductive investments. The marginal loss may well be worth it to investors to avoid facing the mark-to-market system and surtax on non-tradable assets.
All told, this eleventh-hour proposal to wholly overhaul how the wealthiest Americans are taxed should be left on the drawing board. Rather than resorting to fantastical tax proposals to raise enormous sums of revenue, Wyden should consider that perhaps taxpayers cannot afford to cover the ever-rising price tags Democrats are demanding.