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What is the Billionaire Income Tax in the US and How Would It Work?

Editor, TRANSFIN.
Oct 27, 2021 2:09 PM 7 min read
Editorial

The US Capitol is bustling with more activity than usual these days.

The Build Back Better Act, a component of the Joe Biden administration’s massive infrastructural overhaul of the American economy, is currently being considered by the House of Representatives.

The legislation passed the Senate on August 10th, but has since then been stuck in a “strategic pause” due to opposition by Republicans and also deep fissures among Democrats. With President Biden slated to leave for the COP26 climate conference soon, House Democrats hope to pass the spending package - which includes diverse provisions from healthcare to climate action - within this week.

However, doing so will be an uphill task. One reason is that the contents of the package have split Democrats, in particular irking the centrist ones. These disagreements have already caused the legislation to be trimmed down from $3.5trn to $2trn.

The second reason pertains to how Democrats seek to pay for the package. In part, this might result in the rewriting of the tax code and the very redefinition of what the US government considers to be “income”. 

Enter, the Billionaire Income Tax

The original text of the Build Back Better Act included a corporate tax rate hike from 21% to 26.5% and an increase of the individual tax rate on the wealthiest Americans to 39.6% (for income) and 25% (for capital gains).

The expected increase in tax revenue, it was projected, would pay for the package. However, accommodating the apprehensions of centrist legislators meant these tax proposals had to be scrapped. The Democrats then conjured a new tax proposal - the Billionaire Income Tax - in part a last-minute Hail Mary to ensure the additional revenues needed to pay for their bill.

The Billionaire Income Tax is essentially a tax on the unrealised capital gains on the assets of the most wealthy Americans.

Let’s break that down...

 

How the Billionaire Income Tax Would Work

Unlike personal income taxes or corporate taxes, capital gains taxes (aka “unearned income”) are not paid periodically. They are paid only after the underlying asset - equities, real estate, bonds, art etc. - is sold. Taxing unrealised capital gains involves imposing levies on the appreciation of the value of an asset over a certain period even before it is sold.

Significantly, this new tax, which is also being referred to as the Wyden plan after the Senate Finance Committee Chairman Ron Wyden, would not be universal. It would be aimed at only the wealthiest Americans - those with over $1bn in assets or three straight years of income over $100m - which would mean about 700 or so individuals.

Sample Scenario: Say a billionaire X owns $1bn of a stock on January 1st. If by December 31st the value of X’s stock increases to $1.5bn, they would have to pay a capital gains tax on the added $500m even if they don’t sell their stock. Ergo, the $500m is an unrealised capital gain. (The exact billionaire tax rate has still not been determined, but the top capital gains rate in the US is 23.8%.)

FYI: Why are we in India even talking about this? Because a) if this move spooks investors, they might be encouraged to amp up their foreign holdings, which could work well for emerging economies like India’s, and b) tax policy is fun!

If passed, the Wyden plan would fundamentally alter the very definition of “income” in the US. Proponents of the plan argue that one of the most (un)popular ways the wealthy evade taxes is by buying large chunks of intangible assets and taking out huge loans based on the same and paying only levies on dividends and other cash payments from the asset. A billionaire tax on the incremental wealth acquired from these assets would plug this loophole (to an extent). Critics contend the measure is difficult to implement, might lead to unintended consequences, and may even be unconstitutional.

Let’s look at the Wyden plan via three lenses: practicality, viability and unintended consequences.

 

Practicality

Assets like art and real estate are not exactly liquid. So to pay for a billionaire tax on the same, the individual would have to take out cash separately. Moreover, such assets would then have to be appraised each year.

Coming to stocks, the US is in a bull market right now, but the bears will come knocking sooner or later. There is a tentative proposal to claim unrealised losses as deductions - but how exactly this would work is still unclear. Also, billionaire CEOs would have to routinely sell portions of their holdings in their own companies to pay the levies. Which is a concern unless you're someone like Mark Cuban or Jeff Bezos, awash with liquidity.

There’s also the question of effectiveness. The Billionaire Income Tax is expected to bring in only $200-250bn, while even the diluted infrastructure bill has a $2trn price tag. “It doesn't produce that much money," as Pelosi herself admitted.

Complexity is an issue too. Will the billionaire income tax rate be a blanket one or vary by asset? If it’s the latter, people would have to determine their obligations by assets - which, again, would vary annually - making tax-paying an onerous task for those with complex, multiple holdings.

What is the Billionaire Income Tax in the US and How Would It Work?Besides, capital gains taxes are notoriously irregular, unlike taxes on sales or income. After all, these gains are based on stock market performance, which is subject to volatility. Just compare the tax revenues collected by California and Florida (H/T Aswath Damodaran). Californian coffers are highly reliant on capital gains (it treats them like conventional income) while Florida is much less exposed. As the chart above shows, the former’s tax revenues are more unpredictable than Florida’s.

 

Viability

This has to do a lot with politics. Fairly or unfairly, the Wyden plan is being characterised as a “wealth tax”, referring to the much-maligned and much-controversial earlier tax proposal by Senators Elizabeth Warren and Bernie Sanders to impose a blanket tax rate on all wealth, not just income or capital gains, of the richest Americans. This idea has often been portrayed as “socialist”, which can be a death-knell in 21st century Washington DC.

And it hasn’t helped that even Democrats seem to be on different pages on this issue. House Speaker Nancy Pelosi on Sunday said, “We probably will have a wealth tax,” even as Treasury Secretary Janet Yellen has repeatedly denied that the Wyden plan is one.

How the new tax is framed is also vital because it will likely face legal challenges. As a capital gains levy, it is on stronger ground than as a wealth tax.

And as with any tax proposal, there’s the looming risk of loopholes. The handful of people targeted by this proposal are the uber-rich, who have armies of tax lawyers working for them to fish out any possible legal gaps to evade taxes. Billionaires like Jeff Bezos, Warren Buffet, Elon Musk etc. Already pay little to nothing in income tax compared to their massive wealth. But then again, such behaviour is fostered by a broken system - one that enables the effective tax rate for the wealthy to be a mere 8.2%, much lower than that for average taxpayers (not counting unrealised capital gains, this number rises to 26%).

A Billionaire Income Tax would naturally have a threshold to demarcate eligibility: and this will incentivise the usual suspects to rearrange their assets in a way that they remain below that threshold.

 

Unintended Consequences

For what it’s worth, the Wyden plan is a unique and fresh solution for America’s very-real tax problems. But to be fair, there is some historical precedent one could study. In 1969, Uncle Sam introduced the alternative minimum tax (AMT), a levy on top of the income tax, which was aimed at making high-income taxpayers shell out their fair share (sound familiar?). It became the epitome of unintended consequences. Due to inflation, wage increases and cuts in ordinary tax rates, the number of households owing AMT jumped from 200,000 in 1982 to 5.2 million in 2017 - and could rise to 7 million by 2026!

Which is a concern with the Billionaire Income Tax - that it could lead to, for lack of a better phrase, trickle-down taxation. At least in the long run. 

 

Grumbling About Greenbacks

Naturally, rich Americans are not happy about the Wyden plan. Case in point - Mr. Musk:

What is the Billionaire Income Tax in the US and How Would It Work?And it seems as if the wealthy saw this coming. By July-end, US households worth at least $1m had reported $22bn more in capital gains and/or losses YoY to exploit (the relatively modest) existing rates before an anticipated increase.

But they can hold their diamond-studded horses for now at least. Even if the Billionaire Income Tax sees light (and that’s a big “if”), it would face numerous constitutional and bureaucratic challenges before actually being implemented, giving the wealthy ample time to sharpen their tax evasion swords. Perks of having a fractured polity.

FIN.
 

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