The Worst Tax Code Change Ever
As I noted earlier, there may be changes that happen between now and when this gets voted on that help make it better, but as it stands, this is an extraordinarily bad tax proposal, and for many reasons:
- Micro targeting: Since very few of us to like paying more in taxes, but don't seem to mind seeing others paying more, the political payoff from targeting very few taxpayers is that you minimize the backlash. I know that each of us probably has a billionaire that we hate, and may take secret pleasure in watching that billionaire pay more, but if you view the prime role of taxes as generating revenues for governments, it is dangerous to focus raising tax revenues from this small a number. As a general rule, taxes that are broad based and affect most people are more likely to deliver predicted revenues than those that affect a narrow subset of the population, and the billionaire tax is about as narrowly focused as tax law gets. You may have little sympathy for the seven hundred or so billionaires affected by these taxes, but you should also recognized that these individuals also have the most resources to find ways to minimize the impact of these laws. In fact, not only is an army of tax lawyers, accountants and investment vehicles being created while the law in being written, but I would not be surprised if they are providing input on its actual form.
- Taxing capital gains (and losses): The basis used for computing taxes can have implications for revenues from the tax code, and that basis can range from sales (with value added and sales taxes) to salary/wage income, to capital gains. Rather than get into moralistic arguments about whether salary income is more virtuous than capital gains income (or unearned income, as its critics like to call it), I will focus on tax revenue reality. Taxes based upon revenues/sales will yield more predictable revenue for the government than taxes based upon salary income, and taxes based upon salary income will yield more stable revenues than taxes based upon capital gains. Capital gains come from stock price changes, which are far more volatile, than income earned by taxpayers, and that income, in turn, changes more on a year-to-year basis than the value of the assets they own. Without passing any judgment on which approach is better, consider tax revenues collected by California, a state that not only taxes all capital gains as ordinary income, but is also more dependent on capital gains than almost any other state, with tax revenues collected by Florida, a state without taxes on individual income: California's tax revenues are significantly more volatile than Florida's tax revenues, and capital gains are a big reason why that is the case. If you are in finance, and you were measuring the risk of different tax revenue sources, capital gains tax revenue would have a "higher beta" than "income tax revenues or sales tax revenues. It is true that prudent governments can find ways to put aside big portions of the capital gains tax revenues, in years of plenty, to cover shortfalls in years where capital gains tax collections are low, but when was the last time you saw prudent governance?
- Including "unrealized" gains: The new feature of this law is its attempt to tax unrealized capital gains on assets. The problem with taxing "unrealized" gains or income is that since they are unrealized, and taxes have to be paid with cash, the question of how to come up with the cash becomes an issue, making it a central challenge for any plan, built around it. In fact, there are two practical problems with the proposal, at least as described in the press.
- Liquidity questions: If the billionaire is going to apply on assets like real estate and fine art, and not just on stocks and bonds, the idea that you can sell some your holdings in the open market and get the cash you need to pay taxes does not apply as easily, since these non-traded assets are often illiquid and cannot be sold off in small parts. It will also mean that taxpayers who own non-traded assets will need appraisers to revalue these assets every year, great for the appraisal business, but almost guaranteed to create a hotbed of litigation around the appraised values.
- Losses and Gains: After a decade of rising stock and bond prices, I guess that many have forgotten that not only can what goes up come down, but also that you can have extended periods where assets stagnate or drop in value. While there is airy talk of being allowed to claim unrealized losses as deductions, how exactly would this work? Put simply, if stocks are up 20% in 2021 and down in 2022, would taxpayers get refunds on their taxes paid in 2021? It is also not clear what the tax code writers are assuming about what the market will do over the next decade, when they estimate that this tax will deliver about $200 billion in revenues, but are they assuming that the good times will continue? Stock and bonds have a really good run, but history suggests that there will be not just bad times, but extended bad times for markets:
There may be no revenues at all from this tax code change, if the market has a decade like the 1970-1979 or 2000-2009, and if that happens, what are the contingency plans for the expenditure that is being funded by these revenues?
- With side effects for other tax revenues: There is another point that I still not seen a response to, and that is the effect that this billionaire tax will have on revenues from other parts of the tax code, particularly estate taxes. If paying the billionaire tax changes the tax basis for assets, as it should since they are being marked to market, and taxed, that will also mean that when these stocks are inherited, and ultimately sold, there will be less capital gains taxes collected. If all that the billionaire tax code change is doing is moving forward the collection of taxes to earlier, rather than later, there is a time value benefit to the government, but it has to be a net benefit. In other words, the lost future taxes will have to be netted out against the $200 billion that it is expected to bring in revenues over the next decade.
- It is a wealth tax, albeit on incremental, not total wealth: For a few years, progressives led by Senator Warren have argued for a wealth tax, and its pluses and minuses have been debated widely. The administration is trying hard to avoid using the words "wealth taxes" to describe this proposal, but that is sophistry. Janet Yellen's claims notwithstanding, this is a wealth tax, albeit on incremental wealth, rather than total wealth. Put simply, this proposal is biased towards people with inherited wealth, invested in non-traded assets and mature businesses, and against people invested in publicly traded equities in growth companies, many of which they have started and built up. If that is the message that the tax law writers want to send, they should at least have the decency to be up front about that message, and to defend it.
Side Costs
If the history of tax law is that there are always unintended consequences, the problem with this law is that the consequences are entirely predictable and mostly bad, and you and I, even though we are not in the billionaire club, will face them.
- Price Effects: 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 dues. There is no way that an Elon Musk would have been able to pay taxes on the unrealized gains on his Tesla holdings in 2020, without selling a portion of his holding. While there may be enough liquidity in a stock like Tesla to absorb that selling, there are other assets where the liquidity effect is going to be larger and more permanent.
- Founder/Managers: One reason that investors prefer companies that have founders with substantial stock holdings running them is because they believe that there is less of a conflict of interest in these firms, than it those run by professional managers with little or now shareholdings. If this proposal is pushed through, and especially if the tax rate is set at capital gains levels, founders will have no choice but to reduce holdings over time, both to pay taxes and to shift to less traded assets.
- Public to Private: As I said earlier, I am not sure how privately held businesses will be treated, for computing the billionaire tax, but if there is indeed a carve out for these businesses, I will predict that there will be more companies where rich founders will choose to take the company 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, but I am afraid that it is a booby prize. With the billionaire tax, the intended targets will pay far less in taxes than you think they should and now that the door to unrealized profits being taxed has been opened, how do you know that you are not next on the target list?
Conclusion
I understand that those working on these tax code changes face a tough task, given the constraints that they have on them (not raising tax rates, not taxing people who make less than $400,000), but these are constraints that they imposed on themselves, either because too much was promised on campaign trails or because they are working with paper-thin majorities, where one hold out can stop the process.
The problem with the billionaire taxes is that it will be ineffective at collecting tax revenues, and I am willing to wager that a decade from now, we will find that it collected only a small fraction of its promised revenues. Good intentions about creating a better social safety net cannot excuse the writing of tax laws that are inefficient at collecting revenues, ineffective even in their punitive intent and potentially dangerous for the rest of us, in terms side costs.
aswathdamodaran.blogspot.com /2021/10/the-billionaire-tax-worst-tax-idea-ever.html
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fukk it. Throw the statist a bone.