President Biden’s “billionaire minimum income tax,” which the White House announced Monday as part of its 2023 budget, is a serious tax reform proposal. By proposing a major broadening of the tax base that would raise revenues for high-income households in a fair and efficient manner, this plan could solve many of the problems that have hampered previous approaches to taxing property income.
Currently, capital gains taxes are only levied when an asset is sold, not when an asset appreciates in value. This reconciles the payment of taxes with the money generated to pay those taxes. But waiting to tax until gains are realized from the sale of an asset has three major disadvantages. First, linking taxation to realization encourages people to hold on to assets. These gains escape tax at death, increasing the incentive not to sell and preventing the free flow of capital to those who can best use it.
Second, taxing realized gains is unfair because it allows two people with similar income or wealth to be taxed at different rates for arbitrary reasons. For example, if you hold stocks that are going up, they will be taxed less than similar stocks that aren’t going up but pay a dividend.
Finally, taxing only realized gains narrows the tax base and requires higher federal tax rates and more types of taxes to meet revenue goals.
Proposals to tax unrealized gains (or wealth directly) have raised political objections, implementation problems and constitutional concerns. Mr. Biden’s team thought through these questions and came up with the most workable proposal yet. The plan – which would only apply to households with net worth of $100 million or more – would impose a minimum tax of 20% on all income plus unrealized capital gains. The unrealized capital gains tax would be an advance payment of taxes that would be due on the future sale of the asset. Assets would be valued at their market value. If this is not available, the Treasury would use simple rules of thumb such as acquisition cost plus adjustment to determine market value. The upfront payments would be spread over five years, with no upfront payment required for taxpayers who mostly have illiquid assets. However, if a taxpayer is exempt because they have primarily illiquid assets, a deferral fee will be imposed on the sale of an asset, which would effectively increase the tax rate on capital gains to offset the benefit of the delayed tax payment. More than half of the revenue from this proposal would come from households valued at more than $1 billion.
The Biden plan cleverly addresses several issues with taxing unrealized gains. Forgoing upfront payments from those with predominantly illiquid assets would allow payments to be spread over several years and ensure that the tax does not force innovative founders to sell early, thus decoupling them from control of their business.
Also, by requiring people with enough liquid assets to pay tax on their unrealized illiquid gains and receiving a top-up payment for everyone else who sells illiquid assets, the plan would not artificially incentivize people to switch to illiquid assets to avoid the tax. Simple rules for calculating approximate returns on illiquid assets that the Treasury would mandate to develop — with a vote when an asset is actually sold — would make calculating prepayments much easier than calculating estate taxes, which require accurate valuations.
Mark-to-market taxes can create problems for people whose assets fall in value after December 31, leaving them with a phantom gains tax bill. Spreading tax payments over several years would solve this problem for most taxpayers, because if profits were eliminated, they would have paid only one-fifth of the taxes up front and would not be up to date with future tax payments.
Finally, shifting capital gains policy between administrations creates opportunities for avoidance. The upfront payment requirement protects this plan from future changes in capital gains and minimizes perverse incentives.
The Biden proposal deserves the same critical scrutiny that should be applied to anything that might become law. Clever tax lawyers may discover loopholes in the bill that need to be closed, or conversely there are ways to make capital taxation simpler and more flexible. The proposed interest rates, repayment periods and other parameters are a starting point and could ultimately be changed and combined and adjusted with other capital tax changes.
Tax reformers have long focused on broadening the tax base and minimizing distortions by treating different economic decisions in the tax code as similarly as possible, so that decisions can be made on economic grounds rather than tax ones. I believe the tax system should increase revenue in a more progressive way, and the Biden proposal is a great place to start.
Mr. Furman, Professor of Economic Policy at Harvard, served as Chair of the White House Council of Economic Advisers from 2013 to 2017.
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