Matt Rourke/AP Photo
Tesla CEO Elon Musk departs from the Justice Center in Wilmington, Delaware, July 13, 2021. Musk has spoken out against a proposed “billionaires tax.”
Last week, to pay for the priorities in the Build Back Better agenda, Senate Democrats proposed a “billionaires income tax,” which would require billionaires to report and pay tax on their investment gains—the primary source of their income. The reform would have closed one of the most glaring loopholes in our tax law, one that allows the richest Americans to live unimaginably lavish lifestyles without ever paying income tax.
Rather than focusing on these benefits, however, the press coverage centered on a litany of objections. Journalists framed the billionaires income tax as probably unworkable (Reuters), presumptively unconstitutional (Time), and a novel or even radical departure from the income tax as we know it (The New York Times and Fortune, respectively). Sen. Joe Manchin (D-WV) branded it “divisive”—a characterization reported uncritically across many sources.
We are tax law professors, not journalists. But we can say with complete confidence that the billionaires income tax is none of these things. Any honest discussion, in the context of ongoing reconciliation negotiations or further in the future, should begin with this context: The proposed tax is a partial fix within a system defined by complexity and unfairness, which has led to hourly wage earners and salaried professionals paying far higher rates of tax than billionaires.
The proposed reform is properly described as a localized fix, not a radical transformation.
That happens largely because of when income is taxed. With a few exceptions, income taxes only apply to investment profits when the investments are sold. That timing provides a crucial mechanism for Americans to build wealth, and a billionaires income tax would not change it for more than 99.99 percent of taxpayers. However, it also allows the ultra-wealthy to escape income taxes almost completely through a series of financial moves known as “buy, borrow, die”—basically, living off of unrealized investments indefinitely and passing on fortunes tax-free. As a result, scholars estimate that over three-quarters of the true capital gain income of the ultra-wealthy is never reported to the IRS.
The billionaires income tax would change when capital gain income is taxed for the richest 750 or so Americans. Instead of waiting for a formal sale of the asset, the reform would tax capital gains as they accrue, for traded assets like stocks and bonds. Current law already requires these very same methods for many derivatives, financial contracts, partnerships, forms of offshore income, and other assets. The proposed reform would simply apply existing accrual tax rules to the investment income of the wealthiest taxpayers.
That is properly described as a localized fix, not a radical transformation.
Would that fix be endlessly complicated or unworkable? Opponents claim that requiring annual reporting of billionaires’ true capital gain income would be difficult because it can be harder to measure increases in asset values prior to a sale. That might have been true generations ago, but it is not true today. Our most famous billionaires, such as Mark Zuckerberg, hold most of their wealth in the stock of publicly traded companies, whose value is established daily on the stock market.
For harder-to-value and illiquid assets, such as a mansion or a yacht, the proposed reforms would adjust the taxes owed upon an eventual sale to counteract the games that allow billionaires to escape tax under current law. Tax could still be deferred for these assets, but only until billionaires take actions to monetize their accrued gains. At that time, an interest charge and related anti-abuse rules would apply to make the tax due equivalent to that for traded assets. Most importantly, the reforms would close the many loopholes that billionaires currently use to access their accrued gains prior to sale while escaping the income tax.
These rules would involve some complexity, but would also eliminate complexity in the current income tax, with the sophisticated tax structuring that billionaires deploy to take full advantage of its loopholes. Even opponents of the billionaires income tax concede it would be hard to avoid. The immense resources poured into excessively complicated organizational structures and transactions designed for tax avoidance could be put to more productive use. These new tax rules may not work perfectly, but they offer a vast improvement over the current system.
Is it constitutional? Coverage that assumes not, or suggests that a challenge would be likely to succeed (Politico), are ignoring decades of well-established law. To strike down this reform, a court would have to declare it an “unapportioned direct tax,” an archaic and technical designation that has only been applied a handful of times in our history. Some have wondered whether a “wealth tax” could fall in that category, but even if that were so, the billionaires income tax is not a wealth tax—it is a tax on capital gain income.
The 16th Amendment expressly authorizes Congress to tax incomes “from whatever source derived.” The proposed reforms simply redefine, for purposes of the income tax, when capital gains should be included in reported income. The Supreme Court has rightly and repeatedly held that the 16th Amendment authorizes taxes on capital gains even prior to any sale. We would expect it to do the same here.
Finally, suggestions that the billionaires income tax is widely divisive are disingenuous. While “divisive” is a subjective label, the preponderance of available polling suggests the proposed tax would be anything but.
To the contrary, polls show that Americans view the current income tax system, which effectively sets one set of rules for the ultra-wealthy and another for everyone else, as much more divisive. A bipartisan supermajority of Americans find it unfair that today’s billionaires can mostly escape the income tax. Economic inequality has exploded over recent decades, and even more so during the pandemic. Jeff Bezos and Elon Musk saw their net worth skyrocket by a combined $217 billion in 2020. In 2021, both literally rocketed into low-orbit space. No wonder that, back on Earth, more than 70 percent of likely U.S. voters support taxing the ultra-wealthy to fund vital, popular investments—the agenda to build back better.
The billionaires income tax is not radical, unworkable, or unconstitutional. It is a sensible solution to close the most glaring loophole in the tax code, and to ensure that all taxpayers play by the same rules. The next time it is considered, American taxpayers deserve a more honest debate.
