This week, we have a returning guest co-author: Michael Linden is a senior policy fellow at the Washington Center for Equitable Growth. He previously served in senior roles at the White House Office of Management and Budget and on two Senate committees.
Unlike most weeks, there’s been quite a lot of attention on wonky tax law recently. Yesterday, for example, Vice President Harris announced on the campaign trail a set of policies that included a higher tax rate on capital gains than what we have now—though, notably, lower than what President Biden embraced. More excitingly and significantly, she also affirmed her support for something called the "Billionaire Minimum Tax," a new policy that would begin to change the underlying structures of our tax code in a more equitable direction while also raising significant revenue.
Most Americans believe that the rich do not pay their fair share in taxes. In fact, more Americans are concerned that the rich are paying too little in taxes than are concerned that they themselves are paying too much. The American people are right.
When it comes to taxes, the ultrarich really are different and really are getting away with paying extremely low tax rates. One recent analysis found that the average federal income tax rate for America’s 400 wealthiest families was only about 10 percent. That’s far lower than many middle-class families pay.
This imbalance is not an accident: It’s a feature of the current tax code. While the wealthy and their accountants certainly know their way around many a loophole, the main reason the ultrarich can enjoy these extremely low tax rates is because of how the tax code purposefully treats capital income.
Capital income is derived not from working a day job earning a wage or a salary, but from owning an asset like a stock, a piece of property, or a business. While many middle-class families have a small amount of such income—usually in the form of a primary residence or a retirement account—capital income is heavily concentrated at the very top of the income distribution. Among the wealthiest 0.01 percent of Americans, 70 percent of their income comes from capital, compared to less than 3 percent among the bottom four-fifths of American households. For every $1 ultrarich taxpayers make in wages, they make more than $5 in capital income. In other words, the superrich are superrich because of capital income.
And capital income—by and large—gets enormous tax preferences. As a start, the tax rates on capital gains, business, and corporate income are all simply lower than they are for wage income. But even more important is the fact that rich people can defer paying any taxes on their capital gains, sometimes indefinitely. In other words, they get to choose when—and even if—they pay taxes on a huge portion of their income.
That’s because, in our current system, the tax on an increase in the value of a capital asset is only assessed when the asset is sold. And if that asset is passed on to an heir, the increase in value of that asset is never taxed at all. Indeed, rich people can and do employ a range of techniques to reap the benefits of an increase in their net worth while avoiding selling their assets and thereby triggering the tax.
There’s even a widely used term for this in the financial planning world: buy, borrow, die.
Rich people buy an asset. It increases in value, allowing them to borrow money against it at extremely low interest rates; and then, when they die, they pass the asset on to their heirs and the gain is never taxed. Buy. Borrow. Die. That’s how we end up with billionaires enjoying massive annual increases in their net worth and paying a tiny fraction of those increases—if any—in income taxes.
We’ll illustrate with one example: Philanthropist John Donahue owned the most expensive house in the US. He purchased the land it’s on in Naples, Florida, for $1 million in 1985. Donahue and his wife passed away in 2017 and 2022, respectively, leaving the home to their family, who have listed it for sale at an asking price of $295 million. When the house and its “yacht basin” sell, the Donahue family will have made nearly $300 million in profit. But for tax purposes, they get to treat the property as if they bought it two years ago when they inherited it. And as a result, the official “gain” for tax purposes will be nearly zero, and they will owe almost no taxes on hundreds of millions in income.
President Biden proposed a solution to this problem.
Well, actually, he proposed a set of solutions, but one in particular is worth diving into: The Billionaire Minimum Tax. Under the proposal, anyone with at least $100 million in net worth (all ~10,000 of them) will have to pay a minimum of 25 percent in income taxes on all of their annual income, regardless of whether all of that income was “realized.” This proposal would create a backstop against the ability of the superrich to avoid paying income taxes and ensure that, at a minimum, they are not allowed to pay lower real tax rates than middle-class families. This is a commonsense and elegant solution (and one that even arch-conservative Art Laffer supported, not to mention 59 percent of voters).
Think of it like “withholding” for billionaires. When we get our paychecks every few weeks, our employer holds a little bit back to send to the federal government to put toward our eventual income tax bill. That’s effectively what the Billionaire Minimum Tax (BMT) would do for capital gains income for the absolute richest people in the country. Under the current system, the ultrarich are supposed to pay taxes on those capital gains eventually, but they don’t have to pay as they go, like everyone else. With the BMT, they will essentially prepay some of those taxes each year instead of getting to defer their payments until the time of their choosing—which, in many cases, is never. We don’t get to choose whether we pay the IRS our fair share in 10 years or never, so why should billionaires?
That said, every new proposal—even one to address a long-standing problem—is bound to raise some reasonable questions and concerns. So let’s address them!
When the rich get richer, that’s income.
Fundamentally, income is simply the new resources that you have every year that you can use to spend on consumption, save, or pay down debt. For most people, income is very clear and simple—it’s your wages. Rich people, however, get richer in a variety of ways, but it’s all still income, whether it has been realized or not. That is the reason why economists, regardless of ideology or political leanings, have traditionally included unrealized capital gains in the fundamental definition of income.
And more importantly, from a practical standpoint, we know that an increase in a rich person’s portfolio can and does translate into their ability and willingness to spend money. Jeff Bezos’s annual salary is just $82,000. But it would be ridiculous to say that his total income was only $82,000 last year, when his net worth increased by $70 billion! His ability to deploy economic resources did not go up only by $82,000. It went up by $70 billion. That’s income.
The Billionaire Minimum Tax is designed to handle both gains and losses.
Stock prices and asset values are bound to jump around a little. Usually they go up—the very rich tend to get richer—but sometimes they do go down. Fortunately, the structure of the BMT specifically takes this into account. Essentially, any losses are deducted against past gains, so the billionaire will only pay the minimum tax on their net gain. After all, that’s really the point of the tax, to ensure that the very rich are paying taxes on their income, and losses reduce their income.
In most cases, this won’t even require refunds because those subject to the tax pay their minimum tax over five years in equal installments. So even in a very good year for them, they are only paying one-fifth of what they owe, which means that even if their next year is bad, they almost certainly haven’t “overpaid.”
Let’s consider a somewhat stylized example. Bill Gates owns about 100 million shares of Microsoft stock. Over the course of 2023, that stock increased in value by about $134 per share, yielding Gates an increase in his net worth of roughly $13.4 billion. Imagine, therefore, that his BMT liability would be about $3.35 billion for 2023 (in real life, his BMT liability would be different than that, because any ordinary income tax he paid would be subtracted from his BMT, and because he likely has other income streams, but let’s keep it simple here). Gates would only be required to pay one-fifth of that amount in the first year, so about $700 million. Now imagine that this year, Microsoft’s stock dropped by $40 (it’s actually up by $40 right now). Gates’s net gain would be $9.4 billion, rather than $13.4 billion, so his BMT liability would also have gone down by $1 billion. And because he would only have paid a fraction of his liability the year before, in this hypothetical, he hasn’t overpaid his taxes and doesn’t require a refund. He simply has a lower BMT liability going forward. He’s still up by over $9 billion, so he still owes tax on that income, but the BMT has adjusted. In the rare case that losses are so huge that they wipe out previous gains and the billionaire has overpaid, the BMT would issue a refund. BMT refunds would be far less common than ordinary income tax refunds, which occur for roughly 65 percent of taxpayers.
Fairer capital income taxation is good for the economy.
The present system of preferential tax treatment for capital income is economically counterproductive, in addition to being simply unfair. Billionaires are incentivized to hold on to their assets instead of selling them, even when doing so might be more economically beneficial. This is the so-called lock-in effect.
Moreover, low tax rates on capital income exacerbate wealth inequality, stymieing economic growth. Recent research from American University’s Institute for Macroeconomic and Policy Analysis finds that higher capital income tax rates increase GDP, wages, and jobs. And it’s why when President Bush slashed the capital gains and dividend tax rates in 2003, economists found no evidence that these tax cuts generated economic growth. Instead, real wages fell by 2.3 percent between 2002 and 2007.
The Billionaire Minimum Tax is targeted only at the problem: low tax rates for the very rich.
This proposal would affect fewer than 10,000 Americans, or 0.006 percent of taxpayers. For context, that’s one-ninth of the attendance at each of Taylor Swift’s shows at Wembley Stadium last month, and one-fourth of the Nationals ballpark capacity (though usually less full than an Eras Tour show). And besides, President Biden and Vice President Harris have pledged to not raise taxes on anyone earning less than $400,000 per year, or 98 percent of Americans. (As one of us wrote recently, this is a good idea!). As many people on X have pointed out, if your ceiling looks like this, or this, you don’t need to worry about this proposal affecting your tax bill.
But what about in the future? Should you be worried that a future Congress will expand the tax? Not likely. It’s exceedingly rare in modern history for taxes that are designed to apply to the rich to be expanded to a broader population. In fact, it’s been more common that changes go the other direction. The Alternative Minimum Tax, for example, was enacted in the late 1960s to close some loopholes for the rich, and although it was designed poorly and would, without action, have grown to affect many middle-income people, Congress repeatedly and consistently prevented it from doing so. Similarly, the estate tax has gone from only applying to the very affluent to now only applying to the mega-wealthy.
The design of the tax accounts for special cases like start-ups and non-tradable assets.
The purpose of the BMT is to make sure that the ultrarich are paying something closer to their fair share in taxes and to reduce some of the negative economic effects that stem from our current, counterproductive tax preferences for capital income. But the designers of the proposal also understood that we want to avoid introducing new distortions and unproductive avoidance behaviors. That’s why the tax has a mechanism built in to exempt those whose income comes from non-tradable or “illiquid” assets like closely held businesses (including, for example, a start-up company). That sliver of taxpayers would still have to pay a “deferral charge” when they do sell the assets, in order to discourage this exemption from becoming another loophole. But in practice, it will mean that no one will have to sell their business or some rare piece of art to pay their tax bill. And the good news is that the vast majority of the centimillionaires to whom this tax applies have plenty of very liquid assets like publicly traded stocks, so this exemption won’t be widely used. But it’s there, just in case.
The Biden-Harris BMT proposal is one that would go a long way to addressing inequities not only in our tax system, but in our broader economy. It’s well-designed, it’s popular, and it’s based on decades of economic research. And at the end of the day, it’s simply indefensible that the ultra-wealthy get to pay lower income tax rates than people who earn a wage for a living. It’s unfair, it’s counterproductive, and it’s extremely expensive. The Billionaire Minimum Tax helps us solve that problem. It is an essential part of the robust strategy we need to curb the concentration of economic power and to secure revenue to provide investments in workers and families.
If You Ask Eleanor
“The point in making money is to earn it honorably and always to feel an obligation to use your work and what you make out of it for the benefit of the community as a whole as well as for yourself.”
- Eleanor Roosevelt, If you ask me (September, 1941)
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