Posted on February 16, 2012
Finally, an op-ed article on tax policy in The New York Times that isn’t horribly flawed! In a piece last week entitled “The Zuckerberg Tax”, tax attorney David Miller proposes a new tax on the ultra-rich. He would apply the tax to taxpayers whose income exceeds $2.2 million or who own publicly-traded securities worth more than $5.7 million.
Currently there is no income tax on the increase in the value of an asset. The increase in the value of an asset is taxed only when the asset is sold and the gain is both realized and recognized. Mr. Miller proposes a new tax for the super-wealthy on their publicly-traded securities (such as stocks, bonds and mutual funds). Each year the value of these securities would be “marked to market” and the increase in value would be taxed at the 15% long-term capital gains rate. If there were a net decrease in value of the publicly-traded securities, the loss could be carried back to create a refund (presumably only to the extent of prior mark-to-market gains).
This tax would broaden the tax base by taxing increases in value that would not otherwise be taxed currently. In many cases this tax would otherwise be paid in future years. However, under the current tax law, capital gains tax can be avoided entirely by holding the stock until death or making a charitable contribution.
This proposal has many advantages. Additional costs to the government and the taxpayers of collecting the tax would be minimal. The tax would apply to a very small number of taxpayers. It is easy to calculate the value of publicly-traded securities. Cheating would also be difficult due to the availability of third party reporting sources. The taxpayers involved may need to sell assets to pay the tax, but since the securities are publicly-traded, there would be a market in which to sell. Large amounts could be raised from a small number of taxpayers who have the wherewithal to pay the tax. Taxing the accretion in wealth complies with sound theories of income taxation. Any accretion to wealth can be considered income. As a practical matter, it is difficult to tax this income. But when limited to publicly-traded securities of a small number of taxpayers, the practical problems are dissipated.
There are also some disadvantages to this proposal. One can argue with the fairness of taxing only one source of wealth accretion (publicly-traded securities). The proposal excludes taxing the increase in the value of real property, commodities and nonpublicly traded securities such as closely held businesses. Would this change the relative valuations of publicly and nonpublicly traded assets and discourage investment in more liquid assets? For example, an exchange traded fund (ETF) such as GLD would look less attractive than a direct investment in gold. Very successful private companies would be much less likely to have an IPO or to merge into a publicly traded company if this law were enacted. There would be a divergence of interest between entrepreneurs who would have less reason to access the public markets and venture capitalists who want a liquidity event. This is particularly true for pension plans and foundations; investors who do not pay tax on their gains. Undoubtedly there are many more economic consequences to private companies delaying access to public markets.
There are also many practical questions which would have to be dealt with before enacting the “Zuckerberg Tax”. The simplest form of tax planning would be for wealthy taxpayers to transfer their publicly-traded securities into nonpublic entities such as partnerships, LLCs and corporations. Preventing this type of tax avoidance will create quite a bit of complexity in the law. Also, tracking basis in publicly-traded securities for wealthy taxpayers will become more complex. With the current requirement for financial institutions to report the tax basis on newly acquired assets, it would be desirable for the IRS or the taxpayers to report the updated marked-to-market basis to the custodians of the assets.
How to treat “drop offs”
Consideration would also need to be given to taxpayers who are no longer subject to the tax due to lower incomes and publicly-traded securities values in subsequent years. Fairness would suggest that they would still be able to receive refunds of the mark-to-market tax paid if the value of their portfolios ever falls below the value at the end date that they were subject to the mark-to-market tax. However gains and losses in intervening years would make this difficult to administer. An alternative is to say that once you meet the criteria for the mark-to-market tax, you will forever after be subject to that tax.
My final concern is market liquidity. Even with publicly-traded securities, the sale of an unusually large block of stock in a short time can result in a market disruption. Company founders often own a large percentage of the company’s stock, even when it becomes traded on an exchange. At death, the estate tax law permits a “blockage discount” in valuation of public securities. A blockage discount for the “Zuckerberg Tax” would make the tax much more complex since the discount is difficult to ascertain and very specific to each set of facts. Ignoring the blockage discount would result in a tax on value that does not really exist. Since the “Zuckerberg Tax” would only apply to the annual increase in value at a 15% tax rate (plus state income tax), the amount of blockage discount would be much less significant than the discount that would apply to the entire block.
Some people may object to this tax as a “wealth tax” and assert that if this tax is imposed, rich people will leave the country taking jobs with them. They would be wrong on both counts. A tax on the value of an asset is a wealth tax. A tax on the increase in the value of an asset is an income tax. The fact that this income is not taxed under current tax law arises from the difficulties in collection rather than the proper definition of income. Our current tax law makes it quite difficult for taxpayers to give up their US citizenship and leave the country without paying tax on their appreciated assets. But even if wealthy people who hold publicly-traded securities chose to expatriate, the citizenship and location of the shareholders would have minimal, if any, impact on the employment of people who work for these businesses.
I started this article by saying that “The Zuckerberg Tax” proposal is not horribly flawed. It does have some problems, but I would be interested in seeing what Warren Buffett thinks of this idea. He believes that we are “coddling the super-rich.” In my Forbes.com posting on 10/17/11, “Musings on Warren Buffett’s Tax Disclosure”, I stated that Warren Buffett’s willingness to pay a higher income tax rate would have very little impact on his net worth since even a 100% income tax rate under current tax law would cost Mr. Buffett less than 2/10s of 1% of his net worth. Mr. Miller points out that under the “Zuckerberg Tax” proposal, Warren Buffett’s 2010 income tax would have exceeded $1 billion, more than 200 times what he actually paid. It all depends on how “income” is defined. Net accretion to wealth is a classic definition of income. This idea is particularly timely given President Obama’s inclusion of a so-called “Buffett Rule” in his just released proposed budget, which would impose a 30% alternative minimum tax on incomes of more than $1 million.
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