Editorial: What to do about billionaires who pay no taxes

Nothing galls taxpayers as much as hearing about people with far bigger incomes who paid a lot less than they did to the Internal Revenue Service. So when ProPublica reported Tuesday that some of the richest people in America paid no income taxes at all multiple times in the mid-2000s, the revelation triggered a wave of outrage from people not so adept at tax avoidance.

What’s worse, the authors contended, is that the tax burden on the richest Americans shrank as their wealth soared. But that wasn’t an apples-to-apples measure. The authors looked not just at what these billionaires collected in salary, dividends and interest, but also at the escalating value of their stock holdings — gains that are not considered taxable income until the stock is sold.

To some observers, that’s a feature of the tax code, not a bug. If you tax the gain in an unsold stock’s value in good years, the IRS will have to pay refunds to those same taxpayers when their shares decline in bad years. And what about investments whose value isn’t so easy to determine, like non-fungible tokens or ownership shares in a startup that has yet to go public? Taxing gains when they are realized — when an item is sold or transferred — is far more straightforward.

Still, the accumulating wealth of the taxpayers analyzed by ProPublica points to a real problem: the income and wealth inequality that has widened over the last four decades in this country. The trend has accelerated in the wake of the 2017 tax cuts championed by President Trump, and particularly during the COVID-19 pandemic. A driving force has been the rapid rise in stock values; the wealthiest 10% of households own more than 80% of the stocks.

The financial chasm between the wealthiest households and the vast majority of Americans challenges the country on multiple levels, both social and economic. And policymakers should certainly try to reverse the growing inequality and narrow the gap. There are a variety of ways to do that, but like all things related to tax policy, each of the possible solutions comes with tradeoffs.

The place to start would be by narrowing or eliminating the exemptions and preferences in the tax code whose benefits accrue almost exclusively to high-income taxpayers — especially people earning $5 million or more, who pay a lower share of their income in taxes than other wealthy Americans. One preference worth eliminating is the lower tax rate for capital gains; according to the Tax Policy Center, more than 90% of those gains in 2019 went to the households in the top 20% of incomes.

Beyond that, one approach touted by progressives would be to impose a “wealth tax” that requires people with assets worth more than a certain threshold — for example, $50 million in the proposal by Sen. Elizabeth Warren (D-Mass.) and Reps. Pramila Jayapal (D-Wash.) and Brendan Boyle (D-Pa.) — to pay a percentage of that value annually. This would also be the most disruptive measure, given the potential effects on small and closely held businesses, family farms and assets that are hard to value.

It’s not an unprecedented idea — versions of a wealth tax have been tried in a number of other jurisdictions — but most of the European countries that tried a wealth tax abandoned it. One reason is concerns about the tax’s effects on their economies, which would be felt by rich and poor alike. A study by the Organisation for Economic Co-operation and Development found that the wealth taxes in Europe discouraged entrepreneurship and risk taking, and consequently job creation, because they weren’t as forgiving of losses as income taxes are.

A more novel alternative laid out by Senate Finance Committee Chairman Ron Wyden (D-Ore.) would be to require wealthy individuals to measure how much their investments have risen or fallen in value annually and treat that as income (or lost income), taxed at the same rate as wages. Investments that can’t be traded, such as a startup founder’s ownership shares, would be taxed when sold, with a higher rate applied to compensate for the years they went untaxed. But there are plenty of other tradeable assets that can be hard to value before they’re sold. And like a wealth tax, Wyden’s proposal could force people to sell assets in order to pay their tax bill. How that would affect the market and investment incentives is an open question.

Proponents of taxing unrealized gains argue that the wealth isn’t just on paper. People use their investments as collateral for loans, generating potentially enormous sums that aren’t taxed (and, depending on how they’re used, may even lower the borrower’s tax liability). According to securities filings, ProPublica reported, Oracle’s billionaire chief executive, Larry Ellison, used $10 billion in company stock to support a line of credit, and Tesla’s billionaire CEO, Elon Musk, used more than $55 billion worth of company stock to secure personal loans.

So why not tax gains on shares used to collateralize a loan or support some other transaction? That would hew to the logic of the current system, and wouldn’t discourage taxpayers from making investments for the long term — it would simply prevent them from generating consumable income in a way that avoids taxes. Think of it like a consumption tax that applies only to people at the top of the economic ladder. A broad tax on stock purchases and other financial transactions would also fall far most heavily on the top 20% of incomes, although the effects could ripple broadly through the economy.

Congress should also prevent taxpayers from passing enormously valuable estates on to their heirs free from capital gains taxes by rolling back the “stepped up basis” rule, which revalues inherited properties in a way that wipes out the taxation of all prior gains. President Biden has proposed this change to help pay for his $1.8-trillion American Families Plan, with an exception for family-owned farms and businesses that the heirs continue to operate, and it’s worth making.

Estate taxes are one of the two main types of wealth tax in the United States today (the other being state and local taxes on real estate and certain types of personal property), and attempts to raise them have been bitterly contested in Congress. But then, any change in the tax code would be a challenge these days. And making the current estate tax a more effective counterweight to widening income inequality would be a simpler and less disruptive step than expanding the reach of wealth taxes.