A Billionaire’s Tax

Progressives want billionaires to pay their ‘fair share.’ What does that mean?” – The Lonely Realist

The highest income tax rate payable by Americans is 37%, yet reports indicate that billionaires pay less, far less. For example, according to a 2021 White House release, an “analysis from Office of Management and Budget and Counsel of Economic Advisors economists estimates that the wealthiest 400 billionaire families paid an average of just 8.2 percent of their income in Federal individual income taxes.” A May 2022 analysis by Americans for Tax Fairness “found that 26 of the nation’s richest billionaires paid an average effective federal income tax rate of just 4.8 percent.” And according to ProPublica, the 25 wealthiest Americans paid an income tax rate of just 3.4%. Wow. How unfair!

The appropriate epithet, however, is not “How unfair!” but “How untrue!” Those percentages are patently false. They have nothing – absolutely nothing – to do with the actual rate of income tax paid by billionaires … which is, indeed, at the marginal rate of 37%. The 8.2%, 4.8% and 3.4% numbers are fictional estimates of the rate of tax that would have been paid had billionaires’ income included the appreciation in value of their homes, real estate, stocks, bonds, etc. The reality is that appreciation in asset value is not “income” – it has never been subject to income tax anywhere, in America or elsewhere. Income tax systems don’t tax appreciation in value. They avoid doing so for any number of good reasons. What about the wealth tax that progressives have proposed? America never has had a wealth tax. When it’s been attempted in other countries, it was a dismal failure and undoubtedly would fail in America too. But that doesn’t mean that America’s tax laws aren’t unfair. It also doesn’t mean that America’s tax system doesn’t favor billionaires.

Billionaires don’t put their wealth into savings accounts, paying income tax on the interest income they earn. They deploy their wealth into a range of investments. Because of inflation and other factors, those investments most often appreciate in value. If billionaires were to sell those investments, they would pay taxes on the realized gain. That’s precisely what was intended with enactment of the Internal Revenue Code in 1954 …, but billionaires don’t have a need to sell their investments today. Financial engineering has been directed at improving their tax consequences which, in turn, has changed how those investments are managed. The last 7 decades saw the development of products that unlock value without the need to sell appreciated assets. Tax collection has suffered.

Real estate provides the most straightforward example. Mortgages once were tools only for the acquisition of property. They have morphed into a means for withdrawing cash. Assume, for example, that an apartment building had been purchased for $100 million, financed with $20 million of cash and an $80 million mortgage. Assume further that the value of the building appreciates to $150 million. If the mortgage is refinanced for 80% of the $150 million value, 80% of the $50 million appreciation can be extracted by the owner without incurring any tax consequence …, and that’s precisely what real estate investors have been doing for the past several decades.

Tax laws passed by Congress necessarily favor certain constituencies. Real estate is one of the most favored. Preferring certain interest groups is how America’s legislators finance their campaigns and build their constituencies. That electoral motivation naturally has hardened tax benefits. They are impossible to change without a collaborative effort at compromise by Democrats and Republicans. Laughable, no? TLR has repeatedly advocated tax simplification via a proposal called the Comprehensive Tax Plan (last addressed by TLR on January 28th), which is utopian in today’s era of partisan grandstanding. A more targeted solution might address non-acquisition indebtedness – including real estate refinancings and similar non-taxable “cash-outs” –, treating those additional borrowings as a realization event that triggers income tax. That, too, undoubtedly is utopian in today’s era of powerful special interest lobbyists. The unfortunate alternative is to await a crisis of such magnitude that it requires Congress and the President to work together in radically overhauling America’s taxes …, along with a lot of other things. That’s hopefully not imminent.

The last several decades have witnessed the development of additional financial products intended to allow wealthy individuals to avoid disposing of any asset that could trigger an income tax liability. Stocks and bonds? Of course. Brokers and investment bankers are more than happy to fund investments via margin loans. Operating businesses? Banks have geared up their lending facilities, especially for private equity interests, incipient technology companies and family office investors. Moreover, you undoubtedly have read about art, watch and antique auto loan facilities that cater to the wealthy.

But, you may well ask, don’t those leveraged assets have to be disposed of someday? And won’t the government then receive its income tax? Actually …, no. The government will never receive income tax from those appreciated assets since the value of property becomes its tax basis on the death of the owner. Upon death, billionaires therefore will have avoided income tax on their appreciated assets. Although their estates will be subjected to the separate estate tax, there of course are sophisticated ways of minimizing that tax as well. However, many billionaires don’t care about estate tax – billions of dollars, after all, are, well, billions! They also often donate much of their accumulated asset wealth to charities free of both income and estate tax. Many of those charities are generationally family controlled, supporting both legacy causes and the ongoing interests of family members (who are entitled to be compensated for their involvement). The proliferation of billionaire-funded charities is the result of another 20th Century tax incentive intended to encourage a level of charitable giving that may no longer be worth the foregone tax revenue and generational continuation of influence. Congress, however, has no incentive to bite the hands of those wealthy investors who support their continuation in office.

Billionaire’s truly don’t pay their fair share. It’s a problem with only one solution: a revamping of America’s tax system. TLR is not holding its breath.

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Finally (from a good friend)

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