The Democrats have left no stone unturned in their effort to fund their ever-shifting, now roughly $2 trillion spending plan.
They proposed a financial-surveillance regime that would give the IRS access to data on virtually every American’s bank account. Following widespread backlash, Senate Democrats quickly walked back that idea. Meanwhile, Senator Kyrsten Sinema objected to proposed increases in the corporate and individual tax rates. So, Democrats have revealed another trick up their sleeve: a so-called billionaire tax. The brainchild of Senator Ron Wyden, the proposal would tax the unrealized capital gains of those deemed “billionaires” by the federal government.
Under the current system, asset owners pay taxes on capital gains only when they sell their holdings. If the asset has depreciated in value, the taxpayer can deduct the loss from future income taxes. Capital-gains taxes are designed this way because financial assets regularly fluctuate in value. A gain one year can turn into a loss the next, and asset owners receive no income in the meantime.
The Wyden proposal would upend this system by taxing capital gains annually for the ultrawealthy, whether or not they have sold any assets. Leaving aside the possibility that it violates the 16th Amendment, the scheme would impose arbitrary, unpredictable tax burdens and generate significant market distortions.
Start with the year-end cutoff for calculating tax burdens. Suppose John Doe, the founder of a large technology company, sees his wealth increase from $1 billion to $1.25 billion in 2021, and then to $1.5 billion in 2022. He would owe a cumulative $119 million under the plan. Jane Smith, the CEO of a competing company, sees her wealth increase from $1 billion to $1.5 billion this year, but then fall to $750 million the next.
Because of annual write-off limits, Jane would owe roughly the same amount as John despite the blow to her net worth. And both could be forced to liquidate assets to come up with the cash to pay the IRS, eroding their alignment with shareholders. Otherwise, they might take measures to artificially reduce the value of their firms at year-end.
The volatile tax bills would create an incentive for the wealthy to move capital into illiquid assets not subject to the annual tax, such as private equity, real estate, and art. Entrepreneurs would think twice about taking their companies public in a system where private ownership confers tax benefits. The “billionaire tax,” therefore, would move money into alternative assets — accessible only to wealthy, accredited investors — and reduce investment opportunities for the middle class.
The arbitrary nature of the tax also makes it a poor funding mechanism. With revenues tied to fluctuations in the fortunes of some 700 Americans, the government could not reasonably rely on the Wyden plan for consistent funding.
The plan is so impractical and wrongheaded that one wonders why Democrats proposed it in the first place. The answer is that Biden has promised trillions in new spending while maintaining that he will not raise taxes on the middle class. So he is resorting to increasingly convoluted schemes in a last-ditch effort to salvage as much of his reconciliation bill as possible.
As with the IRS proposal, the rule appears unlikely to make it past Senator Joe Manchin. It comes as a relief that a select few senators will likely stop the measure from passing. It is less comforting that a slightly larger Democratic majority would very likely pass it.