Whoever claimed there’s not a “dime’s worth of difference” between the political parties clearly was not referring to American politics in 2020. For tax policy alone, the difference is in the trillions.
On one hand, a Trump victory would likely mean continued divided government, possible consideration (although not adoption) of a middle-class tax cut, and a resumption of the status quo. If Trump has a fifty percent chance of winning next fall, then there’s a fifty percent chance your taxes don’t change substantially in the next few years.
On the other, a Democratic victory would likely result in Democrats controlling both the House and the Senate (it’s hard to see how they win the White House but Republicans hold the Senate), immediate repeal of the filibuster in the Senate, and the imposition of a new wealth tax along with several trillion in other new taxes, right?
Well, maybe not. If the Democrats do take control of the Senate, it won’t be by much. Their majority will be a slim one or two votes, so the moderates in both parties will represent the deciding votes and pull policy towards the middle.
Under those circumstances, it’s hard to see how something as extreme as the Warren/Sanders wealth tax passes. That’s not to say tax burdens won’t rise, and rise sharply, but rather that any increase would take place through more conventional means. Here is our thought process.
The wealth tax proposal put forward by Senators Warren and Sanders might be the most anti-free market tax ever put forward by serious presidential candidates. Even in Europe, where they have a more robust history of targeting wealth, it’s an outlier. As NPR recently noted, most of the EU countries that tried wealth taxes in recent decades subsequently repealed them:
In 1990, twelve countries in Europe had a wealth tax. Today, there are only three: Norway, Spain, and Switzerland. According to reports by the OECD and others, there were some clear themes with the policy: it was expensive to administer, it was hard on people with lots of assets but little cash, it distorted saving and investment decisions, it pushed the rich and their money out of the taxing countries—and, perhaps worst of all, it didn’t raise much revenue.
So for many EU countries, their experiment with wealth taxes failed on multiple fronts. Those three countries that retain wealth taxes, meanwhile, maintain them at levels much smaller than the Warren/Sanders proposal. Norway’s wealth tax, for example, tops out at 0.85 percent, or a rate seven times lower than Warren/Sanders.
Additional concerns not listed by NPR:
- Its pro-cyclical – it hits hardest when times are tough, exactly the opposite of what you want.
- It forces fire sales – one reason we have an income tax is to ensure that taxpayers have the money to pay the tax. The wealth tax is owed whether you make money or not.
- It might be unconstitutional — the Constitution prohibits “direct” taxation, while the 16th Amendment applies to income taxes only. Is the wealth tax a direct tax? The courts will have to decide.
Finally, this new tax would be layered on top of numerous other tax hikes, including mark-to-market taxation of unrealized capital gains and higher rates on corporations and individuals. This combo platter of higher marginal rates and layer upon layer of tax would take US tax policy into uncharted territory. According to Richard Rubin:
Potential tax rates over 100% could result from the combination of tax increases the Massachusetts senator proposes for the very top tier of investors. She wants to return the top income-tax rate to 39.6% from 37%, impose a new 14.8% tax for Social Security, add an annual tax of up to 6% on accumulated wealth and require rich investors to pay capital-gains taxes at the same rates as other income even if they don’t sell their assets.
The US has had high individual rates in the past, but they have always been paired with lower rates on capital gains and corporations, together with a generous menu of allowable deductions. Enacting a wealth tax while raising rates across the board and maintaining our current broad tax base would impose levels of taxation beyond anything we’ve tried in the past. That should be enough to scare more moderate legislators away from adopting a wealth tax.
If the wealth tax is a step too far, a less aggressive policy might be to impose M2M on capital gains by taxing them on an annual basis. Senator Ron Wyden, the Ranking Member on Senate Finance, released a plan last summer entitled “Treat Wealth Like Wages” that looks very serious. Key provisions include:
- Raising rates on capital gains to regular income tax rates;
- Imposing M2M taxation on taxpayers whose income and/or wealth exceeds certain thresholds;
- Dividing assets into three classes:
- Residences and retirement accounts up to certain levels are excluded from M2M;
- Publicly traded assets are subject to immediate M2M taxation; and
- Private asset gains are taxed upon their sale, but at a higher, formula-based tax rate.
How is M2M less aggressive than a wealth tax? First, it’s a tax on income, so the potential constitutional challenges of the wealth tax won’t apply here. Second, its counter cyclical (which is a good thing) – the effective tax rate increases when times are good and decreases (you get deductions, refunds and/or carryovers) when times are tough. And finally, as an income tax it should blend more smoothly with our existing tax code and there’s less danger of applying multiple layers of tax on the same income.
So M2M is not as draconian as a wealth tax, but there remain serious concerns. Taxing gains before they are realized, particularly with private companies, creates both valuation and liquidity issues — how do you determine the value of the asset and how do you ensure the taxpayer has the means to pay the tax?
The Wyden proposal attempts to address these concerns by treating publicly traded assets differently than private ones. Gains on public assets with liquid markets and transparent pricing would be taxed annually under the Wyden plan. Gains on private assets, on the other hand, would be taxed when there is a sale (or death), with a special formula used to calculate the tax. The goal of the formula is to balance out the treatment of public and private assets – the longer the private asset is held, the higher the tax. Exactly what it looks like remains to be seen.
It’s an interesting approach, but it doesn’t address all the issues raised by M2M:
- What happens when you have a loss in a particular year? Can you take those losses and, since everything is taxed at the same top rate, apply them against your wage and salary income? If not, can you carry them forward to offset future gains?
- What happens if you have an asset that suffers a large loss between the end of the year and April 15th? You owe tax on the higher valuation but will have to sell the stock at the lower price.
- How do you track basis? As long as the stock price moves in one direction, it’s not that hard, but what happens when the price fluctuates, so the taxpayer pays taxes in one year and accumulates losses in another?
- How do you prevent gaming between the three asset categories? Even with a formula-based tax, its likely investors will prefer private investments with deferred taxation over public ones with immediate taxation.
So M2M is an improvement over the wealth tax, but is it too complex to sell? We think so, and doubt that even a unified Democratic Congress would adopt it.
A More Likely Third Option
If the wealth tax is too draconian and the M2M too complex, what’s left? A third option for a new Democratic President is to simply increase taxes on the wealthy while leaving our basic approach to taxation in place. Such a package would:
- Increase individual rates;
- Increase corporate rates and eliminate 199A;
- Increase the capital gains tax rates and tax gains at death;
- Increase estate tax rates; and
- Increase the minimum tax on foreign income.
This approach has the advantage of including more traditional tax policies that policymakers are familiar with. It is not, however, modest in size or a “win” for the business community by any stretch. It would take us back to tax levels that precede Reagan, but without the safety net of lower alternative rates and lots of allowable deductions. It would be a tax hike of historic proportions.
Circling back to where we started, it’s clear the post-election outcomes for tax policy reflect the broader polarization of our politics – we could see little or no change, with the low rates adopted in 2017 continuing for the next few years, or we could see a sizable tax increase featuring uniformly higher taxes on businesses and upper income Americans.
What’s dangerous for the business community is if all this focus on wealth taxes and mark-to-market has inured them to the very real threat of sizable, albeit traditional, tax hike. By our analysis, it is time to start pricing in a fifty percent chance of the latter happening beginning in 2020.