Reuven S. Avi-Yonah is the Irwin I. Cohn Professor of Law at the University of Michigan, and David Gamage is a professor of law at the Indiana University Maurer School of Law.
In this installment of Academic Perspectives on SALT, Avi-Yonah and Gamage explain why billionaire income tax reforms would not result in double taxation but instead would rectify a major flaw in the tax regime that enables wealthy individuals to escape tax on most of their investment gains.
In their essay, “Is It Time to Tax Disney’s Unrealized Capital Gains From 1965?” Donald B. Susswein and Kyle Brown argue that a mark-to-market reform like the recent proposals for billionaire income tax reforms would amount to double taxation. We explain here why their arguments are incorrect. Instead, the primary impact of enacting a billionaire income tax reform would be to close the loopholes and combat the harmful political-optionality dynamics that enable many billionaire and megamillionaire taxpayers to fully and permanently escape income taxation on the majority of their true investment gains.
The past couple of years have seen a series of prominent proposals for mark-to-market income tax reforms targeted at billionaires and megamillionaires, at both the federal and state levels. This is part of a larger movement calling for fixes to how existing tax systems are mostly broken when it comes to taxing the wealthiest individuals and families.1 For simplicity, we will hereinafter refer to the entire category of mark-to-market income tax reform proposals targeted at billionaires and megamillionaires as billionaire income tax (BIT) reforms, regardless of the design mechanics and whether these proposals just target billionaires or also apply to megamillionaires.
The first prominent BIT proposal was the New York State Billionaire Mark-to-Market Tax Act (S. 8277B/A. 10414) introduced in 2020. This was followed by the Illinois Extremely High Wealth Mark-to-Market Tax Act (H.B. 3475) introduced in 2021. At the federal level, the first prominent BIT proposal was the billionaire’s income tax, unveiled in October 2021 by Senate Finance Committee Chair Ron Wyden, D-Ore. This was followed by the Babies Over Billionaires Act (H.R. 7502), introduced in April 2022 by Rep. Jamaal Bowman, D-N.Y. Most recently, President Biden proposed a “billionaire minimum income tax” as part of his federal budget in 2022, and legislation to enact that reform is being worked on in Congress.2
In this essay, we clarify some confusion about how BIT reforms would interact with the rules of the existing federal and state income taxes. In particular, we respond to some mistaken arguments by Susswein and Brown in their recent essay, “Is It Time to Tax Disney’s Unrealized Capital Gains From 1965?”3
Susswein and Brown argue that BIT reforms would amount to double taxation “because the taxpayer still owns the asset generating the income and would thus be taxed twice on the income: once as an increase in anticipated future ordinary income and twice when the ordinary income is actually received.”4 Moreover, they argue, “double taxation would result even if a basis adjustment were permitted and even if the mechanism used was an interest charge rather than outright mark-to-market taxation.”5 (Note that all of the prominent BIT reform proposals have either mechanisms for basis adjustment or — as in the case of the president’s billionaire minimum income tax proposal — alternative mechanisms for preventing double taxation that work similarly to basis adjustment.)
As we will explain, for wasting assets, the basis adjustment and loss recognition mechanisms of BIT reforms prevent double taxation. For non-wasting assets, there is no double taxation, because the value of the assets does not diminish, so no recovery of capital should be provided.
Under current law, absent a BIT reform, zero taxation is the most common result for the investment gains of billionaires and megamillionaires. Scholars estimate that over three-quarters of the true investment gains of billionaires and megamillionaires fully and permanently escape income taxation under existing law.6 This is why BIT reforms are needed.
II. The Susswein and Brown Argument
Susswein and Brown argue that BIT reforms would amount to double taxation. The core of their argument is:
We conclude that, in the case of income-producing assets, such as an equity interest in an operating business or property held for the production of rents or royalties, the idea of treating unrealized capital gains as income is irretrievably flawed. Upon close examination, treating such unrealized appreciation as income would do little more than tax the same income twice to the same taxpayer. . . .
For income-producing assets, both basic finance and well-established tax law tell us that their market value is the market’s assessment of the present value of the stream of future revenues they will generate (net of any anticipated operating expenses of generating those revenues, such as the amounts a popular restaurant will have to pay for groceries, salaries, utilities, and so forth). For tax purposes, the resulting net income will generally be taxed as ordinary income. As a result, an unrealized capital gain is generally nothing more than an increase in the market’s assessment of the present value of the asset’s future cash flows — including the portion treated as income and any portion treated as a return of capital. If the income-portions of those amounts are taxed once, as an increase in the amount of anticipated future income, they cannot be taxed again when the cash and income are actually received. That would not be a better definition of income; it would only be a double inclusion of the same income.7
Susswein and Brown are of course correct in saying that finance theory tells us that the market value of assets should generally approximate the predicted discounted value of future profits (plus other current and future benefits of owning assets8). Nevertheless, they err in concluding that this means that BIT reforms would result in double taxation. For wasting assets, this is because the market value of assets should go down as the assets produce profits. For non-wasting assets, this is because the taxpayer still has the assets after profits are produced, so no recovery of capital should be provided because the assets are not diminishing.
III. For Wasting Assets, Loss Recognition Prevents Double Taxation
Let us first consider wasting assets. Suppose a land asset with basis of $1 million appreciates to be worth $1.5 million, because valuable minerals are discovered on the land. Under a BIT reform, the owner of the asset would potentially then owe tax on that $500,000 of capital gain in the year in which the market value appreciates because of the discovery of the valuable minerals.
To keep things simple, let us then say that the $500,000 materializes as ordinary income for the owner in the following year, because all the minerals are then taken from the land and sold for $500,000 of profits. At that point, the value of the land asset should be expected to decline back to $1 million (assuming nothing else has changed).
All serious BIT reforms have mechanisms for refunding losses, at least to the extent of prior recognized gains. Thus, following the removal of the minerals and the consequent decrease in the market value of the land asset, the taxpayer should recognize a $500,000 capital loss. This capital loss would fully offset the prior recognized capital gains. The overall net result would leave the taxpayer just with the $500,000 of ordinary income from sale of the minerals, which is the same net overall result that would occur under current law.
For fully wasting assets, then, the only real difference between a BIT regime and current law is the timing. Under the BIT regime, the taxpayer would recognize capital gain if and when the market value of the asset increases and would then recognize capital losses if and when it decreases. By contrast, under current law, neither that capital gain nor that capital loss would be recognized, unless there was a sale or other recognition event.
Consequently, as we will elaborate later, realization and the recovery of capital are, in theory, all about timing, and all that a BIT reform does is change the timing of when gains and losses are recognized. In practice, however, as we will further explain, realization and the recovery of capital are largely about loopholes and political optionality.9 Thus, the more important practical consequence of enacting a BIT reform would be to close loopholes and combat political-optionality dynamics that currently allow many billionaire and megamillionaire taxpayers to fully and permanently escape income taxation on most of their investment gains.
We could make the examples in this section more complicated by having the ordinary income manifest over a period of years, rather than in a single year, such as with the profits earned over time by a business. But the key takeaways would remain the same. For wasting assets, the ordinary income manifesting from profits should correspond with a decline in the value of the asset, which should then generate recognized capital losses under a BIT reform. Thus, there is no double taxation.
Another way of thinking about this is to view how a BIT would recognize gains and losses for wasting assets as a more accurate form of recovery of capital. Current income tax law generally provides depreciation or amortization deductions for assets considered to be wasting assets. But these deductions are offered based on formulaic approximations of how the assets are deemed to lose value over time, with these formulaic approximations often being highly inaccurate at measuring true changes in value. By contrast, a BIT reform would measure changes in the value of wasting assets more directly and would then provide loss deductions for wasting assets to the extent that the assets are measured as truly declining in value.
IV. For Non-Wasting Assets, Recovery of Capital Should Not Be Provided
Let us now consider non-wasting assets. For instance, instead of there being valuable minerals on a land asset, let us say that the land asset is expected to produce regular steady streams of rental income and that this is expected to continue indefinitely.10 Let us say that the market value of the asset with a basis of $1 million appreciates to be worth $1.5 million in year 1, because something happens in that year to increase the expected future streams of rental income.11 Under a BIT reform, the owner of the asset would potentially then owe tax on that $500,000 of capital gain in year 1.
In year 2, the owner would then be taxed on the ordinary income from the annual rent. However, by contrast to the examples with wasting assets, the owner should not recognize any capital losses (assuming nothing else changes) because the value of the land asset would not be diminishing.
Susswein and Brown call this double taxation, but they are mistaken. This is because after receiving the rental income in year 2, the taxpayer would still have the land asset, which should still be worth approximately $1.5 million (assuming nothing else changes and simplifying from inflation and other related time-value-discounting complications). Put another way, at the end of year 2, the taxpayer would have an asset that could be sold for approximately $1.5 million in addition to having received the annual rental income in year 2.
More generally, for non-wasting assets, the manifestation of ordinary income from profits over time should not correspond with diminution of the value of the asset, so the taxpayer should still have the full value of the asset after receiving the ordinary income. In other words, the increase in the value of the taxpayer’s marketable wealth that occurred in year 1 of this example is not reduced or counteracted by the receipt of ordinary income in year 2 or any subsequent years. Once again, we could make the examples more complicated by considering a longer period of years, but the key takeaways would remain the same.
Consider a variation of these examples that already occurs under current law. Imagine that an employer was to pay an employee with valuable land instead of cash wages. The employee receiving that land from the employer in lieu of cash wages should then include the full value of that land in taxable income under current law. Thus, if the employee received $1.5 million worth of land from the employer, then the employee should have taxable income of $1.5 million. If the employee-taxpayer then rented that land out in year 2 and subsequent years, the rental income received would generally be taxed as ordinary income. Just as in our example with a BIT reform, this would not be double taxation, because the employee-taxpayer would still have the land worth approximately $1.5 million after paying tax on the ordinary income from the annual receipt of rent.
Both (1) the receipt of a new valuable land asset, and (2) an increase in the value of a land asset that a taxpayer already owns, represent true economic gains for the taxpayer. Current tax law would recognize the economic gains from (1) in such scenarios as when an employee receives the asset from an employer in lieu of cash wages, but not in some other scenarios, such as when the asset is received as a qualifying excludable gift. Current tax law would generally not recognize the economic gains from (2) until there is a sale or other realization and recognition event.
A BIT reform would recognize the economic gains from (2) currently, rather than waiting for a sale or other event that current law treats as a realization and recognition event. Again, for assets that will eventually be sold, the only real difference here is the timing. This is why we say that in theory, realization and the recovery of capital are all about timing, and all that a BIT reform does is change the timing of when gains and losses are recognized.
However, not all assets will be sold before benefiting from loopholes, like section 1014’s stepped-up basis on death. This is why we also say that in practice, realization and the recovery of capital are largely about loopholes and political optionality. Again, the most important practical consequence of enacting a BIT reform would be to close loopholes and combat harmful political-optionality dynamics that currently allow many billionaire and megamillionaire taxpayers to fully and permanently escape income taxation on most of their investment gains.
V. In Theory, the Differences Between a BIT and Current Law Are Only About Timing
For assets that are eventually sold for their market value and that do not benefit from any loopholes,12 the taxpayer should eventually recognize gain or loss equal to the amount realized minus adjusted basis. For those assets, the differences between a BIT regime and current law should be only in timing. The BIT regime should accelerate recognition of both gains and losses to when assets are measured as changing in value, rather than waiting for sales or other transactions that are treated as realization and recognition events under current law.
This is not to say that timing is completely unimportant. There are long-standing debates in the tax literature about timing, and more specifically about the best ways to deal with time-value returns.13 It is generally understood that our income tax is something of an ugly hybrid of an idealized consumption tax and an idealized Haig-Simons income tax. A BIT reform would move us toward the direction of a Haig-Simons income tax, but a BIT reform would only be a partial move in that direction.
We have our own views on these debates.14 However, in practice, we think that the real-world importance of these ideal tax base questions is greatly overshadowed by the impact of loopholes and political optionality. Regardless of whether you think that our tax system should ideally measure consumption or something closer to Haig-Simons income, many billionaires and megamillionaires fully and permanently escape tax on most of what their tax bases should be under either of these philosophical views. A BIT reform would alleviate this problem, and that would be its primary impact.
VI. In Practice, a BIT Reform Would Primarily Serve to Close Loopholes and Combat Harmful Political-Optionality Dynamics
Scholars estimate that under current law, over three-quarters of the investment gains of billionaires and megamillionaires fully and permanently escape tax.15 This point deserves repeated emphasis.
To further illustrate, consider the unrealized income from Mark Zuckerberg’s appreciation in the shares of the Facebook stock he owns. Under a BIT, Zuckerberg would be subject to many billions of dollars in tax on that unrealized appreciation, which escapes tax in the current regime (but benefits Zuckerberg because he can borrow against the value of the shares with no tax consequences). There is no particular reason to anticipate that Zuckerberg will ever sell most of his Facebook shares, which give him control of the company. Thus, absent a BIT reform, not only would there not be any double tax, there would most likely not even be a single tax on the shares that are not sold. This is because Zuckerberg’s heirs will presumably get the basis step-up from section 1014, allowing them to then sell the shares without paying any income tax. That is the problem that BIT reforms are designed to address, and solving this problem can produce a lot of revenue from the individuals most likely to escape income taxation under current law.
For another example, consider Larry Ellison, who has purchased multiple mansions, superyachts, and the Hawaiian island of Lanai, among other extravagant expenditures. Instead of selling his massively appreciated stock in Oracle, which has made him one of the richest people in the world, Ellison has financed these expenditures using a $10 billion personal line of credit. The reason for this is tax avoidance. By deferring realization and instead borrowing to finance his expenditures, Ellison is engaging in the classic “buy, borrow, die” form of tax planning that so many billionaires and megamillionaires use to escape income taxation on most of their investment gains and other wealth accumulations.16
Arguably, the most important loophole that billionaires and megamillionaires use to escape income taxation under current law is section 1014’s stepped-up basis rule.17 But this is not the only such loophole.18 And existing loopholes are only a part of the problem. As one of us has explained at length in a prior coauthored article, the bigger part of the problem is caused by harmful political-optionality dynamics19:
The broader lesson here is that the income tax almost certainly cannot be sustainably fixed just by calling for an end to stepped-up basis and the other major loopholes that allow taxpayers to wipe out their deferred tax liabilities. Even if these reform attempts were to be enacted, why should we expect them to be sustained? Both theory and history strongly suggest the opposite. Even if the major loophole benefits were to be ended, absent an accompanying current assessment reform, ultra-wealthy taxpayers would just continue to defer their tax liabilities while lobbying for the loopholes to be restored (or perhaps for new loopholes to come into effect), and these efforts by the ultra-wealthy would ultimately win the day.
To combat these harmful political-optionality dynamics so as to sustainably fix the broken state of the personal tax system, a current-assessment reform, like a BIT, is needed. Thus, in practice, a BIT reform would primarily serve to close loopholes and combat harmful political-optionality dynamics.
VII. A Note on the Corporate Income Tax and Business-Level Tax Issues
Susswein and Brown elide the key issues regarding loopholes and harmful political-optionality dynamics by using as their primary example the unrealized gain of the Walt Disney Co. from Disney World. But the BIT reforms we are discussing would apply to individuals, not corporations (which do not die, hence no step up). The question is whether Walt Disney as an individual should have been subject to mark to market in 1965, and the answer is yes.
Susswein and Brown address the problem of corporate shareholders who can defer gains indefinitely on the unrealized appreciation in their corporate shares. In that case, they suggest taxing shareholders directly on the book income of the corporation, as if it were a partnership. However, this would be a difficult reform to administer, even assuming it were desirable outside administrative concerns. There is no easy way to attribute corporate book value to the numerous shareholders in large corporations, especially when share ownership may change hands constantly so that the corporate officers may not even know who their shareholders are (and note that many shareholders are foreign or tax exempt). Moreover, this proposal seemingly entails eliminating the corporate income tax, and there are many good reasons to retain a corporate-level income tax.20
More problematically, Susswein and Brown assume that corporations necessarily pay tax at a 21 percent effective rate and that this tax is then borne by the shareholders. Neither assumption is accurate.
For many of the largest, most profitable U.S. corporations, the effective tax rate (ETR) is well below 21 percent. For example, in 2021 Amazon reported record profits of more than $35 billion (75 percent higher than its 2020 record haul) and paid just 6 percent of those profits in federal corporate income taxes.21 Over the past decade, Facebook paid an ETR of just 12.7 percent; in 2020 Amazon’s ETR stood at 11.8 percent and Facebook’s at 12.2 percent.22
Moreover, Susswein and Brown assume that the corporate tax is borne by shareholders. There has been an immense literature for over 50 years on the incidence of the corporate tax, and it is inconclusive. But especially for corporations that are quasi-monopolies like Amazon, Google, or Facebook, it is quite likely that they can shift at least substantial portions of the corporate tax they pay to their customers. For example, Amazon was able to shift the digital services tax that was imposed on it by France to its French customers.23
Thus, the existence of the corporate income tax does not defeat the case for enacting a BIT reform to close loopholes and combat harmful political-optionality dynamics.24 Whether and how the corporate income tax and the overall business-level tax system should be reformed are distinct questions, worthy of debate, but that should not distract from the need for reforming the individual-level tax system.
The individual-level tax system is badly broken, especially when it comes to billionaires and megamillionaires, and with many harmful consequences.25 This is the problem that BITs are primarily designed to solve.
Susswein and Brown are simply wrong in claiming that a BIT reform would be double taxation. Quite the contrary, the primary effect of implementing a BIT reform would be to close loopholes and combat harmful political-optionality dynamics that enable many billionaires and megamillionaires to fully and permanently escape tax on most of their investment gains. BIT reforms would tax the likes of Jeff Bezos, Ellison, Elon Musk, and Zuckerberg on their billions of dollars of unrealized gains that will likely never be taxed under current law. Through doing so, a BIT reform would both rectify a major flaw in the existing tax regime and produce revenue that could be used to fund other worthwhile purposes.
1 See David Gamage and John R. Brooks, “Tax Now or Tax Never: Political Optionality and the Case for Current-Assessment Tax Reform,” 100 N.C. L. Rev. 487, 497-505 (2022) (explaining how the income tax system is broken). The recent rise in prominence of mark-to-market income tax reforms targeted at billionaires and megamillionaires comes in part because these are often seen as less politically or constitutionally ambitious compared with extreme wealth tax reform proposals, such as those offered by Sens. Elizabeth Warren, D-Mass., and Bernie Sanders, I-Vt. For discussion of how calls for wealth tax and related reforms have gained newfound prominence in recent years, see Goldburn P. Maynard Jr. and Gamage, “Wage Enslavement: How the Tax System Holds Back Historically Disadvantaged Groups of Americans,” 110 Ky. L.J. 670, 673 (2021-2022).
2 For disclosure, one of us (Gamage) has helped design and co-draft each of these reform proposals, except for Senator Wyden’s, which Gamage advised and consulted on but did not co-draft.
3 Donald B. Susswein and Kyle Brown, “Is It Time to Tax Disney’s Unrealized Capital Gains From 1965?” Tax Notes Federal, June 13, 2022, p. 1717.
6 Gamage and Brooks, supra note 1, at 501-502.
7 Susswein and Brown, supra note 3, at 1718-1719.
8 Not all current or future benefits of owning assets are subject to income taxation, which gives rise to another flaw in Susswein and Brown’s argument.
9 For definitions and discussion of loopholes and political optionality, see infra notes 13 and 16-20 and accompanying text.
10 For true non-wasting and non-growth assets, the future streams of rental income should be expected to grow with the relevant discount interest rate, so that their present values would remain constant. If the future revenue streams were expected to grow slower than this, the asset might partially be a wasting asset. If the future revenue streams were expected to grow faster than this, the asset might partially be a growth asset. However, we abstract from these complications in the discussion above to keep things relatively simple.
11 For example, a freeway might be built near the land in a manner that increases the expected rental value of the land.
12 There is no standard definition for loopholes, and what should be considered a loophole is contentious. Here, we use the term “loophole” to refer to departures from the income tax law’s basis framework — such as section 1014’s stepped-up basis in death rules — that allow taxpayers to fully and permanently escape income taxation on their investment gains.
13 E.g., Edward D. Kleinbard, “Capital Taxation in an Age of Inequality,” 90 S. Cal. L. Rev. 593 (2017); Joseph Bankman and David A. Weisbach, “The Superiority of an Ideal Consumption Tax Over an Ideal Income Tax,” 58 Stan L. Rev. 1413 (2006); Alvin Warren, “Would a Consumption Tax Be Fairer Than an Income Tax?” 89 Yale L.J. 1081 (1980).
14 E.g., Gamage, “The Case for Taxing (All of) Labor Income, Consumption, Capital Income, and Wealth,” 68 Tax L. Rev. 355 (2015); Reuven S. Avi-Yonah, “The Three Goals of Taxation,” 60 Tax L. Rev. 1 (2006).
15 Supra note 1, at 501-502.
16 Gamage and Brooks, supra note 1, at 489-490 and 500-504.
17 Id. at 503-504.
19 Id. at 552-553.
21 Matthew Gardner, “Amazon Avoids More Than $5 Billion in Corporate Income Taxes, Reports 6 Percent Tax Rate on $35 Billion of US Income,” Institute on Taxation and Economic Policy (Feb. 7, 2022).
22 Ryan Koronowski et al., “These 19 Fortune 100 Companies Paid Next to Nothing — Or Nothing at All — In Taxes in 2021,” Center for American Progress (Apr. 26, 2022).
23 Elizabeth Schulze, “Amazon Is Passing Along Costs of a New Digital Tax to Thousands of French Sellers,” CNBC, Aug. 19, 2019.
24 For further discussion on this point, see Gamage and Brooks, supra note 1, at 509-512.
25 Id. at 497-520.