Reuven S. Avi-Yonah is the Irwin I. Cohn Professor of Law at the University of Michigan Law School. He thanks Lily L. Batchelder, Jake Brooks, Kimberly A. Clausing, Edward Fox, David Gamage, Joel Slemrod, Clint Wallace, and Bret Wells for helpful comments.
In this installment of Reflections With Reuven Avi-Yonah, the first in a two-part series, Avi-Yonah proposes how to tax the wealthiest members of society in a constitutional manner in the wake of the Moore v. United States decision.
The tax system dodged a major bullet when the Supreme Court refused to constitutionalize the realization requirement in Moore.1 But the decision also indicates that the Court is likely to strike down a mark-to-market tax on billionaires as proposed by the Biden administration and by Sen. Ron Wyden, D-Ore. (S. 3367). Four justices (Clarence Thomas and Neil M. Gorsuch in dissent and Amy Coney Barrett and Samuel A. Alito Jr. in concurrence) clearly indicated that they regard realization as a constitutional requirement.2 Congress is not likely to risk an adverse outcome by adopting either a wealth tax or a mark-to-market tax, so what comes next?
The same interests that brought Moore to the Court are likely to continue to try for another test case, but in the absence of mark-to-market legislation, there is no obvious candidate. Subpart F, the global intangible low-taxed income regime, and subchapters K and S are protected by the attribution rule because they only apply to realized income. Sections 1256, 1259, and 877A can plausibly be described as excise taxes not subject to realization.3 The corporate tax has been declared an excise tax as well, although that outcome may be more dubious.4 Still, it is hard to see the Court taking up another case soon because the Moore decision already deters mark-to-market taxation, which was the real target of the litigation. In any case, passing mark-to-market in Congress is very difficult even if the Democrats control both chambers and the White House because it is politically unpopular to impose taxes on phantom income.5
So if mark-to-market taxation is unlikely and wealth taxation is even more unlikely, what can be done in the meantime to tax the superrich? This question is important because taxation of the superrich decreases inequality and promotes fairness, and also because taxing the superrich may be the political key to other needed reforms, like adopting a VAT.6
I would suggest three reform proposals.7
Increase the Corporate Tax
First, because much of the wealth of the superrich like Jeff Bezos, Elon Musk, and Mark Zuckerberg is in unrealized appreciation in the shares of public corporations they control, Congress could increase the corporate tax. There is a lot of evidence that the corporate tax falls on economic rents, that is, profits that are not subject to competition. And that is particularly true for the corporations controlled by the superrich.8 If corporate tax falls on economic rents, then the incidence of the corporate tax is on the shareholders: The corporation would have increased taxes and reduced wages to the extent possible before the tax because there is no competition. Moreover, under these conditions, increasing the corporate tax is efficient because it does not affect corporate behavior, and from a distributive perspective the corporate tax reaches 100 percent of equity capital instead of just the 27 percent of equity owned by individual taxable shareholders.9 I have previously suggested reinstating the progressive corporate tax and taxing the most profitable corporations at a very high rate (like the World War II-era excess profits tax, with its 80 percent rate).10 This reform could be linked to expensing (so that the normal return is exempt from tax) and to alleviating the shareholder-level tax through integration (dividend exemption, imputation, or even dividend deduction).11
Unrealized Appreciation
Second, the superrich cannot sell their shares without triggering a capital gains tax at 23.8 percent.12 But they can borrow against the unrealized appreciation tax free to fund other projects, like Musk did when he borrowed against his Tesla stake to acquire Twitter and like Larry Ellison did when he borrowed against his Oracle shares to acquire inter alia an island in Hawaii. Edward Fox and Zachary Liscow have therefore proposed13 that borrowing by the superrich against unrealized appreciation be treated as a realization event:
Turning back to Ellison, we use illustrative numbers to show how the tax would work. Suppose for simplicity that all his $140 billion wealth takes the form of Oracle stock. Let’s also suppose that Ellison originally paid $1 billion for his earliest-purchased stock, now worth $10 billion. In other words, for those shares, 90 percent of the value is gains that have not been taxed. Now suppose that he borrows $10 billion, which is only possible because banks know he has the (appreciated) assets to repay. We propose that Ellison pay income tax on his borrowing by realizing gains on his assets. . . .
The tax would be calculated as follows. Since Ellison is getting $10 billion in cash through his stock ownership, the tax code would conclude that $10 billion of the stock has been realized (that is, become taxable). When income is realized, the tax code subtracts the basis, which is the amount that the owner paid for the asset and has already paid tax on. We propose imposing a first-in, first-out assumption. We thus suggest using taxpayers’ basis in their oldest assets to calculate gain under the tax. Compared with using the basis in all assets, and thus having to value all assets (as would be the case if our proposal used a taxpayer’s average basis), the FIFO proposal has considerably lower compliance costs because it requires only valuing the portion of assets whose total value equals the borrowing amount. In the example, because Ellison’s oldest tranche of stock was purchased for $1 billion and is now worth $10 billion, he would get a basis offset of $1 billion on his loan. Thus, he would pay income tax on $9 billion of gains when he borrows $10 billion ($10 billion realized minus $1 billion of basis).
In return, when or if (in light of “buy, borrow, die”) Ellison sells his stock, he pays less income tax. That $9 billion of income that is taxed becomes new basis allocated to his oldest stock. Going forward, when Ellison borrows additional amounts, his basis offset is calculated based on his oldest assets not yet revalued under the borrowing tax.14
But would this tax be constitutional after Moore? Fox and Liscow argue it would be:
Some might argue that the proposal taxes unrealized income and is thus unconstitutional. However, the tax should be upheld as an excise tax on the activity of borrowing under long-standing precedents. For example, in Flint [v. Stone Tracy Co., 220 U.S. 107 (1911)], the Supreme Court upheld the corporate income tax as an excise on the privilege of doing business as a corporation, even though the amount owed under the tax was based on the income of the corporation. Similarly, here we are proposing an excise on borrowing that sets tax liability in part based on the borrower’s previously unrealized income on assets.
In the alternative, the borrowing tax should be upheld as a constitutional income tax. The Supreme Court has repeatedly said the realization rule is “founded on administrative convenience,” and the code taxes apparently unrealized income in a variety of areas, including in partnership and international taxation, as well as the taxation of some financial products. Nevertheless, the Court has granted certiorari in Moore on whether realization is constitutionally required for economic income to constitute income under the 16th Amendment. If the Court finds that the answer is “yes” — an unjustified holding, in our view — our proposal should still pass constitutional muster. In particular, the petitioners in Moore rely on [Eisner v.] Macomber[, 252 U.S. 189 (1920)], a Lochner-era case, which finds that realized income is a gain “received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal.”
When taxpayers borrow against gains on assets and in return receive cash or property for their own “separate use, benefit and disposal,” they have, in our view, realized income derived from those gains for purposes of the 16th Amendment.15 [Internal citations omitted; emphasis in original.]
Repeal Estate and Gift Taxes
Third, the estate and gift taxes, which are full of loopholes, should be repealed.16 As former Treasury Assistant Secretary for Tax Policy Lily L. Batchelder has written, the exclusion for gifts and inheritances should be repealed as well, and heirs and donees should be subject to the progressive income tax. She wrote in 2009 that:
if inheritances are included in an optimal tax framework, existing evidence suggests that the ideal wealth transfer tax would be much higher than current law, and take the form of a comprehensive inheritance tax, which includes amounts inherited above an exemption in the tax base and subjects them to higher rates. Doing so accounts for the net efficiency benefits of taxing inheritances, and the direct and indirect information they provide about the heir’s economic status.17
Conclusion
The combination of these proposals would achieve results that are similar to a mark-to-market tax on the superrich. First, those whose main asset is shares in a corporation would be subject to current taxation because the mega corporations in which they own shares would be taxed at a much higher rate than the current 21 percent or even the proposed 28 percent. Second, if they borrow against the unrealized appreciation in their assets, they would be taxed as if they had sold them. Third, if they actually sold the assets they would be taxed, and if they tried to avoid the tax by leaving the United States and expatriating, they would be taxed as if they sold the assets.18 Finally, if they held the assets until death, their heirs would be taxed, and if they donate the assets to a foundation, that could be a taxable realization event as well. None of these reforms is likely to be held unconstitutional even if the Court holds in a future case that realization is a constitutional requirement for an income tax.
In the next article in this series, I will explore what Congress can do now to defend the many parts of the code that would be subject to a constitutional challenge if the Court decides in a future case that realization is a constitutional requirement, as it barely avoided doing in Moore.
FOOTNOTES
1 Moore v. United States, No. 22-800 (June 20, 2024). On the collateral damage that would have resulted from the opposite outcome, see Reuven S. Avi-Yonah, “If Moore Is Reversed,” Tax Notes Int’l, June 26, 2023, p. 1725; Brief of Amici Curiae Avi-Yonah, Clinton G. Wallace, and Bret Wells in Support of Respondent, Moore, No. 22-800 (U.S. Oct. 19, 2023). The majority correctly characterized this outcome as a “fiscal calamity” (Moore, No. 22-800, slip op. at 22) and noted that the “blast radius” (id. at 16) from such an outcome would be very wide.
2 The majority notes that “our analysis today does not address the distinct issues that would be raised by (i) an attempt by Congress to tax both the entity and the shareholders or partners on the entity’s undistributed income; (ii) taxes on holdings, wealth, or net worth; or (iii) taxes on appreciation.” Moore, No. 22-800, slip op. at 8, n. 2. But the majority also noted, “Those are potential issues for another day, and we do not address or resolve any of those issues here.” Id. at 24. Justices Barrett and Alito, however, wrote, “The question on which we granted review is ‘whether the Sixteenth Amendment authorizes Congress to tax unrealized sums without apportionment among the states.’ The answer is straightforward: No.” Id. at 2 (Barrett, J., concurring) (internal citation omitted). Justices Thomas and Gorsuch state that “Sixteenth Amendment ‘incomes’ include only income realized by the taxpayer. The text and history of the Amendment make clear that it requires a distinction between ‘income’ and the ‘source’ from which that income is ‘derived.’ And, the only way to draw such a distinction is with a realization requirement.” Id. at 1 (Thomas, J., dissenting).
3 Avi-Yonah, “What Is the Best Candidate for a Post-Moore Constitutional Challenge?” Tax Notes Int’l, Jan. 1, 2024, p. 17.
4 Avi-Yonah, “Effects From Moore: Does the Corporate Tax Require Realization?” Tax Notes Int’l, Jan. 22, 2024, p. 437.
5 Zachary Liscow and Edward Fox, “The Psychology of Taxing Capital Income: Evidence From a Survey Experiment on the Realization Rule,” 213 J. Public Econ. (2022).
6 Avi-Yonah, “What Matters in Moore,” Tax Notes Int’l, Feb. 12, 2024, p. 883; Avi-Yonah, “Can the United States Curb Its Debt?” Tax Notes Int’l, Apr. 15, 2024, p. 413.
7 There are other options available as well. Joel Slemrod has proposed to treat death as a realization event but tax the capital gain retroactively during the decedent’s lifetime on a present-value basis. See Joel Slemrod and Xinyu Chen, “Are Capital Gains the Achilles’ Heel of Taxing the Rich?” 39(3) Oxford Rev. Econ. Pol’y 592 (2023). This proposal can be defended as an excise tax. Another possibility is the ULTRA method proposed by Brian Galle, David Gamage and Darien Shanske. Under the ULTRA method, shareholders are given the choice of either (a) current taxation or (b) mark to market taxation or (c) deferred taxation upon realization with an interest charge. Most shareholders choose option (a) because option (b) risks taxation on phantom income that will disappear if the stock market value falls, and option (c) involves a hefty interest charge and thus a massive one-time tax payment. See Brian Galle et al., Solving the Valuation Challenge: The ULTRA Method for Taxing Extreme Wealth, 72 Duke L. J. 1257-1343 (2023). Such an elective regime would be harder for the Court to strike down precisely because it is elective. If option (c) is constitutional because it involves realization at the shareholder level, it is hard to declare options (a) or (b) unconstitutional because the shareholder could choose option (c) instead. Justice Kavanaugh rejects electivity as a defense of S corporation taxation because all the shareholders need to consent, Moore at 19, but under ULTRA (like the passive foreign investment company rules on which it is modeled) each shareholder makes the election separately.
8 Kimberly A. Clausing, “In Search of Corporate Tax Incidence,” 65(3) Tax Law Rev. 433 (2012); Clausing, “Capital Taxation and Market Power,” 77(2) Tax L. Rev. (forthcoming 2024); Fox, “Does Capital Bear the U.S. Corporate Tax After All? New Evidence From Corporate Tax Returns,” 17(1) J. Empirical Legal Stud. 71 (Mar. 2020).
9 Steven M. Rosenthal and Livia Mucciolo, “Who’s Left to Tax? Grappling With a Dwindling Shareholder Tax Base,” Tax Notes Federal, Apr. 1, 2024, p. 91 (describing the ownership shift for publicly traded U.S. stock); Rosenthal, Testimony Before the Senate Finance Committee, “Integrating the Corporate and Individual Tax Systems: The Dividends Paid Deduction Considered” (May 17, 2016). See also Leonard E. Burman, Clausing, and Lydia Austin, “Is U.S. Corporate Income Double-Taxed?” 70 Nat’l Tax J. 675 (2017) (corroborating the ownership shift shown by Rosenthal and Mucciolo).
10 Fox and Liscow, “A Case for Higher Corporate Tax Rates,” Tax Notes Int’l, June 22, 2020, p. 1369; Avi-Yonah, “A New Corporate Tax,” Tax Notes Int’l, July 27, 2020, p. 497. This tax must be applied on a worldwide basis with strong anti-inversion rules to be effective.
11 See Bret Wells, “International Tax Reform by Means of Corporate Integration,” 20(2) Florida Tax Review 70 (Fall 2016); Avi-Yonah, “The Treatment of Corporate Preference Items Under an Integrated Tax System: A Comparative Analysis,” 44(1) The Tax Lawyer 195 (1990); Avi-Yonah and Amir C. Chenchinski, “The Case for Dividend Deduction,” 65(1) The Tax Lawyer 3 (2011). But see Burman, Clausing, and Austin, supra note 8; and Avi-Yonah, “Back to the 1930s? The Shaky Case for Exempting Dividends,” Tax Notes Int’l, Jan. 6, 2003, p. 91; and part 2 of this series, which will argue against integration.
12 There is evidence that raising the capital gains rate actually increases the effective tax rate on the rich, which is currently 23 percent (i.e., about the same as the capital gains and dividends rate). See Gabriel Zucman, “It’s Time to Tax the Billionaires,” The New York Times, May 3, 2024. The data comes from Emmanuel Saez and Zucman, The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay (2019).
13 Fox and Liscow, “No More Tax-Free Lunch for Billionaires: Closing the Borrowing Loophole,” Tax Notes Int’l, Jan. 22, 2024, p. 451.
14 Id.
15 Id.
16 Alternatively, at least the section 1014 step-up should be repealed, but that is a poor substitute for taxing inheritances in full.
17 Batchelder, “What Should Society Expect From Heirs? A Proposal for a Comprehensive Inheritance Tax,” 63 Tax Law Rev. 1 (2009).
18 For a recent case illustrating the effectiveness of the exit tax, see Robert Goulder, “The Immaculate Expatriation: Bitcoin Jesus and the Exit Tax,” Tax Notes Int’l, May 13, 2024, p. 1107. On the constitutionality of the exit tax see Avi-Yonah, “What is the Best Candidate for a Post-Moore Constitutional Challenge?”, Tax Notes Int’l, Jan. 1, 2024 p. 17; and Avi-Yonah, “Are Exit Taxes Discriminatory?,” Tax Notes Int’l, June 24, 2024, p. 1947.
END FOOTNOTES