By Kyle Pomerleau
The Wall Street Journal reports that lawmakers are considering a tax on billionaires’ unrealized capital gains to pay for parts of Joe Biden’s “Build Back Better” agenda. Several commentators have incorrectly described this “billionaire tax” (also referred to as “mark-to-market” income taxation of capital gains) as a wealth tax. On CNN, Speaker of the House Nancy Pelosi said, “we will probably have a wealth tax,” while discussing this policy. Likewise, the Wall Street Journal Editorial Board called it a “de facto wealth tax, which would be levied on property rather than income.” Others have said the proposal is “definitely a wealth tax.”
Although the proposal to tax billionaires on their unrealized capital gains and a wealth tax share similar features, there are important differences between the two policies.
Under current law, capital gains are taxed based on the realization principle: Capital gains are only added to taxable income when assets are sold for a profit. The mark-to-market proposal would deviate from this principle and require taxpayers with either $1 billion in net assets or $100 million in income (on average over three years) to add the value of unrealized capital gains to their taxable income each year.
A wealth tax, in contrast, would tax the value of a taxpayer’s net wealth (assets minus liabilities) each year. In 2020, Senator Elizabeth Warren (D-MA) proposed a progressive net wealth tax under which assets between $50 million and $1 billion would be taxed each year at 2 percent, and assets over $1 billion would be taxed at 6 percent. Senator Bernie Sanders (I-VT) proposed a similar tax with rates ranging from 1 percent to as high as 8 percent.
A mark-to-market income tax on capital gains and a wealth tax do have similarities. For example, both taxes fall on the owners of wealth and would require taxpayers to value assets each year. As a result, both policies face similar administrative challenges related to valuation. Assets would need to be valued each year, and while this may be straightforward for publicly traded securities, it is significantly more difficult for assets like real estate, unique artwork, and closely-held businesses.
However, there are significant differences between these policies.
One difference involves the breadth of the two policies. The mark-to-market income tax only applies to assets that generate income through capital gains. A wealth tax, on the other hand, would fall on assets that generate capital gains and on other forms of capital income such as dividends, rents, and royalties.
Both taxes also differ in their treatment of negative returns. Under a mark-to-market income tax, taxpayers would only face additional tax if the value of their wealth increased during the year. A reduction in wealth would result in a rebate or a loss carryforward that would offset positive taxable income in the future. A wealth tax, however, would apply regardless of whether the wealth nets income or not. Importantly, a taxpayer would still face a positive wealth tax burden even if the value of their wealth declined in a given year.
In addition, these policies differ in their treatment of assets when rates of return vary. A wealth tax applies to the value of an asset each year. As a result, it reduces the rate of return on an asset by the wealth tax rate. For example, a 1 percent wealth tax on an asset that appreciates by 5 percent would reduce the asset’s rate of return by 1 percent. This is equivalent to a 20 percent income tax on the same asset. However, the same 1 percent wealth tax could place a burden equivalent to a 50 percent income tax on an asset that only earns a 2 percent pre-tax return or what’s equivalent to a 5 percent income tax on an asset that earns a 20 percent pre-tax return. In contrast, under a mark-to-market income tax, the effective tax rate on returns is fixed at the statutory tax rate. Therefore, taxpayers earning extraordinary returns on their assets would face lighter taxation under a wealth tax than under a mark-to-market income tax.
Several commentators have conflated the proposal to tax billionaires on their unrealized capital gains with a wealth tax. A wealth tax and a mark-to-market income tax have similarities, but they are two different policies.