It’s an unworkable and possibly unconstitutional idea, but some members of the party seem determined to see it through.
Democrats promised that taxing the rich could finance a massive expansion of federal benefits. Yet a full Democratic government is having trouble agreeing on even $1 trillion in upper-income taxes. In their desperation, they are turning to a tax proposal so unworkable that no country in the world—not even in tax-loving Europe—has ever imposed it before. It’s a new tax on the investments of billionaires called mark-to-market taxation.
Yet no sooner had Sen. Ron Wyden (D-OR) released a draft of the proposal—based off his 2019 framework—than his colleague Sen. Joe Manchin (D-WV) threw cold water on this new billionaire’s tax, asserting that “I don't like it. I don’t like the connotation that we’re targeting different people. There’s people that… contribute to society, that create a lot of jobs, and invest a lot of money, and give a lot to philanthropic pursuits.”
Manchin offered a preference for applying a 15 percent minimum tax rate to both corporations and wealthy individuals, which also requires much more vetting, while House Ways and Means Chair Richard Neal said he was considering a 3 percent surcharge on those making $10 million or more, even as Wyden insisted that his billionaire’s tax plan was still in play.
In short, Democrats are grasping for any new billionaire tax system that is workable. Yet because mark-to-market taxation—an idea that Bernie Sanders and Elizabeth Warren have previously pushed—will remain on the table at least until Democrats scrambling to find funding to match their expansive proposals coalesce around another option, it is worth exploring why mark-to-market taxation is one of the most unworkable ways of taxing the wealthy.
Under current law, capital gains taxes are assessed on investments such as stocks, bonds, property, jewelry, and art. When the assets are sold, the seller’s capital gain (typically measured as the sale price minus the acquisition price) is taxed at ordinary income tax rates if it was held for less than a year, and at a rate ranging from 0 to 23.8 percent (depending on the filer’s taxable income) if it was held for longer than a year.
Because investors can decide when to sell their assets, they can essentially decide when to pay capital gains taxes. And some capital gains can permanently escape taxes if held until death and then passed down to an heir.
Mark-to-market taxation would instead assess capital gains taxes every year on the annual change in the value of the investments, even if they have not been sold. In a sense, it shifts capital gains from being an income tax to a property tax, since the capital gain at that point represents only theoretical income that has not been received.
The Democratic proposal would impose mark-to-market taxation on investors with a net worth over $1 billion, or annual income exceeding $100 million for three consecutive years.
The concept is simple—and no one is going to cry for the billionaires—but the implementation could be disastrous.
The first issue is that the IRS would have to annually determine the value of all investments held by affected individuals. That’s easy for stocks and bonds, but what about items that are not regularly traded like closely-held businesses, art, and jewelry? The proposal would delay taxes on those hard-to-value items, but instead assess an interest charge that could nonetheless create incentives for tax gaming.
A second problem is budgetary. If Washington is going to tax rising investment values each year, then what happens in years when markets or investment values decline? That’s right: The IRS would likely find itself mailing enormous refund checks to America’s billionaires. Financial markets have already endured three major market declines this century (2000, 2007-2009, and early 2020), which typically occurred during recessions. Because investment markets generally move with the broader economy, mark-to-market taxation would create vast tax revenue volatility, bringing in extra tax revenues during booms, and driving recessionary deficits even higher with huge payments to America’s billionaires. And since most state tax systems dovetail the federal tax code, this new revenue volatility would significantly strain most states with annual balanced budget requirements.
A third challenge could be paying a steep mark-to-market tax bill when the investment has not yet been sold to bring in the money to pay the tax. This is especially the case because the proposal would begin applying mark-to-market taxation retroactively without limitation. This means someone who, over several decades, built a publicly-traded company that is now worth $1 billion could receive a one-time retroactive $238 million tax bill. Paying such a tax would almost surely require selling much of his/her ownership in their own company.
Finally, legal scholars assert that mark-to-market taxes are likely unconstitutional. The 16th Amendment allows the federal government to impose income taxes and since mark-to-market is more of a property tax (the investment gains have not been received as income) that is not apportioned to the states in proportion to their population, it would likely be struck down by the courts. State governments, however, could legally impose the policy.
Mark-to-market taxation for the ultra-rich would finance only a fraction of the reconciliation bill (perhaps $250 billion over the decade), in part because much of the revenue represents an acceleration of capital gains taxes that would have been paid eventually when the investment was sold. The big exception is that some investments would no longer permanently escape capital gains taxes by being held until death and then passed down to heirs. However, closing that loophole can be done simply by taxing the wealthy’s investments immediately at death, or at least adding on those taxes when the heirs eventually sell the assets (as long as duplication with the estate tax is addressed). That policy would raise a comparable amount of revenue without creating this new unworkable system. Yet taxing capital gains at death was one of the options that Congressional Democrats quickly rejected.
Mark-to-market taxation would produce an administrative nightmare for the IRS, a revenue volatility nightmare for the federal budget, and a liquidity nightmare for business owners who receive a massive look-back tax—all for a policy that raises limited revenue and would likely be struck down by the courts. When even Europe refuses to impose a certain type of tax, Americans should take the hint.
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Brian M. Riedl is a senior fellow at the Manhattan Institute. Follow him on Twitter here.
This piece originally appeared in The Daily Beast