There’s an easy way to tax billionaires that would actually work

• The ultra-wealthy avoid paying taxes by using stock as collateral for loans and deferring the sale of assets.
• Fair and effective tax policy would treat large personal loans for the wealthy similar to realized income.
• Tax policy should target consumption and the “buy, borrow, die” tax avoidance schemes of the wealthy. 
• Emil Skandul is an opinion writer on economic policy and is the founder of a digital innovation firm, Capitol Foundry.
• This is an opinion column. The thoughts expressed are those of the author. 

With the infrastructure bill now having passed Congress, the debate about the different tax policies to fund the infrastructure bill over the past several months has come to a temporary quietus. The bill is without a direct increase on taxes, and the ultra-wealthy remain unscathed — at least for now.

Still, pressure has mounted on billionaires so much that Elon Musk has attempted to address the issue head on. “Much is made lately of unrealized gains being a means of tax avoidance, so I propose selling 10% of my Tesla stock,” he tweeted earlier this month. The decision was ultimately made by polling his followers — around 4% of his holdings have now been liquidated.

For the many impractical tax schemes introduced by economists and members of Congress, none have addressed how the wealthiest Americans avoid paying taxes to begin with: They take out loans to live on using their stock as collateral. In fact, the likely motivation for Musk to sell off some of his Tesla shares was to pay off these loans.

So if low-interest loans are used by wealthy individuals to avoid selling shares and paying capital gains taxes, the solution should be obvious: Directly tax the underlying loans that are treated as personal income.

A slew of bad tax policy

Wealth taxes are a policy debate that has grown ferociously louder over the years, and it has fixed the affluent in the crosshairs of legislators and the public. In recent years, it has become a central theme in campaigns, political messaging, and news stories about growing income inequality.

Much of America’s understanding of why income inequality is inevitable and how it has reached the highest levels since the Gilded Age can be attributed to the French economist Thomas Piketty’s “Capital in The Twenty-First Century,” which laid the groundwork for the arguments for increasing taxes on the wealthy. There is a greater return on capital than on labor, and the bigger a fortune, the faster it will grow. Fortunes of the top 1% are consistently less diversified, and often accumulate exclusively in one or two firms.

The numbers speak for themselves. The top 1% of Americans today have accumulated 27% of total wealth. Even more glaringly, since the start of the pandemic, more than half a trillion dollars has been added to the net worth of billionaires, whose numbers have increased by 13.4%. While net worth has increased over the past decade, this value remains locked up in the companies owned by these individuals, unless shares are sold or borrowed against. From taxing unrealized gains to implementing an annual wealth tax, a number of haphazard proposals have attempted to simultaneously fund public investments and capture these unrealized gains in wealth.

Senator Elizabeth Warren’s 2% annual wealth tax for those individuals with a net worth above $50 million was one tax response. However, when this policy was implemented in France, it led to 10,000 French nationals leaving the country in order to avoid being taxed. The economists behind the plan, Gabriel Zucman and Emmanuel Saez, argue that mobility and expatriation taxes are different in the US than in Europe — so the same scenario would be unlikely. But in a highly globalized and mobile world, there would undoubtedly be some attrition. The loss of even a fraction of the US’s most ambitious and entrepreneurial minds along with their capital would be bad for the US economy and isn’t worth the downsides of a tax experiment that has been tried before. 

Even more recently, a proposal by Senate Finance Chair Ron Wyden included a plan to tax unrealized gains. Billionaires are able to avoid long-term capital gains taxes of 23.8% by never selling shares in the firms they own if the expectation is that the shares will increase in value. This strategy has allowed the wealthy to take out loans, which are later refinanced as a stock’s value increases in order to pay back previous loans. This can be done ad infinitum as a stock’s value increases, meaning the borrower never has to sell shares to pay back the loans. 

However, taxing an unrealized gain leads to a never-ending series of questions regarding fairness and implementation. When exactly do you execute the tax if someone’s net worth is fluctuating because of a volatile stock price? If a stock is worth $3 today and $1 tomorrow, and no stock sale has occurred, is it fair to effectively collect the remaining amount because it was worth $3 yesterday?

Additionally, there is the problem with liquidity as Musk’s recent sale has shown. Selling any large number of shares in a company will mean there will have to be buyers for those shares, and if not, then a large sale will significantly reduce the price of the stock as it did for Tesla, the price of which initially fell 15.4% to recover 7%. Likewise, for other illiquid assets, such as real estate and art, how do you collect on the appreciation in value?

Treat large loans as realized income

The equation for wealth preservation may be best summed up as: “buy, borrow, die.” In spite of this, tax policy has placed “borrowing” in a blind spot — a loan is viewed as a debt, not an asset.

Ownership of a company or a stock only has value if it can generate cash flow or has resale value to others. But when stocks are used as collateral to draw a line of credit and avoid a taxable event, it creates immediate value for the owner. Fair and effective tax policy would treat large personal loans similar to realized income, because the value from the stock is being extracted, even if impermanently, by the owner.

By placing a tax of 10% on large loans that are drawn against existing assets, the knock-on effect may also require high net-worth individuals to voluntarily sell their assets to cover the costs of the principal and interest, thereby triggering a larger capital gains tax. This tax policy would effectively reduce this popular tax avoidance scheme used by the wealthy around the world. It would ensure that the value that is captured by borrowing against assets is taxed — a value that grows larger every year. According to some estimates, the wealthiest Americans avoid paying $163 billion in taxes every year, and debt is the primary tool used to escape tax burdens. 

Indirectly taxing consumption — the wealth derived from personal loans — and inheritances is an approach to the problem of hyper-wealth accumulation that Musk, surprisingly, would agree with. Combined with other prudent tax policies including targeting trusts and foundations as well as loopholes in estate taxes, an uncomplicated tax framework emerges that taxes individuals after selling, borrowing, and dying. It’s this path of least resistance to making sure taxes are collected that will require targeting the schemes like asset-based lending that have enabled the ultra-wealthy to eschew paying taxes.