As Congressional Democrats continue to attempt to move ahead with their reconciliation package, they temporarily included a so-called billionaire tax in hopes of making the spending measure deficit-neutral. Although the tax measure ultimately fell out of the proposal, the short-lived measure is illustrative of a process issue that can drive up deficit spending. Although proponents suggested that a billionaire tax would add $300 billion of new federal revenue over the 10-year budget window, it was never scored by the Congressional Budget Office. And unless a measure is analyzed by CBO and other independent observers, its deficit impact should be taken with a hefty grain of salt.
According to a Senate Finance Committee legislative summary, the new tax would have applied to individuals with at least $1 billion of assets or at least $100 million of income for three consecutive years. The number of individuals falling into these categories across the United States appears to be less than 1,000. Instead of paying capital gains when they sell their assets, under the tax, affected individuals would have to revalue their assets each year and pay the federal government a percentage of any annual increase.
Internal Revenue Service records leaked to ProPublica showed that several high-profile billionaires pay relatively little in federal taxes. They can avoid taxation while maintaining luxurious lifestyles, in part, by retaining their appreciated assets and then borrowing against them.
Setting aside the question of whether a new tax targeting asset values of the very wealthy is the best solution, estimating the revenue it would raise is non-trivial, meaning basing government spending on that revenue is fraught. It may be tempting to look at the Forbes Billionaire Lists for two consecutive years, take the difference in estimated wealth for each billionaire on these lists and multiply by the tax rate. But such a top-line approach neglects various factors that could result in deficit-fueling revenues.
First, the proposed billionaire tax, if ever implemented, could then be temporarily stayed and ultimately thrown out by the judiciary on constitutionality grounds. Article 1 Section 9, Clause 4 of the Constitution says, “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken.”
In modern terminology, this means that federal taxes on individuals or their property (“direct taxes”) must be the same amount for everyone. This clause was used to defeat the original federal income tax. Only after the passage of the 16th Amendment could the federal government impose the income tax, which it did in 1913. The text of the amendment was short and straightforward:
“The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”
Because the 16th Amendment only makes an exception for income, any other direct tax, such as one on wealth, would appear to be unconstitutional. That said, courts have not struck down things like estate and gift taxes, and some legal scholars have defended the constitutionality of wealth taxes, although their arguments remain to be tested in court.
Proponents of the new levy likely structured it as a tax on unrealized capital gains rather than total wealth to protect it from being overturned. But undoubtedly, some billionaires would recruit the best legal minds money can buy to try to defeat it.
Moving ahead, assuming the tax is passed and the Supreme Court neither strikes down the unrealized capital gains tax nor delays its implementation, there are still other risks to the revenue forecasts. Most notably, some billionaires may leave the United States and renounce their citizenship to avoid the new tax. According to fintech startup Stilt, 5,313 Americans renounced their citizenship in 2020. Each quarter, the IRS publishes a list of individuals who have given up their citizenship or their U.S. resident tax status. Among the people who have appeared on these quarterly lists — rock star Tina Turner, Facebook co-founder Eduardo Saverin, and Campbell Soup heir John Dorrance III, the latter two of these individuals were billionaires when they gave up their U.S. passports.
More billionaires can likely be expected to initiate the renunciation process if their U.S. tax liability were to increase as it would under the billionaire tax proposal. At least a few are already well-positioned to take this step. For example, Peter Thiel has reportedly obtained New Zealand citizenship, while former Google CEO Eric Schmidt has obtained a European Union passport. With a total tax base of fewer than 1,000 individuals, the departure of just a few taxpayers could significantly impact revenue collections from a billionaire tax.
The Senate Finance Committee draft partially addressed the renouncement issue by requiring billionaires who give up their citizenship to pay any unrealized capital gains tax before leaving. If such a requirement passed legal muster and could not be circumvented, it would compel billionaires to pay taxes on their past gains but the federal government would still be deprived of revenues from future capital gains.
Finally, capital gains taxes may generate strong revenues when the economy is booming and could produce very little revenues during recession years.
It was wise for Congressional Democrats to shelve the billionaire tax proposal, but the issue seems certain to reemerge down the road. If and when it does, taxpayers should be skeptical that the tax would produce the revenues some proponents claim it would, especially in the absence of a CBO score.