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.

The post The ‘billionaire tax’ and a wealth tax are not the same appeared first on American Enterprise Institute – AEI.