This piece first appeared in Post Alley on October 27th 2021.

A new plan, captained by Democratic Oregon Sen. Ron Wyden, would tax the unrealized gains of America’s richest — which amounts to about 700 billionaires. It is perhaps the most narrowly focused tax proposal in U.S. history. The plan popped onto everyone’s radar last week amid the scramble to fund Biden’s ambitious social infrastructure plan. Some notable Washingtonians are sitting upright and paying close attention, since the founders and early employees of Amazon, Microsoft, McCaw, PACCAR, Starbucks, and more call the Seattle area home, as do several very wealthy real estate developers, team owners, and venture capitalists.

But the rapidly-developing proposal faces tremendous headwinds, starting with the extremely fragile political unanimity required for passage. Sen. Joe Manchin, for instance, is already dubious. But assuming it passes, the new tax is certain to face immediate and well-funded legal challenges about its constitutionality. Thus the plan would ultimately be decided by a Supreme Court that is sympathetic to conservative arguments.

In the unlikely event it passes and meets constitutional muster, there are still several thorny unintended side-effects that might arise: Would capital flee, as it has when Europe experimented with wealth taxation in multiple times past? And in a stock market crash or an Enron-like or Lehman Brothers type scandal, would American taxpayers accept the federal government crediting back to billionaires hundreds of millions of dollars?

The biggest immediate obstacle is the hard political reality that it only takes a single legislator to object.

This means all 50 Democrats need to be willing to risk being primaried by one or more billionaire-funded candidates a year hence. We might well see potential objections from states with billionaires like New York, Texas, Florida, Massachusetts, California, and here in Washington state. There appears to be zero Republican support for this idea, and already, there are clear rumblings that some Dems aren’t fans of the idea. Signs have emerged of waffling in the House, including Rep. Richard Neal (D-MA), chair of the powerful tax-writing Ways and Means Committee.

Speaker Nancy Pelosi (D-CA) tried to signal optimism this past weekend: “We will probably have a wealth tax.” (Note that “probably.”) The proposed tax shines and sparkles to some, but tends to look thornier once the realities are explored.

Though the plan seems to have come out of nowhere for many Americans, Sen. Ron Wyden, chair of the Senate Finance Committee, has been working with his staff on the idea for several years, and published the framework for it in 2019.

There have been some big changes from that 2019 plan. Wyden’s original 2019 proposal had a much lower threshold: you’d have been in this select group if you had either either $1+ million in income, or assets of at least $10 million in each of the prior three years. The fact that a much lower threshold was central to the original plan bolsters Elon Musk’s criticism that this is just the camel’s nose in the tent, and that very soon, the plan would affect many more Americans.

Another big change is the rate itself. Instead of taxing these gains at ordinary income rates as the original 2019 plan proposed, the latest proposal is to tax them at 23.8%. You can see more details of the emerging plan in Wyden’s announcement on Tuesday.

We’ve arrived at this juncture quite suddenly. While generic proposals to “tax the rich” have been part of the overall messaging from Democrats for several years now, the specific details for taxing the unrealized gains of billionaires have not really been in the broad political zeitgeist until the second week of October, 2021. And just as rapidly, the idea is fading.

How did we get here? President Biden and his allies in Congress are trying to thread a very difficult needle. On one hand, they have pushed an historic $1.5-$3 trillion combined “Build Back Better” agenda. Progressives led by Rep. Pramila Jayapal (D-Seattle) insist that a major social spending package be part of the overall agreement on the Senate-passed infrastructure bill (as was agreed to when the traditional infrastructure bill first passed the Senate), and thus far Biden and the Democratic leadership seem to agree on holding the infrastructure bill hostage.

Yet at the same time, Biden has promised his bold spending plan will cost zero dollars to anyone earning under $400,000 per year.

These parameters are fundamentally at odds with each other.

Biden is convinced that Congress will find revenue to pay for $1-$3 trillion in new spending which does not impact the vast majority of Americans’ wallets or life savings. And, for the blissful summer months of agenda-dreaming, that seemed somewhat more possible, as a great deal of this was assumed to come from substantially hiked tax rates on corporations and upper-income households. But a few weeks ago, Sen. Krysten Sinema (D-AZ), (and perhaps other backstage legislators) officially nixed any substantial hikes in corporate and individual income taxes, taking this option off the table.

And so it was that Democrats quickly resurrected and repackaged Sen. Wyden’s “Treat Wealth Like Wages” plan from 2019, taking aim at the unrealized gains of billionaires.

How The Billionaire Tax Would Work

Reports by the Wall Street Journal and Washington Post suggest that the billionaire tax would apply only to tradeable or liquid assets, at least initially, and only tax those 700 or so people with net worth of at least $1 billion. Presumably, those reasonably close to $1 billion in wealth might also have to prove or attest somehow that they are not over that threshold.

“Unrealized” gains are appreciations in value which only exist on paper. That is, they’ve not yet been “realized” or converted into cash, which typically happens when the assets (e.g., stocks or bonds or real estate) are sold. Under current US tax law, only realized gains are taxable, and they are taxed at different rates, depending upon whether the owner holds it for less than a year (a “short-term capital gain or loss”) or at least a year (“long-term capital gain or loss.”) A deduction is allowed for gains on sale of primary residences (currently $250,000).

Long-term capital gains — gains on those securities held for at least a year — are currently taxed at a maximum of 20%, which is substantially below today’s 37% top ordinary income marginal rate. (The capital gains rate is bumped up to 23.8% in Wyden’s latest proposal.) Short-term capital gains are taxed at the same rate as wages and ordinary income are taxed. So, if you’re a day-trader, for instance, you’re paying wage-level, ordinary-income tax on any gains.

Thus, current tax policy generally favors holding capital assets for more than a year, and offers favorable treatment to income earned from investing versus wage labor. The economic argument for such preferred treatment of long-term capital gains is that it incentivizes investing, particularly for long-term periods. Capital put at risk for long periods of time is necessary to build innovation, employ people, and create wealth.

The spread between high-net-worth households and the rest of America has widened considerably over the past three decades, and it’s most extreme at the very top. According to the advocacy group Americans for Tax Fairness, the total wealth of U.S. billionaires grew by $1.3 trillion during the first 11 months of the COVID epidemic — a 44% increase. And companies which have benefitted from the pandemic — significantly the digital ones — have seen their founders’ wealth soar. Jeff Bezos alone is a staggering 86% richer than just one year ago; his wealth currently stands at approximately $194 billion, and that’s after a very sizable divorce settlement. Bezos still owns approximately 10% of Amazon, the company he founded in Bellevue in 1994 and led as CEO through earlier this year.

Like Bezos, a great many of the billionaires on the 2021 Forbes List earned their billions by risking capital, effort and time to start a company, successfully holding on to large ownership stakes in them. The Seattle metropolitan area alone has at least eight billionaires, most associated either directly or indirectly with the creation of companies like Amazon, Microsoft, and Starbucks.

Amazon’s stock appreciation by itself does not generate realized income for Bezos. But his large holdings do afford him access to low-cost securitized loans and other many benefits, even if he chooses not to sell at any given moment. (Should this tax pass and head to the courts, expect the government to argue that this increase in wealth “generates income” because of the increased capacity to borrow against it.)

This ballooning of wealth is the juicy target. But take a breath. Taxing people like Bezos faces several implementation challenges:

• Is it Constitutional, only to be struck down by the Supreme Court?
• How do you value privately-held businesses?
• Who decides the valuation of non-liquid assets? Wyden’s proposal would distinguish between “tradeable” and “non-tradeable” assets. His plan said that if the asset in question is not “tradeable” you’d pay capital gains tax on sale, because that’s when the market value is known, but you’d also pay another “lookback charge” to account for the “privilege” of delaying those payments. This rate is set at 1% plus the IRS short term borrowing rate.
• Could billionaires manipulate who owns the assets, spreading out the holdings among many?
• Will the favored treatment of “non-tradeable” assets create enormous incentives to make non-tradable something “tradeable”? Investment banks would be happy to assist; they’re good at securitizing and complexifying things, as we all found out with the derivatives-fueled housing crisis of 2008.
• Generally, when taxes are imposed, you get less of what’s taxed. What happens when you treat wealth like wages?

The plan being discussed hurriedly by Congress would require only a few citizens (those with $1 billion in liquid assets or more) to tax their tradeable-asset holdings, calculate the appreciation on those holdings, and pay a capital gains tax of 23.8% on it over five years. In future years, the owner takes a tax credit for any mark-to-market loss, or pays an annual tax on the paper gain. When the time came to actually sell the asset, the final amount owed would be the remainder of the gain not taxed, or a credit or refund if the asset lost value.

Democratic legislators certainly count on its popularity. After all, a tax that only 700 or so billionaires would have to pay sounds at first like the elusive perfect policy, since taxing billionaires on their wealth is understandably popular with a majority of Americans. Cynics know that the most popular tax is “any tax someone else has to pay.”

Over the past five years, both CNN and New York Times have tested the idea of a wealth tax on those with assets of $50 million or more. Both found majority support — 54% in the CNN poll, and 61% in the Times poll. But neither poll attempted to explain the constitutional and implementation hurdles, nor did they explain that the current proposed tax would reduce estate taxes dramatically.

How much might such a plan raise? (Let’s put aside for a moment the reality that virtually every billionaire would search for and likely discover multiple ways to minimize their liability.) Though the Congressional Budget Office has yet to score the plan, House Speaker Nancy Pelosi estimated Sunday on CNN that the tax would raise $200 billion to $250 billion. On the upper bound, the total wealth of U.S. billionaires is approximately $4.2 trillion as of March 2021, so she’s figuring that the government would be able to harvest about 6% of the total.

Let’s sanity-check Pelosi’s stated estimate. There’s a surprise gotcha. We have to subtract out the enormous reduction in estate taxes that would result. Today, when a billionaire dies, up to 50% of their overall wealth might be hit with taxation before being passed along to heirs. (Moreover, there would likely be substantial and negative impact on high-billionaire-count state budgets like Washington state, should this plan pass, given our relatively high estate tax. The federal government would have already scraped much of this windfall away.)

In this sense, the Wyden plan simply accelerates estate taxes into the current year. When you subtract out the estate taxes that would be avoided by such a plan, you start to get closer to Pelosi’s stated estimate of $250-350 billion, or “10% of what’s needed to pay for the social safety net package,” as she stated on CNN.

And how might these sophisticated billionaires (and their tax attorneys) respond? There are many options: to divvy up ownership, to renounce citizenship, to securitize and obfuscate holdings, or to seek more private and less tradeable tax havens for wealth. Wyden’s proposal attempts to cut off each of these loopholes, but there are many more.

SpaceX Founder and Tesla Chairman Elon Musk took to Twitter this past week to note that Congress won’t wait long before changing the threshold, so citizens need to protest. Musk’s warning has history on his side. When the first U.S. income tax was passed in 1913, it was just 1% on those earning the equivalent of about $80,000 today, rising to 6% on those earning the equivalent of $13 million today. People earning less than the equivalent of $80,000 paid nothing. The percentage has increased 30-fold since then, and the thresholds greatly lowered.

We can also be certain that there would be forceful legal challenges of this tax. There is a strong argument that wealth taxes are unconstitutional, since the Constitution explicitly requires that “all direct taxes be equally apportioned among the States” (Article I, section 9, clause 4.) This equal-apportionment clause, if applied here, clearly blows up the whole thing, since the location of wealth of billionaires is entirely up to them, and is far from “equally apportioned among the states.” The only hope of advocates is to convince the Supreme Court that this isn’t a direct tax at all, a tough sell.

Some say that we pay property tax on real estate, so why aren’t wealth taxes also legal? It’s legal for states and counties and cities to do it, but it is not constitutional for the federal government to do so. Indeed, when the United States federal income tax was passed in 1913, Congress agreed that it might not be constitutional, and so it also passed the 16th Amendment in 1913, which reads: “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.” Paper gain is not “income” to an individual until it is actually converted into cash. You can read more legal skepticism of the constitutionality of this plan from Jonathan Turley in this article in The Hill.

Regardless of whether you can muster an argument that it’s constitutional, the only opinions which will ultimately matter on this have the last names Alito, Gorsuch, Kavanaugh, Coney-Barrett, and Roberts. Pick any two of these who will find this a permissible “income” tax, and not a a direct tax, and therefore constitutional.

Another worry: the unintended consequences go on and on. Had this plan been in place in 1995, what might have happened to, say, Enron CEO Jeff Skilling’s tax payments to and from the federal government? Skilling presumably would have paid enormous sums, hundreds of millions of dollars, into the IRS as Enron stock rose from 1998 through 2001. Then, when it all came crashing down, and he had stock worth $0, would we taxpayers then reimburse him hundreds of millions of dollars? Assets decline in value all the time, sometimes all the way to zero. Major airlines are a great example of large entities going into and out of bankruptcy.

Anolther consequence: Such a tax would create strong incentives to make “tradeable” securities “non-tradeable.” We would likely see many more companies go or stay private, which arguably would hurt American workers who have benefitted from employee stock plans. From a billionaire’s perspective, there would be yet another incentive to avoid the public market altogether, because as a private firm, you could better ensure those shares aren’t “tradeable.” Wealthy founders might scurry to divvy up their holdings to family members and new owners before such a law goes into effect, so that no individual taxpayer meets the billionaire trigger threshold. (Wyden’s proposal does attempt to derail that loophole.)

The best kind of tax is always the one that others have to pay. But now that this plan has entered the public discussion, expect even more detractors to emerge.

Warns Rep. Jim Himes (D-Conn) in expressing his concerns to The Wall Street Journal: “There are 20 other better ways and more workable ways to get the wealthy to pay their fair share.”