Tuesday, April 05, 2022

Hiding a Giveaway to the Rich Behind False Populism

by Neil H. Buchanan 
The Biden White House included in its new budget proposal, at last, a proposal to eliminate a tax giveaway to the wealthiest Americans that has infected our system almost since its inception a century ago.  Although that proposal is long overdue, it is also politically doomed, for two reasons.
In my Dorf on Law column last Thursday, I quoted Seth Meyers's sarcastic-but-accurate observation that this progressive tax proposal is "the part [of Biden's proposal that] they'll have to cut out before it'll pass."  Back in December, the ever-frustrating Senator Joe Manchin surprised everyone by indicating that he could support this kind of tax increase on the rich, but he continues to play the part of Lucy pulling away the football from the Democrats' Charlie Brown by now opposing the proposal -- but insisting, just to make Orwell's ghost scream, that "everybody has to pay their fair share" by making "other" changes, which he of course will later denounce.

The second reason that this proposal is politically doomed is that Republicans would immediately repeal it upon retaking power in 2025.  It is only a statutory change, after all, and they will even probably use the repeal bill as a Trojan Horse to add ever more egregiously regressive tax measures.  (Florida Senator Rick Scott has not backed off of his plan to increase taxes on tens of millions of poor and middle-class people, for example.)

Moreover, because Republicans are already putting in place all of the elements of a plan to seize control of our political system permanently, there is no chance that the Democrats will ever again hold power, making it impossible to imagine a time when they could repeal the Republicans' repeal.  We are still a dead democracy walking, and every day chips away at the last vestiges of hope for a better future.

Why, then, bother to discuss any proposal to make the tax code fairer?  In other words, why write this column at all?  I admit that I am doing so because the issues are simply interesting to me, but they are also consequential in the real world.  This is what is at stake from the standpoint of the plutocrats who are funding the Republicans' grievance-culture-camouflaged attack on the rule of law.  Money is at stake for those with (almost) all of the money, and they are willing to pull out all of the stops to keep what they believe is rightfully theirs.

What is the policy change at issue?  It is not at all difficult to describe what is truly at stake, allowing us to set aside the technical details that make tax policy debates so boring to so many people.  It is no mistake, after all, that the tax system is the policy lever of choice for the Republicans, because they know that people are desperate not to think at all about something that seems so complicated.
In addition, as I described in that column last week, the guardians of inequality can count on even well informed and apparently well motivated people to echo false claims that Republicans are making about Biden's proposal.  And that proposal is, quite simply, to require that everyone declare all of their income in the year in which it is earned.  Sounds simple, no?  If you earn a salary of $80,000, or even $800,000, you have to include all of it in your tax computations for the year in question.  Everyone else should, too.

But the "realization requirement" says that if you are able to arrange your financial affairs so that you receive your income in the form of property that goes up in value, then you do not have to pay taxes on that income until you realize the gains -- that is, when you sell the property.  If you have a share of common stock that rises in value from $1 to $101, you are $100 richer, in exactly the same way that someone who works ten hours for $10 per hour is $100 richer.  (Well, not exactly.  The worker had to, you know, work; and besides, she will pay payroll taxes that the property owner will not.)  Both are income, and both should be included in the taxpayers' income in that year.

People object that "paper gains" are not really income, because it does not look the same as receiving cash.  But almost nobody receives cash anymore, with salaries deposited directly into bank accounts, which simply show up on paper.   (I guess we should now be calling these "ether gains," given the death of record keeping on paper).
The salary earner must pay taxes on the full amount of income even if she does not touch the money in her bank account, but a person who holds other forms of property -- including what amounts to a deposit account that is invested in stocks -- can hold off on paying taxes on the gains from increases in the market values of their property.

Moreover, it is not as though everyone has the same ability to arrange their financial transactions to benefit from the realization rule.  As soon as Congress treats two forms of income differently, there is a rush to recharacterize income into the lower-taxed category.  But even though most salaried workers would love to get in on the game, only the most connected people in any given company have been able to say, "Pay me $1 in salary and the rest by making my shares go up in value -- and of course, never pay me in cash dividends, either."  That $800,000-a-year salary earner is likely to be able to take advantage, whereas the $80,000 earner is not.  The ability to benefit from the realization regime is not randomly distributed across the population.
And it is worth remembering that, because wealthier people can leave their income unrealized throughout their lives, they then benefit from a rule that allows all unrealized income to be exempted from tax forever when property is received by heirs.  But that is a rabbit hole that is best explored on another day.

Even so, apparently smart people hem and haw and say that increases in wealth "might be likened to income" or "could be construed to be income," even though it is simply true that income is income whether it is unrealized or not.

Conservative tax dogmatists often say that we should "broaden the base and loewr the rates," which means that having a larger pool of taxable income allows us to tax each dollar of income at a lower rate, given any target level of tax revenues.  If the tax base is $1,000, we can raise $200 with a 20 percent tax rate.  If the tax base is expanded to $2000 by requiring all income to be taxable, the rate can be 10 percent -- or we can use some or all of the increased revenue to fund things that society values.

But of course, when it comes to forcing someone like Elon Musk or Warren Buffet to include all of their income in the tax computations, suddenly conservatives are horrified by the idea of expanding the base.

At least for now, however, the apologists for Gatsby-level inequality feel the need to put a populist veneer on their regressive schemes.  In addition to muddying the waters by saying that unrealized income is not income at all, we therefore see absurd arguments about how everyone else should worry about the billionaires.  Musk disgustingly claimed that eventually "they" (the grabby government tax people) "will come for you" (the non-billionaires), in an insane attempt to commandeer the "then they came for the Jews, but I did not speak out, for I am not a Jew" admonition.

At bottom, however, the realization doctrine is the ultimate example of over-inclusiveness, because all of the arguments that sound like decent rationalizations for a realization doctrine can at most justify a very narrow set of exclusions from a general rule.  The malefactors of great wealth, however, use those arguments to say that if there is any kind of unrealized income that should not be taxed, then every kind of unrealized income should not be taxed.

What are those plausible justifications for limited realization requirements?

(1) Liquidity constraints -- Maybe you have earned income "on paper," but if you were required to pay taxes on unrealized gains, you would have to sell the very property that went up in value in order to gain access to the cash needed to pay your taxes.  And maybe that property is your house!  To most people, it would be perverse (whether or not they live in an area with annual local property taxes) to be forced to include increases in the value of their homes in their federal taxable income, because coming up with the annual payment after a big run-up in local housing prices might force them to sell the house itself.

OK, so we can have an exclusion for gains from increases in the value of primary residences.  As it stands, Section 121 of the tax code allows homeowners to exclude even realized gains upon selling their houses.  It is a weird little section, but it basically works.

More to the point, the "I'll have to sell my house" objection treats all property as if it cannot be divided.  To free up $20,000 from a house (if you cannot tap into your equity through the financial markets), you must sell the whole house.  That is not true of larger tracts of real property (which can be subdivided and sold in parts), and it is certainly not true of financial assets like stocks and bonds.  Or, to be more precise, it is no more true of most property than it is of your particular piece of property called a bank account.  If Bob has to cash in 10 percent of his stocks to pay taxes on his stocks, and Ray has to cash in 10 percent of salary to pay taxes on his salary, both are doing the same thing -- trading assets for cash to pay taxes.

(2) Valuation -- If (setting aside the arguments in (1) just above) the tax code requires me to include the increased value of my house as income, how do I know how much my house is worth unless I sell it?  This is hard!  First, note that housing wealth is only a subset of the relevant category of income, because a vast amount of the wealth in question is in stocks, bonds, and other assets that are easily valued -- so easy that one can see real-time changes in their values on a computer screen.  The Biden plan is all about easily valued assets, which will surely cause some game-playing by rich people to move into harder-to-value assets, but that is easy to handle, too.

How easy?  I will turn over the floor to Professor Dorf, who sent me the following in an email last week:
But even for unique assets, the tax code already copes. After [a friend's parents died, he] needed to estimate the value of their respective homes at the time of death for purposes of (a) calculating the value of the estate; and (b) determining the size of any gain or loss when [selling] the properties some months later. In a dynamic real estate market, it was possible to be off by tens of thousands of dollars. And while neither estate was nearly large enough to trigger federal estate tax, there were other taxes for which this mattered, and for large estates, this will matter a whole lot. One must estimate unrealized values at time of death because of the stepped-up basis [i.e., the tax giveaway noted above re unrealized gains at death]. And yet, the tax code seems to manage.
Exactly.  (And local property tax regimes manage, too.)  We deal with uncertainty and mete out rough justice all the time.  It is easy enough to make corrections along the way and, if necessary, use the ultimate realization date as an opportunity to clean up any remaining miscalculations.
(3) The same asset that went up in value this year could lose money the next year.  As I noted in my column last week, however, we already allow wealthy taxpayers to take advantage of paper losses.  Even more importantly, there is nothing stopping us from allowing taxpayers to take losses in bad years and use them to offset gains in others.  We already do that for businesses with the Net Operating Loss allowance, and we could easily do this on a wider basis.
All of the above demonstrates why I talked above about over-inclusiveness.  The wealthiest Americans send out their paid hacks to say that people who are illiquid should not be required to pay taxes, that people whose assets might be hard to value should not be required to pay taxes, and that people should not be required to pay taxes if their gains might be reversed in later years.  But of course, none of those apply with any real force to the wealthiest Americans -- in fact, in latter case, not to anyone at all.

Rather than saying that the tax code can handle small deviations from the requirement that everyone should pay taxes in the same way (and on the same schedule) as people who work for a living, however, Congress has spent a century saying that millionaires and billionaires deserve to pay nothing at all, lest we accidentally force someone to sell their split-level in a middle-class suburb.

The non-rich should not be used as a shield to protect the richest Americans from paying taxes.  This Congress could stop it, but even if it does, the Republicans know how to make their paymasters happy.  Just get people to say "it's only on paper" over and over again, and the political system will preserve the biggest tax giveaway that has ever been hidden in plain sight.