Our institutions created centibillionaires and are now trying to contain them.
In Ayn Rand’s novel Atlas Shrugged, a group of high-achieving industrialists have had enough with being exploited (in their view) by “parasitic” collectivists and “second-handers”. They withdraw to a perfect community Galt’s Gulch aka Atlantis where they can live in peace and prosperity with each other, far away from the do-nothing (in their view) populace and according to their own laws and beliefs.
Because Rand mercifully never wrote a sequel (the original has more words than either War and Peace or Les Misérables), it is not clear whether these supermen and women lived happily ever after or whether, after enjoying the initial high of sticking it to humanity, their infinite egos led them to devour each other to oblivion and Galt’s Gulch disappeared Roanoke-like with no explanation left for posterity. That is, no explanation other than the obvious which is that a healthy society requires a fuller range of social strata and cultures, not only a super-stratum and a monoculture, in order to survive and to prosper.
No escape to Galt’s Gulch is currently offered to today’s billionaires who have so far opted to remain in the real world though they contend daily with insults and attacks from many quarters. It is necessary to say “so far” because some have been toying with otherworldly escapes, be they monetary via cryptocurrencies or interplanetary via emigration to planet Mars. Cryptos would free them from the gravity of central banks. And space from the gravity of Earth. After all, in our culture, “to leave it all behind” is nearly synonymous with high quality living. And to disrupt, to reject the dominant paradigm, are seen as ways to create new wealth.
Bernie vs. Billionaires
While still among us on earth however, even the ultra rich deserve… empathy. Or at least some recognition for their achievements. Their defining characteristic, shorn of all social and economic artifice, remains their humanity, not their wealth. Yet it is assumed by the angry-egalitarian political complex that it is fine to insult and harass a billionaire, as if their humanity was inversely proportional to their wealth. Starting with Bernie Sanders for example, some members of Congress have stated plainly that “billionaires should not exist”.
Because there are among the people mob inciters who amplify their message through social media, this slogan could be interpreted as incendiary, or as unsafely ambiguous. Does ‘billionaires should not exist’ mean that we should tax them until they are no longer billionaires? That would entail taking away 99% of some billionaires’ wealth. Or does it mean that we should limit their growth plans when their wealth hits the $999 million mark? Or force them to give away their wealth to charity? Or something else?
Parenthetically, one reason that Sanders has gained popularity late in life is that his typically incendiary words in younger years were not yet dampened by the excuses generally afforded to older people. Today some believe that he is more aging than dangerous, that he is merely a ranting old man, a grumpy but avuncular figure of sorts. But the reality is otherwise: Sanders seems very lucid and his views have steadily grown in popularity in the past ten years.
A June report by ProPublica suggested some new directions in taxing billionaires. The report’s authors, led by senior editor Jesse Eisinger (a 2016 guest on our podcast), noted that billionaires are able to amass vast fortunes thanks to the rise in value of their assets and that they are able to do so essentially tax-free until they sell those assets. This is both true and legal. Income tax applies to many categories of income but mainly to W2 earnings (wages from a job), interest, dividends, income from a business, and capital gains on sold assets (such as a home or a stock).
Most glaring in ProPublica’s telling is the fact that there is currently no income tax applied to unrealized capital gains, which are gains on assets that were not sold during the tax year under consideration. This is an important point because the vast wealth (over 90% in many cases) of most billionaires has resulted from gains in the stock market, gains that are unrealized as long as these holdings are not sold. So, for example, Jeff Bezos’s wealth is mainly in his Amazon stock. And Elon Musk’s in Tesla stock.
But how then are billionaires able to live their expensive lifestyles if they never sell any stock? ProPublica explains that many of them borrow against their stock holdings, ostensibly in order to avoid having to liquidate them. This strategy is perfectly legal and it makes a lot of sense from a tax-saving perspective. But it also makes good fodder for anti-billionaire headlines.
Of course, the ordinary American is also benefiting from the fact that he/she is not paying tax on unrealized capital gains. Were he to do so, he would have to send a check to the US Treasury for every year in which his house appreciated in value, which is to say in most years. The vast majority of people would not be able to make these cash payments while still owning their houses. So every homeowner (65% of households) can be thankful that taxing unrealized capital gains has so far been considered off limits.
So on the one hand, we have huge reserves of wealth accumulated tax-free that also allow large scale borrowing and tax avoidance. On the other hand, we have the impossibility and unfairness of taxing unrealized capital gains.
The answer from the ‘make them pay their fair share’ camp would be to only tax the very wealthy in this fashion, but not the middle class or the merely well off. What constitutes “fair share” is of course never defined. The only certainty is that “fair share” is “more” and will always be more than what the wealthy are paying at any given time, for as long as politicians can build a following by using the rhetoric of envy.
Politicians sometimes use math to promote their arguments. One favorite of late is the comparison of a wealthy person’s tax rate to that of a low-earning person. If the lower earner has an income of $30,000 and pays 20% or $6,000 in taxes, it is considered “unfair” if the higher earner has an income of $3 million and pays a lower rate, say 15% or $450,000 in taxes. The fact that the higher earner is paying a tax that is 75 times greater in dollar terms is deemed to be of no relevance to the discussion. This sleight of hand seems rooted in a growing belief that the higher earner does not fully deserve his/her wealth and that it was largely obtained through privilege or cronyism, rather than through hard work and personal merit.
A 2020 study by Pew Research addressed this very question by asking why people are rich. Only 33% of those surveyed believe that the rich have worked harder than most other people. As many as 65% believe that the rich have had more advantages in life than most other people. As recently as 2017-18, these responses were close to dead even near 43%. Republicans give more weight to personal effort than Democrats do. However, both Republicans and Democrats give more weight to privilege than they did a few years ago.
The same Pew study asked whether billionaires are “a bad thing” for the US, a strange unspecific question but one that echoes the political debate. 23% of all respondents and 39% of those aged less than 30 said that billionaires are “a bad thing”.
We argued previously that the spread of cronyism and the accumulation of wealth through rent-seeking were fertilizing the seeds for “socialist” ideas in our society.
The Billionaire Makers
If billionaires are “a bad thing” in the eyes of some, it follows (for some) that they should be taxed more heavily than others. But before we consider the various ways to tax (or not) billionaires, we should ask how we got here in the first place. How did we reach what many are calling the Second Gilded Age, a period like the first characterized by enormous wealth creation and its attendant rise in inequality? There were two main drivers.
The first is the prolonged boom in technology, telecom, pharma and biotech that accelerated in the 1980s and has sustained itself, with only brief setbacks, until the present. Here, innovation, personal merit and hard work clearly occupy a central role. No amount of birth privilege can tip the scales when teams of engineers are staying up all night to develop cutting-edge software or the most advanced graphics processing units (GPUs) .
The second is a Federal Reserve that was too accommodative for long periods and that became more interventionist starting in the mid-90s. Rate policy and then quantitative easing did not merely preserve the wealth boom; it turbocharged it over and over with greater inputs of money at every cycle.
A too-dovish monetary policy was a “problem” that predated the pandemic in that it led to large distortions in asset markets. Since the mid 1990s, the stock market has seen several bubbles. And with these bubbles, there came higher inequality and the creation of many more billionaires, and then of deca- and centibillionaires. The sizes of these bubbles were so large that the Federal Reserve judged, probably correctly, that it should not risk an unmanaged aftermath that could spiral into an economic depression. The repetition of this cycle has reinforced moral hazard over several decades and explains in part how he reached this point today.
According to Americans for Tax Fairness, in 1990, there were 66 American billionaires with estimated total wealth of $240 billion. And in 2021, there were 614 American billionaires with a total of $4.18 trillion (see charts and other info in this link). Between 1990 and 2021, there were several crises and bailouts, each followed by a period of monetary policy that looked in hindsight too lax for too long.
Here are some taxation scenarios. In each case, we attach a score of who gains, who loses, and who gets a mixed bag, on a scale of 0 to 5, with 5 being the best outcome for each and 0 the worst.
1- Do Nothing
Score: Billionaires 5, Bernie Sanders 0
One option is to do nothing. Doing nothing is in general the best decision in more cases than our action-biased culture is willing to recognize. There is also a good rationale for doing nothing in this particular instance. The ProPublica report came out at a time of record stock prices. When a correction comes, the wealth of billionaires will shrink back to less extreme levels, albeit not enough to assuage the more vociferous taxers. In this vein, it is useful to remember that Amazon stock fell 94% in the 2000-02 Nasdaq crash and then again 65% in the 2008 crisis. Yet even after a future correction, Bezos and Musk will still be worth billions of dollars.
While doing nothing is clearly a respectable option, it is no longer the option favored by Democrats in Congress and by a sizable share of the electorate. Instead the option now being promoted by these constituencies is to start taxing the unrealized gains of the ultra wealthy, but not the unrealized capital gains of the rest of us. With discussions ongoing in Congress regarding this very proposal, there have been many calculations showing the likely tax revenues that would result from such a new tax. Progressives get lyrical about all the government programs that these new revenues would cover. But their calculations usually ignore the impact that the new tax would have on stock prices. It would be a downward impact or at best a neutral one. Would such a new tax deter entrepreneurship and innovation? Probably not, as few entrepreneurs expect to become billionaires in the first place.
2- Impose a One-Time Tax on All Unrealized Gains
Score: Billionaires 1, Bernie Sanders 5
A one-time tax on unrealized capital gains at the peak of the stock market is a half baked idea. What happens if the market hits a final high on December 31st 2021 and then falls 25% in early 2022, even before tax returns have been filed, and then proceeds to drop another 10% before the end of 2022? Will the same billionaires who paid the new tax calculated at the end of year 2021 get a fat refund for unrealized capital losses calculated at the end of 2022? This does not seem like the way to go.
What if Tesla loses a trillion dollars of market value as some believe it should? Will the Treasury mail billions in checks to those who bought near the top and held on all the way down? And if Elon Musk is by then ‘only’ worth $50 billion but he had been made to pay $70 to 100 billion in taxes in 2022, does fairness dictate that he should claw back some of the tax that he paid after Tesla stock dropped?
Is it even constitutional to tax fictitious gains? Proponents of the new tax will claim, not entirely without merit, that these gains are not fictitious when the wealthy use their stock as collateral to obtain large loans in lieu of liquidating that same stock. The other camp will claim with reason that a gain is not a gain until it is liquidated and that billionaires have no control over stock market vagaries.
3- Impose a Tax on Gains from Tranches of Stock
Score: Billionaires 2, Bernie Sanders 4
Yet another approach would be to have a billionaire liquidate tranches of his stock holdings for every threshold of wealth achieved. For example, at $10 billion of stock value, a forced sale of 10% of the stock; at $15 billion, another 5 or 10%, at $20 billion, another increment etc. This essentially forces the holder to realize some capital gains and to pay the related taxes. Alternatively, the holder would not have to sell the stock but would have to pay a tax that he would have incurred had he sold the stock. It is a bad solution but not as bad as a one-time tax on the entire unrealized gain.
4- Redistributive Dream: Spread Stock Ownership
Score: Billionaires 0, Bernie Sanders 5
A twist on this approach would be to implement the redistributive dream (not our dream) and to fragment ownership of a company past a certain threshold of individual wealth. In order to do so, the government would have to implement policies that are adverse to open-ended compounding. This would set limits on the total wealth that can be held in one stock by one individual, de facto forcing periodic sales as in the previous approach.
5- Limit Borrowings against Large Sums of Stock
Score: Billionaires 3, Sanders 2
ProPublica argued in its report that some of the very wealthy avoid taxes by borrowing money instead of selling stock. A future law could limit the sum borrowed against large stock holdings, in particular when the loan is taken out with the purpose of avoiding realized capital gains. Such a new rule may be difficult or impossible to roll out in practice because it is difficult to prove intent. Borrowing is after all the prerogative of every citizen.
6- Limit Stock Option Grants
Score: Billionaires 3, Sanders 3
This article is not complete without a mention of stock options. The biggest fortunes today are often built on very generous stock option grants. This was already a problem before the pandemic and we now see it in its full manifestation. For decades, corporate boards and shareholders have agreed to stock grants that could potentially add up to tens of billions on the hope that anointed CEOs will do a good enough job for shareholders to amass much smaller sums.
The cult of personality is heady in corporate America in ways not seen in other countries. This may be for good reason since this country has been much better at creating successful new companies. But the question remains whether any CEO is really worth a cumulative compensation that runs in the nine digits or higher. These packages would be significantly smaller if there was more competition at the top, as we have previously argued in The Cure for Inequality is More Laissez-faire.
We live in a time of extreme wealth for some and uncertain prospects for a majority. This great disparity will correct itself as it has in the past, through a combination of government action and more normal economic conditions. The latest explosion in wealth from stocks came about due to the pandemic and due to an exceedingly lax monetary policy. Perhaps the Fed should have acted sooner to forestall the latest bubble. If/when the pop comes, we may all be scrambling for our own version of Galt’s Gulch, imaginary or real.
READ MORE >>> The Billionaires Tax Isn’t New.