This article does not conflates income and wealth, stop saying that. This is NOT what it says.
Thats' the whole damn point, they say that the system "tax the income" is flawed because it allows to borrow as much as your wealth allows, and live your life exactly as if you had that in income, without ever paying the income tax.
I am quoting "Their wealth derives from the skyrocketing value of their assets, like stock and property. Those gains are not defined by U.S. laws as taxable income unless and until the billionaires sell"
> "tax the income" is flawed because it allows to borrow as much as your wealth allows, and live your life exactly as if you had that in income, without ever paying the income tax.
I don't see how that can be true, you eventually have to repay the loan, to do that you need income which will be taxed. For example if you borrow 100000 dollars for one year with 3% interest you will have to pay to the bank 103000 dollars, as far as I understand you can only write off the 3000 dollars on your taxes. The reason rich people borrow against their equity is because they don't want to sell it and their equity makes them more money than the interest rate on their loans.
Furthermore while the article does distinguish wealth from income, it fails to distinguish realized from unrealized gains. Taxing unrealized gains comes with two very significant downsides.
Firstly to make the system fair it should provide tax credits for unrealized losses which means when the market goes down all of these people will use that tax credit to cancel out the huge salaries they will be paying themselves on that year.
Secondly while a tax on unrealized gains will be annoying to rich people it will be devastating to small time investors, because it will force them to liquidate their minor positions in order to pay their taxes.
To give a concrete example lets assume a college grad has a single share of amazon he bought last year for around 2000 usd, today that same share is worth around 3000 usd that's 1000 dollars of gains if our hypothetical student has to pay income tax on that 1000 dollars let's say 20% because he also has income. He will have to pay with his income (which has already been taxed) or he will have to sell that stock essentially robbing him of the future gains he could have if he held that stock.
This is what I guessed, but maddeningly the article doesn't actually say it out loud, instead talking about estate taxes and trusts (which surely also play a role). Do you know another source for this?
The US tax code has had step-up basis for over 100 years, since income tax was first put in place. I don't think there are any archival documents showing the reasoning for that particular choice. I think the common belief is that it was a simplification due to the relative lack of record keeping 100+ years ago.
If you inherited some assets in 1909 it could have been very hard to figure out what the cost basis was, since you would have no idea where the records were or if any records had even been kept.
This isn't true; they have no relation to one another. It definitely wasn't a "well, since we are taxing the estate, we should create a step-up basis".
The step-up basis was the result of Treasury Decision T.D. 2690 in 1918. The modern estate tax went into effect in 1916.
The step-up basis is likely simply a mistake influenced by UK norms. The tax code was created from whole cloth by regulators that had never done it before. (Congress basically passed the buck, abdicating responsibility to Treasury to figure it all out.)
Treasury made several errors of basic logic in the early years, some of which were subsequently fixed, others (like step-up basis) weren't.
On the UK influence: back in 1913 the UK (and most other countries at the time) didn't tax capital gains at all. The law passed by Congress implied that capital gains should be taxed but the drafter of the law (it was written by a single person) was surprisingly confused and vague on the subject giving five or six different possible interpretations of what he meant.
And so: step-up basis. The original 1913 income tax law didn't say what should happen. Over the next several years Treasury grappled with the issue, and related capital gains questions, effectively a "first time in history" kind of solving the problem.
From a history of early errors in the tax code by the Treasury:
"Beyond mere error, there was the influence of the income tax of the United Kingdom––the foreign income tax most prominent in the minds of the drafters of the 1914 regulations––which did not tax capital gains at all. As Marjorie Kornhauser recounts in her work on the early history of capital gains taxation under the federal income tax, from 1913 until 1921 Treasury’s interpretation of the income tax as encompassing capital gains was controversial, and it was unclear whether Treasury’s interpretation would withstand judicial challenge. If total exemption of capital gains was thinkable because of the UK model, then basis rules allowing for widespread self-help exemption might have seemed unexceptionable. In addition, the trust law distinction between principal and income––under which capital gains are assigned to principal rather than income—may have influenced Treasury’s misunderstanding of the role of basis in an income tax. Finally, there was the statutory declaration that income did not include the value of property received by way of gift or bequest. For regulators not accustomed to the distinction between deferral and exclusion provisions, it would have been easy to overread the statute as implying a permanent exclusion rather than as merely being silent on the question of permanent exclusion versus deferral."
The Treasury decision was enshrined into law in 1921 -- based on the Congressional testimony of a single person whose testimony has been described as "not his finest hour" due to logical errors like this that went unremarked upon by the Senators -- cementing the mistake permanently due to a failure to apply consistent logic to taxation issues.
The claim that one should get a step-up basis because of the estate tax is obviously nonsensical. If you sell the assets before death, you pay both the capital gains tax and then the estate tax. But if you don't sell the assets before death, you only pay one tax.
There is no logical explanation for why the application of both taxes should occur if the sale happens before death but only one tax should apply if the death happens before the sale.
In 1976 Congress got rid of the step-up basis in the Tax Reform Act of 1976.
Due to intense lobbying by rich people, it was restored in 1980.
You have $100M of stock in Berkshire Hathaway. You use use that as collateral to borrow $11M. You use $1M of the loan to pay expenses (including the interest on the loan). You invest the other $10M in Amazon.
A year later you have $11M in Amazon stock and $110M in Berkshire Hathaway. You borrow against the Amazon stock and use that to pay off the first loan. Lather, rinse, repeat.
The bankers are always happy. Why would they ever foreclose on you?
You are right, they aren't. You need to grow wealth and hang out with bankers at company expense ;)
No more growth and no more yaht trips then it is time for dividends or shares sell off to pay loans.
Only if the value of the assets goes down signficantly. Your loan based on Enron stock needs to be paid back (or recollaterialized), but one based on a stock that's been doing well or on a reasonably diversified portfolio can probably avoid repayment until you sell or die. From what I've seen, asset backed loans will have a % limit of value for initiating a loan and a higher % limit to keep the loan, but both limits are often much lower than a brokerage margin loan.
Of course they aren't, which is why they're perfectly happy to continue refinancing. They make money on the interest, not the principle. And each refinance increases the bank's total collected interest. As long as they eventually get the principle back, a bank is perfectly happy with this arrangement.
Why do you think people are willing to put money into accounts that they pay no taxes on now, but will have to pay taxes on later?
There's multiple reasons, and they all tend to apply to equity too. As a bonus, equity in things like property has even more bonuses for taking loan cash now and repayment later: things depreciate in value (theoretically), and you get write offs. There's all sorts of tax shenanigans you can do to shift around what money you owe when to minimize your tax burdens. Getting 'paid' with a loan is one of them.
Another major thing is: they can borrow so much that it doesn't matter. If you could borrow a billion dollars based on your house, would you do it? Do you think you could turn that money into something more? What if you never turned a profit off that billion, and instead just lived off of it. Then died. Never paid any taxes, because you 'lost' money every year. Combine that with all the BS you can do with estate taxes, and you can probably send a huge chunk of change to your kids too.
I googled a bit, it looks to me that pledged asset lines, typically require you to pay off the capital.
There are loans marketed as interest only, but my understanding is that even with these loans the payment of the capital is deferred to the end of the term, not that you don't have to pay it back at all.
There are annuities, a financial instrument where the seller receives a lump sum and then pays back a fixed amount in perpetuity but I think only insurance companies sell these.
I think the most likely scheme is what the other comment is suggesting, refinancing the loan repeatedly
No, there is no "end of term". You just have to pay the interest every month. They can ask for the principal back at any moment though but by the nature of the loans if that happened you'd sell your stocks to make good on it. But in practice that would only happen if there is a sharp decline in the underlying assets so if you only borrow like 30% of the value then you are generally fine. Obviously there is risk involved since this involves the stock market and borrowing money.
That's exactly how they work. As long as you keep making interest payments, and the value of the asset you took the loan against remains above a pre-defined threshold, you never need pay back the principal. The idea being that you invest the money you borrowed and earn a profit on the difference between the interest payment and your investment return. And the interest payment itself is tax-deductible because you borrowed to invest. Neat trick, right?
Btw, this is a power also available to ordinary people, in the form of a HELOC.
Is that true though? "Ordinary people" also have to pay additional fees (ex. Mortgage insurance), have higher interest rates, and have access to fewer high-interest investment opportunities.
I mean, I'm glad I didn't HELOC my way to a few Bitcoin last month, so maybe it's best we leave these tricks to the rich folk anyway.
Only borrow half of what they allow you to. Don't borrow the full amount. In that case it would require more than a 50% drop before you run into issues.
I don't think anyone is arguing to tax any unrealized gains except the exceptionally wealthy? Like can you argue that someone worth over 100mm would be hurt by say 1% annually?
I can see an argument for executive controlled corps, like Zuckerberg wants to maintain control of a company. But it seems like there are many ways Zuck for instance could avoid losing his voting power or restructure some even odder special share class so it doesn't matter.
If he doesn't want to pay cash maybe even allow treasury to hold this 1% as stock and pass the voting power back to the owner.
Opens a HUGE can of worms in many ways (hold, sell, incentives to increase value can be bad for the rest of us).
But I like the fundamental concept of adding back benefit for OUR gov for all we do to help.
if the rest of us taxpayers are giving huge support to the market and corporations like QE, stimi, loose regulation/tax law, trade wars, whatever, we should also get some of the gains to fund services or lower taxes on the other 50 or even 99%.
> This article does not conflates income and wealth, stop saying that.
The article repeatedly uses what it calls a "true tax rate", which is calculated from wealth. It does this knowing that people reason about tax rates as percentages of income.
With this in mind, I think it's fair to say that the article puts a fair amount of work into talking about wealth and income as different, but also willingly conflates the two in order to produce shocking numbers when it's convenient.
They explicitly calculate it based on increase in wealth, rather than total wealth, which seems like a reasonable substitution.
If you look at Scrooge McDuck's giant pit full of gold coins, and even though the pipe flowing into the room marked 'income' doesn't have any coins rolling down it into the pile, but the pipe heading out marked 'expenses' seems to be steadily draining coins... and yet the pile of coins is somehow still getting bigger...
.... maybe you have to accept that just looking at what's going on in that income pipe isn't giving you the whole picture.
You're completely right on both counts. That's precisely what they do. Income is definitely not the whole picture.
I don't disagree with anything you've written here. I just think that conflating growth in value of assets and liquid cash is misleading, and using a snappy sloganeered idiom to do so compounds the error. That this is done in pursuit of illustrating an absolutely critical and nuanced political point about finances makes it, in my opinion, all the more important to be clear.
I recognize that this is a position with which reasonable people might differ.
I think that would be a great approach. Incomes and asset values are very different and work differently. They benefit from being discussed with different vocabulary in order to make this distinction clear to the general public.
I don't understand. How that is a reasonable alternative to income? The degree to which your stock goes up or down is irrelevant for tax purposes, until you sell.
It is reasonable in this analysis, which is trying to compare normal people to billionaires. As explained in the article, wealthy people can get loans collateralized by their financial assets. Then they proceed to spend and pay back the loan (which is a deductible expense). The result is that they pay minuscule taxes compared to their worth (read more here: https://news.ycombinator.com/item?id=27447959 and here: https://news.ycombinator.com/item?id=27438941). The argument that their worth is not spendable until they sell does not stand up to scrutiny, as the example above shows.
So you end up with these wealthy people spending a ton and increasing their net worth by huge amounts, and paying small (or zero!) taxes.
I agree with you that a different tax law that calculated owed tax like this would not be completely reasonable, but it certainly shows the inequality and I believe it's a reasonable alternative. How would you measure the tax impact on the mega-rich otherwise?
Excellent advice! I read and understood the article as using this the first time. I feel my criticism stands, though again I understand that others may feel differently.
I think most people forget about this. You can have capital gains, not pay taxes, and borrow against them, and spend the money.
In my opinion, do away with income and capital gains tax and have a pure consumption tax instead. Want a lavish lifestyle? Then you will pay higher taxes.
>> In my opinion, do away with income and capital gains tax and have a pure consumption tax instead. Want a lavish lifestyle? Then you will pay higher taxes.
I hold a similar view. Why should someone pay more taxes just because they earn more.
Taxes should include a 'constant' term for benefit that everyone in the society is reaping (e.g., security, public infrastructure and facilities, etc.). There can also be terms proportional to the spendings/lifestyle (i.e., sales tax) and even income, when again the government is introducing some benefit per sale or money earned.
The prime purpose for governments, and thereby enforced taxes should be to pay for things needed that no one individually will otherwise pay for but which the society as a whole needs. An an example, pollution hurts everyone, yet, no particular entity would spend on curbing pollution unless done by enforcing at a social level.
Note: If there is no tax whatsoever in earnings, there would also be a need for some additional tax like inheritance tax, which I support, so that people do not just keep on hoarding the earnings without ever spending.
You don't necessarily have to pay back the loan until your death, then it is taken from the estate and the balance passed on to heirs. At that point the step up basis occurs and the process starts over again. No taxes were paid on the value of the loan. (Correct me if wrong on this)
That’s one of those things that seems too dumb to possibly be true, but it looks like it is? An estate can sell stocks in probate with cost basis set to date of death, not purchase? Sort of makes sense, the heirs would get the stepped-up basis, the stocks, and the debt if the executor didn’t net them out in probate.
I guess it’s a bet you’ll be dead before the interest outweighs the potential tax, or volatility spikes? Betting on your own death seems to macabre, and too tempting too the fates.
For ultra-high net worth individuals it's a pretty safe strategy. Typically a low volatility equity that doesn't pay dividends is used and only a small percentage of their portfolio is used.
Over the long run it tends to work in their favour as well, since it's very likely that the increase in the portfolio value will outpace the interest paid.
That's assuming the asset that would've been sold doesn't increase in value. It's likely that the asset will increase in value more than the cost of the loan.
Loans still have to be paid back with cash plus interest. It can give wealthy people some leverage to make their tax payments more efficient in that they can spread their payments over time or wait for a down year, to liquidate a chunk of assets to pay down debt so they never have a bulge in realized income. But there is still a cost in terms of debt service that make this have limited value. It's not like loans are free money.
Is this even serious?
"what-about" them? It seems pretty obvious that they don't have as much wealth, so the issue is less relevant. Again, that's the point of the article.. Common folks didn't see their wealth skyrocketing
It depends on what your definition of common folks is. Even here in Montreal, where housing prices have been historically depressed VS the US and the rest of Canada, I know plenty of families with very modest salaries who bought 200-300k $ homes 10-20 years ago that are now worth well north of 1.5m+. Obviously a lot of people didn't get richer, but a huge proportion of the population did (at least on paper).
By any definition being worth more than 1m$ is a lot of money, especially here. But it seems like the goalposts keep getting moved to the point where saying "what about the millionaires" is seen as an attack on the working class because billionaires exist. I've seen people argue that Bernie wasn't rich because he is just worth less than 2m$(!!). Sure, billionaires have a lot more wealth than your average millionaire but I'd bet even taxing them at 100% would bring so much less revenue than raising the tax rates on the "lower millionaire bourgeoisie" by a few percentage points. Yes we can do both, but it's not going to happen considering the complete focus on the mega wealthy sometimes coming from other rich people in denial.
You can get similar returns buying index funds and you don't need a down payment or good credit. The sunk cost or rent is usually higher than the sunk cost of mortgage interest and home maintenance, but gives the added benefit of increased liquidity and ability to diversify. And personal mobility.
I am quoting "Their wealth derives from the skyrocketing value of their assets, like stock and property. Those gains are not defined by U.S. laws as taxable income unless and until the billionaires sell"