Comment: Democrats’ plan to tax rich will miss wealth of most

Because it goes after salaries — and not income from assets — the wealthy can easily avoid the tax.

By Alexis Leondis / Bloomberg Opinion

Democrats love to talk about their big ideas for soaking the rich. They’ve proposed various ways to do it, from creating a special tax for billionaires to closing decades-old trust loopholes. Those have been shelved as lawmakers wrangle over the particulars of their big tax and spending bill, leaving just one provision aimed at the very wealthy.

It’s a surtax on high income and capital gains. And there’s not much bite to it.

On paper, the surtax sounds serious. Taxpayers with incomes of at least $10 million would see their marginal federal tax rate increase by 5 percentage points, to 42 percent. Those earning $25 million would be subject to an eight-point increase, or a rate of 45 percent, according to the most recent version of the proposal.

In addition, the capital gains tax rates that group would face when selling appreciated stock or other assets would also jump by 5 to 8 percentage points. So those with $25 million would face a capital gains tax rate of 31.8 percent, which would be the highest since 1978, up from 23.8 percent currently.

But many of the 22,000 people potentially subject to the surtax don’t have much to fear. Most of them derive the bulk of their income from assets — stocks, private businesses or real estate — rather than from big salaries.

Most data on income sources focuses on the top 1 percent of households (those making more than $540,000 annually), but even there, capital income from stocks or rental properties, as well as income from private businesses or partnerships, accounts for more than 60 percent of total income. It’s reasonable to think the proportion is much higher for the $10 million-and-up crowd.

Those folks would be able to hang onto their holdings, rather than sell and incur capital gains taxes. Many are thinking they’ll just wait it out until a Republican Congress changes course.

Those who need cash don’t have to worry, either. Thanks to securities-based loans, wealthy bank clients can finance their lifestyles by borrowing against their stock, bond or real estate holdings. They don’t have to sell much of anything, and since the proceeds aren’t income, the tax bite is zero.

Morgan Stanley reported a 27 percent increase in such loans as of Sept. 30 compared with the end of 2020, and Bank of America says its loans have jumped by 25 percent over the past year. A higher capital gains tax rate would only make the strategy more popular.

Even taxpayers who wind up selling stocks or businesses can take steps now to protect themselves against the possibility of the higher rate. The easiest option is to sell between now and the end of the year. An earlier iteration of the proposal would have made the higher capital gains tax rate retroactive to when the proposal was first announced in September, but that was scrapped. As of now, the higher rates would take effect on Jan. 1, 2022.

Wealthy taxpayers can also spread income over several years to stay below the $10 million threshold by selling assets in installments rather than in one fell swoop.

Many people who work at private equity firms or hedge funds are likely to restructure their businesses to make themselves subject to the lower corporate tax rate of 21 percent, according to Emmanuel Saez, an economist at University of California, Berkeley. Right now, many of those firms are set up so they report profits via owners’ personal tax returns. If Democrats really wanted to make the surtax bite, they would have paired the higher capital gains tax rate with a tax on assets unsold at death, or eliminated a cushy benefit for heirs (they get to ignore gains in an asset that happened prior to when they inherited it, thereby greatly reducing any taxes owed when they sell).

The taxpayers hardest hit by the surtax would be those few who live mainly off extremely high salaries. There is a lot less flexibility when it comes to paying taxes on labor income, considering there is a W-2 tax form reporting earnings to the IRS.

But most multimillionaires don’t rely on wages to finance their comfortable lives. That makes the surtax much less than a seismic shift.

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.

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