Paul L. Caron

Thursday, February 9, 2012

The Zuckerberg Tax: A Progressive Mark-to-Market System

FacebookNew York Times op-ed, The Zuckerberg Tax, by David S. Miller (Cadwalader, New York):

When Facebook goes public later this year, Mark Zuckerberg plans to exercise stock options worth $5 billion of the $28 billion that his ownership stake will be worth. The $5 billion he will receive upon exercising those options will be treated as salary, and Mr. Zuckerberg will have a tax bill of more than $2 billion, quite possibly making him the largest taxpayer in history. He is expected to sell enough stock to pay his tax.

But how much income tax will Mr. Zuckerberg pay on the rest of his stock that he won’t immediately sell? He need not pay any. Instead, he can simply use his stock as collateral to borrow against his tremendous wealth and avoid all tax. That’s what Lawrence J. Ellison, the chief executive of Oracle, did. He reportedly borrowed more than a billion dollars against his Oracle shares and bought one of the most expensive yachts in the world.

If Mr. Zuckerberg never sells his shares, he can avoid all income tax and then, on his death, pass on his shares to his heirs. When they sell them, they will be taxed only on any appreciation in value since his death. ...

Our tax system is based on the concept of “realization.” Individuals are not taxed until they actually sell property and realize their gains. But this system makes less sense for the publicly traded stocks of the superwealthy. A drastic change is necessary to fix this fundamental flaw in our tax system and finally require people like Warren E. Buffett, Mr. Ellison and others to pay at least a little income tax on their unsold shares. The fix is called mark-to-market taxation.

For individuals and married couples who earn, say, more than $2.2 million in income, or own $5.7 million or more in publicly traded securities (representing the top 0.1% of families), the appreciation in their publicly traded stock and securities would be “marked to market” and taxed annually as if they had sold their positions at year’s end, regardless of whether the securities were actually sold. The tax could be imposed at long-term capital gains rates so tax rates would stay as they were.

We could call this tax the “Zuckerberg tax.” Under it, Mr. Zuckerberg would owe an additional $3.45 billion when Facebook went public (that’s 15% of the value of the roughly $23 billion of stock he owns). He could sell some shares to pay the tax (and would be left with over $20 billion of Facebook stock after tax), or borrow to pay the tax. ...

President Obama has proposed a “Buffett rule” that would require millionaires to pay tax at a 30% effective minimum rate. Under the rule, Mr. Buffett’s taxes might have doubled to $12 million in 2010, but this would represent only a trivial amount of additional tax for him. If the Buffett rule applied in 2010, Mr. Buffett’s effective tax rate would be only about 2/100 of 1 percent on the $8 billion in appreciation of his holdings. A Zuckerberg tax would be far better: under it Mr. Buffett would have paid $1.2 billion in tax in 2010.

A mark-to-market system of taxation on the top one-tenth of 1 percent would raise hundreds of billions of dollars of new revenue over the next 10 years. The new revenue could be used to lower payroll taxes, extend the George W. Bush tax cuts, repeal the alternative minimum tax, reduce the budget deficit, prevent military cuts or a combination of all of these.

This tax would not affect the middle class, or even most wealthy Americans. Nor would it affect small-business owners. It would affect only individuals who were undeniably, extraordinarily rich. Only publicly traded stock would be marked to market. ...

The most profound effect of a mark-to-market tax would be to level the playing field between wage earners, on one hand, and founders and investors on the other. Superwealthy holders of publicly traded securities could no longer escape tax on their vast wealth.

David explains his proposal in greater detail in A Progressive System of Mark-to-Market Taxation, 121 Tax Notes 213 (Oct. 13, 2008). For reactions, see:

(Hat Tip: Deborah Schenk.)

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Here's a related comment on the Buffett Rule that I posted a couple days ago on another blog:

The Buffet rule is essentially a second Alternative Minimum Tax. Call it AMT2.

At its inception in 1982 the original AMT taxed capital gains at 20%, the same rate it applied to other income. Currently capital gains are excluded from the AMT1's regular income basket and they have a lower tax rate. The concept of AMT2 is a return to the roots of the AMT.

The problem is that applying high tax rates to realized capital gains is an expensive and unfair way to make the tax code appear more fair. The richest taxpayers have no difficulty avoiding selling appreciated assets. They don't need the money, so they don't have to liquidate assets. The capital gains tax will hit those who hold most of their net worth in a single asset and who need to raise cash.

What kind of tax hits taxpayers who need to raise cash but spares those who have so much cash that they never need to sell anything? Not a progressive tax, that's for sure.

In my opinion, AMT2 will make sense only after enacting mark-to-market taxation of large unrealized gains. This will eliminate the tax-free build-up that billionaires like Warren Buffett and Bill Gates have always used to shield their wealth from the IRS.

Unrealized appreciation is where the money is, not in taxing realized capital gains beyond the revenue maximizing rate. The Buffet Rule is a bad idea unless the Buffett Shelter of tax-free build-up is first removed.

Posted by: AMTbuff | Feb 9, 2012 10:09:18 AM

I've been advocating this for years, but the author beat me to it in his 2008 paper.

Only publicly traded stock would be marked to market.

That's a huge loophole that will be exploited quickly. Buffett could keep avoiding tax by converting his investments into a private company. Companies re-organize like this all the time without creating taxable events. Furthermore, the "publicly traded" loophole exempts private real estate empires. That will have to be addressed unless we really want to blow another real estate bubble. Artwork and other accoutrements of the rich also would go untaxed.

My preference would be to included all assets if net worth exceeds a much higher taxation threshold than the author's $5M, maybe as high as $100M.

Second, I would give the taxpayer a choice of paying half the current capital gains tax rate as a deposit (earning no interest) against future tax liability, if any, or paying 100% of the current capital gains tax rate in exchange for a full increase in basis that eliminates future liability on the gain to date. Any taxpayer would also be allowed to opt in to Mark to Market if he wanted to pay tax now rather than later.

Posted by: AMTbuff | Feb 9, 2012 10:07:31 AM

So, his essential idea is to make the system more complicated, more confusing and more expensive to comply with and administer?

Posted by: Yo Gabba Gabba | Feb 9, 2012 9:35:13 AM

"If Mr. Zuckerberg never sells his shares, he can avoid all income tax and then, on his death, pass on his shares to his heirs. When they sell them, they will be taxed only on any appreciation in value since his death."

The step up in basis upon death only applies to assets included in the gross estate. You can only avoid the 15% tax on built in gain by paying a 50% estate tax on the total amount.

Posted by: Mark | Feb 9, 2012 8:05:12 AM