Larry Zelenak is an amazing tax storyteller, not to mention a highly-respected tax scholar. He seems to have a treasure box full of fascinating tax stories. I enjoyed going to the annual Tax Movie Night event held every Tax Day at NYU School of Law, where Larry was always a special guest speaker. It was a lot of fun to watch classic television episodes featuring various tax matters in everyday life, mostly from the "Mad Men" era, and then listen to Larry's comments afterwards. Larry recently published another fascinating tax story, 1924, 2021: Taxes of the Ultrarich, and Mark-to-Market Reforms, 172 Tax Note Fed. 583 (2021) that covers the billionaires' tax story, ranging from contemporary billionaires, like Jeff Bezos, Elon Musk, Michael Bloomberg, and Warren Buffet, to the “billionaires” from the past century, such as Rockefeller, Ford, and J.P. Morgan. Embedded in the story, he presents an important lesson on how to reform the taxation of unrealized capital gains.
Larry starts with the ProPublica's recent report, "the Secret IRS Files: Trove of Never-Before-Seen Records Reveal How the Wealthiest Avoid Income Tax," which compared how much in taxes the 25 richest Americans paid each year from 2014 through 2018 to how much Forbes estimated their wealth grew in that same time period. The wealth of the 25 rose by $401 billion, but they paid $13.6 billion in federal income tax. But the more important number for the ProPublica's report was their true tax rate—3.4% for the group, 3.27% for Musk, 1.3% for Bloomberg, 0.98% for Bezos, and 0.1% for Buffet. Bezos even received a $4,000 child tax credit in 2011 when his net worth was about $18 billion. ProPublica found that the primary cause of such low tax rate for the 25 richest was the failure of taxing unrealized appreciation of assets, mostly stock that constitutes their wealth. The recent trend of paying little to no dividends from corporate stock also contributed to the low tax rate. The ProPublica proposed mark-to-market income tax reform as a solution in addition to a wealth tax, although it is not likely to be implemented in the near future.
Interestingly, there was a similar revelations of the federal income tax payments of the wealthiest Americans about a century ago. The Revenue Act of 1924 directed the Commissioner to disclose taypayer lists in the local tax collectors' office, containing the name and address of each person filing an income tax return in the district and the amount of the income tax paid by such person. Due to privacy concerns, Congress repealed the provision in 1926, leaving the two rounds of disclosure and relevant media publication in 1924 and 1925. According to the data on some of the largest individual income tax payments published by the New York Times, John D. Rockefeller Jr. made the highest 1924 tax payment (on 1923 income) at more than $7.4 million, and Henry Ford and his son Edsel Ford came in second and fourth, respectively (with Payne Whitney between them), with combined payments of more than $4.4 million. For 1925 payments (on 1924 income), Rockefeller Jr. again led the way (paying about $6.3 million), followed by the two Fords (together paying about $4.8 million). Treasury Secretary (and wealthy banker) Andrew W. Mellon was fourth on the list, paying almost $1.9 million. In addition, there are many other household surnames on the list, such as Whitney, Dodge, Vanderbilt, Astor, Duke, and Morgan.
However, the 1920s' list did not generate any public discourse on mark-to-market income tax reforms. Larry offers the following three reasons. First, the true tax rates on the ultrarich in the 1920s were not as low as those for today's billionaires. Although the millionaires in the 1920s also benefited from the nontaxation of unrealized capital gains of their stock, the stock distributed significant taxable dividends. Also, such dividends were taxed at ordinary income tax rate, not at the preferential long-term capital gains rate. On the other hand, the stock owned by Buffett, Bezos, and Musk (Berkshire Hathaway, Amazon, and Tesla, respectively) has never paid dividends. If we roughly apply the ProPublica's methodology to a 1920's millionaire who owned a net worth of $100 million subject to the top tax rate bracket of 40% and entirely invested the wealth in a hypothetical S&P 500 of that era, the investor would have earned $12 million of dividend income and $19 million of unrealized capital gains, resulting in $4.8 million of tax in 1923 and 1924 and the true tax rate of 15.5%. This is not impressively high, but not terribly low compared to Buffet's 0.1%.
Second, it was too early for the general public, journalists, and politicians in the 1920s to understand unrealized appreciation as economic income and potentially taxable income. To conceptualize unrealized appreciation of wealth as income was familiar to the leading economists of the time, such as Robert M. Haig. However, it was only 1913 when the modern federal income tax was enacted, and taxing realized capital gains as income was revolutionary and still contested in the 1920s. The more sophisticated journalists who were aware of the discrepancy between the ranking of the net worth and the ranking of the tax payment amounts identified the tax-free municipal bonds as the most important reason of the discrepancy. The nontaxation of unrealized capital gains was simply beyond imagination.
Third, the disclosures of tax payment information in 1924 and 1925 were framed very differently. ProPublica's exposé focused on how little the billionaires' the true tax rates are, rather than the dollar amount of their tax bills, and pointed out the unrealized capital gains as the main reason. In contrast, 1920s' disclosure was about the ultrarich's tax payment amounts, and the media stimulated public interest on how much tax they paid in dollars, not how little they paid tax as a percentage of income. If ProPublica followed the frame of 1920s' media and published a list of the largest income tax payments in dollar amount, Buffet might still be ashamed of his relatively small tax bills ($23.7 million). But Bloomberg ($292 million) and Musk ($455 million) would have impressed the general public by putting themselves among the top 400 taxpayers, and Bezos ($973 million) even nearly the top of the list.
In sum, Rockefeller, Ford, and their fellow millionaires had sizable taxable sources of income, especially dividends, that were reflective of their net worth. However, Larry's fascinating story about the tax bills of the 1920s' richest magnifies that the lion's share of the 21st century billionaires’ wealth lies in the unrealized capital gains, which current tax system completely fails to tax. His story convincingly amplifies the policy reason why we need mark-to-market taxation more than ever. I believe his Tax Notes Federal article will give further momentum for us to consider mark-to-market proposals, at least for the ultrarich. That's why Larry is such a great tax storyteller and a great tax scholar.