The big flaw in Biden’s billionaire tax proposal, according to experts

President Biden wants to raise taxes on Elon Musk, Jeff Bezos, and their cohort of Americans, who are amassing extraordinary wealth that is not taxable under current law.

Biden says his plan would make the system more fair — but experts say it lacks practicality.

The president wants to impose a minimum 25% tax on all Americans with assets over $100 million. The “billionaire tax” would impact the 10,700 wealthiest Americans and generate an estimated revenue of $400 billion over 10 years.

The idea of levying higher taxes on those at the top of the economic ladder is not new. Yet the latest proposal raises more questions than answers.

“Are you taxing the rich? Are you taxing the wealthy?” Peter Ferrigno, director of tax service at Henley & Partners, a citizenship investment consulting firm, told Yahoo Finance. “They’re very similar, but they are not the same thing.”

Furthermore, the proposed policy challenges a fundamental principle of the US tax code, which treats money earned as income differently from wealth generated through valuation growth.

Read more: How bonuses are taxed (and why it matters)

A mobile billboard calling for higher taxes on the ultra-wealthy depicts an image of billionaire Jeff Bezos near the US Capitol on May 17, 2021, in Washington, D.C. (Photo by Drew Angerer/Getty Images) (Drew Angerer via Getty Images)

How could the US government tax wealth?

Biden hasn’t offered many specifics, but to get to a minimum 25% rate, experts say he would have to tax unrealized gains — unsold profits from increases in asset values — as part of billionaires’ income. Under current law, unrealized gains aren’t taxed until the asset is sold at a profit.

The president says this is the proper way to calculate the true income — and true tax rate — of the ultra-wealthy. Billionaires make the bulk of their money through stock or investment growth instead of a wage from a 9-to-5 job. So, the president says, they shouldn’t be able to shelter income simply because they haven’t pocketed the profits.

“Billionaires don’t often have a typical paycheck,” Brandon Zureick, managing director and portfolio manager at Johnson Investment Counsel, told Yahoo Finance.

Take one of the world’s wealthiest people, for example: Elon Musk’s net worth surged nearly $12 billion over a span of five years beginning in 2018, from $8.4 billion to $20 billion. However, Musk reported only $1.52 billion in income during those years and paid $455 million in taxes.

That may sound like a lot, but Musk’s true tax rate amounted to only 3.79%. By contrast, the median American household earned $70,800 in 2021 and paid an average tax rate of 15%.

Under Biden’s proposal, Musk’s tax bill would have totaled $3 billion for 2018 through 2022 — nearly seven times higher than what he paid.

The 25 wealthiest Americans paid $13.6 billion in federal income taxes from 2014 to 2018. Meanwhile their wealth collectively increased by $401 billion in that same period, ProPublica reported. This means their collective average true tax rate was 3.4%.

To redesign this aspect of the tax code, Biden needs to consider: What happens when unrealized gains turn into losses?

In other words, how will the taxes work when investment values decline on paper?

“When you start taxing unrealized gains rather than realized gains, you’re going down a very slippery slope,” Ferrigno said. “You want to tax the going up? Are you going to give money back when they go down again?”

For instance, if Musk’s share in Tesla (TSLA) surges from $100 billion to $200 billion, Biden’s proposed wealth tax would cost Musk $25 billion in that year — 25% of the unrealized $100 billion gain. But if Tesla shares declined by $100 billion the next year, would the government need to pay Musk back?

“That’s where you open up a whole reason that other countries don’t do this,” Ferrigno said. “Income tax has been around for centuries. And the reason no one’s ever done this is because it’s practically impractical.”

Also read: What is the earned income tax credit, and do you qualify?

NEW YORK, NEW YORK - SEPTEMBER 13: (EXCLUSIVE COVERAGE) Alexandria Ocasio-Cortez departs The 2021 Met Gala Celebrating In America: A Lexicon Of Fashion at Metropolitan Museum of Art on September 13, 2021 in New York City.  (Photo by Jamie McCarthy/MG21/Getty Images for The Met Museum/Vogue )

Democratic Rep. Alexandria Ocasio-Cortez wore a “tax the rich” dress at the 2021 Met Gala in New York City. (Photo by Jamie McCarthy/MG21/Getty Images for The Met Museum/Vogue ) (Jamie McCarthy/MG21 via Getty Images)

Top 1% pays nearly half of US tax

Opponents of a wealth tax reason that the share of federal taxes paid by the top 1% is already adequate. In 2021, the top 1% paid over $1 trillion, almost half of all tax revenue collected, according to the Tax Foundation.

“The income tax system in the United States is highly progressive and redistributive,” Erica York, senior economist at the right-leaning think tank Tax Foundation and author of its latest report on income tax data, told Yahoo Finance. The top 10%, she added, paid almost 76% of all tax revenue.

Critics also note that there is already a separate income tax on the rich, making Biden’s proposal redundant and unnecessary.

The alternative minimum tax (AMT) is a parallel system that sets a floor on what high-income individuals must pay. It removes some benefits and deductions on their tax returns, limiting the reductions to their tax liabilities.

“The US has had the alternative minimum tax for about 50 years,” Ferrigno said. “They already have a tool in the toolbox to try and address [taxes on high incomes].”

Ferrigno said an update to the AMT would be sufficient in taxing billionaires’ incomes.

A slew of billionaires left Norway in 2022 after the country implemented a 1.1% capital asset tax.

A number of billionaires left Norway in 2022 after the country implemented a 1.1% capital asset tax. (Westend61 via Getty Images)

Caution: Don’t be like Norway

History shows how exorbitant income disparities can lead to social crises: “Back to the French Revolution and guillotine if not careful,” Ferrigno said.

But he said the Biden administration should start with a lower tax rate on billionaires, like 10%, and progress from there before landing at 25%.

After all, levying an overwhelming wealth tax on the super rich, who are also super mobile, can backfire. A number of billionaires left Norway in 2022 after the country implemented a 1.1% capital asset tax on married households with equity over the equivalent of $3.7 million.

“Find out what works and import it and avoid what Norway did to drive half of [ultra-wealthy] away,” Ferrigno said. “Look at how Spain has a high enough threshold that people just grudgingly accept it.”

Spain has a long-standing regional wealth tax from 0.16% to 3.5%. But instead of emigration, wealthy Spaniards either accepted their wealth tax rate or relocated to a cheaper region within the country.

“[Spain’s wealth tax] has been there for a long time as well, so people are used to it,” Ferrigno said. “Plus the exemptions ensure that few people get into the highest brackets.”

Switzerland also assesses various wealth taxes at the regional level on individuals’ assets worldwide, including bank account balances, equities, boats, and airplanes.

Transformative technology, such as blockchain ledgers and artificial intelligence, is transforming financial systems, yet the US tax codes haven’t kept up.

“Our current system where we sit today may have been great in the past, but it’s not so great today,” said Jose Murillo, partner and National Tax Department leader at Ernst & Young.

An overwhelming share of American voters, or 70%, support the idea of raising taxes on billionaires, a recent Bloomberg poll shows.

“Imagine what we can do,” Biden said of taxing the wealthiest Americans, “from cutting the deficit to providing for childcare, to providing healthcare, to continue to provide our military with all they need.”

“This is not beyond our capacity,” Biden said.

Rebecca Chen is a reporter for Yahoo Finance and previously worked as an investment tax certified public accountant (CPA).

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