Should the wealthy pay taxes on expensive art and wine? Joe Biden thinks so. Here's how it would work

WASHINGTON – Steve Cohen is an uber-rich man with an enthusiasm for expensive art.

The hedge fund magnate, estimated by Forbes to be worth more than $17 billion, has amassed a personal art collection that rivals the works found in some museums.

According to Fortune magazine, Cohen’s collection includes paintings and sculptures by Picasso, Andy Warhol, Jeff Koons and other celebrated artists. In 2015, the New York Post’s Page Six identified him as the secret buyer who plunked down $143 million at a Christie’s auction to purchase the world’s most expensive sculpture, Alberto Giacometti’s life-sized bronze statue called “Man Pointing.”

The estimated value of Cohen’s collection: $1 billion. But under current law, Cohen pays no taxes on his art unless he sells a particular piece.

President Joe Biden is looking to close that loophole by ensuring that the uber-rich pay taxes on assets like stocks, artwork, or fine wines as they gain value – even if they choose not to sell them.

Artwork and other nonliquid assets, such as land, homes and high-end jewelry, are more than just an expensive indulgence for the super wealthy like Cohen, who did not respond to a request for comment. They’re also a way to lower the owner’s tax burden.

The value of such assets often rises steeply over time. Even though the assets become worth significantly more than their purchase price, the owner doesn’t have to pay capital gains tax on them until he or she sells them.

“There's a big problem right now where you can, as they say, hold your assets until death and then end up never having to pay tax,” said Jonathan Choi, a professor at the University of Minnesota Law School and a specialist in tax law.

To end that practice, Biden is proposing a “minimum income tax” on American households worth more than $100 million. The plan calls for the wealthiest Americans to pay a tax rate of at least 20% on their full income, including unrealized gains from assets that have increased in value since their purchase.

Biden, who pledged during his presidential campaign to raise taxes on the wealthy, billed the proposal as a fairer tax code that would prevent the nation's highest earners from paying a smaller share than middle-class Americans.

“I’m a capitalist: If you want to make a million bucks, great,” he said while unveiling the tax plan at the White House on March 28. “Just pay your fair share.”

The tax would impact only the superrich – about 0.01% of American households representing the 700 richest Americans. The White House estimates it could bring in an additional $360 billion in tax revenue over the next decade.

But financial experts said it’s difficult to estimate whether the tax would generate the kind of revenue the White House is projecting, partly because determining the value of some assets can be a tricky business.

Even so, they said, forcing the wealthy to pay taxes on those assets would help correct what has long been a serious inequity in the American tax system.

"The greatest injustice of the U.S. tax system is that the billionaires pay less, relative to their true economic incomes, than ordinary Americans,” said Emmanuel Saez, an economics professor and director of the Center for Equitable Growth at the University of California, Berkeley.

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‘An unusual kind of tax’

Biden’s push for what the White House is calling a “billionaire’s tax” comes amid a growing debate in Washington over the unequal distribution of wealth and whether superrich people are paying their fair share.

Democrats have come up with multiple proposals over the years to target rich people who utilize loopholes to cut their tax liability.

Massachusetts Sen. Elizabeth Warren pushed for a “wealth tax” when she ran for president in 2020. Last year, Warren joined Sen. Bernie Sanders of Vermont and six other senators to introduce legislation calling for an “ultra-millionaire tax.” Their plan would impose a 2% tax on households with a fortune between $50 million and $1 billion and an additional 1% on those with more than $1 billion.

Former New York City Mayor Michael Bloomberg, estimated by Forbes to be worth an estimated $82 billion, unveiled his own plan to tax the rich during the 2020 presidential election. His proposal called for a 5% surtax on incomes over $5 million a year.

Ebay founder Pierre Omidyar, who Forbes says is worth $12.9 billion, was among the first to say yes when business magnates Warren Buffett, Bill and Melinda Gates and others asked some of the richest Americans in 2010 to pledge to give at half of their money to charity.

Omidyar’s philanthropic endeavor, the Omidyar Network, gave $100,000 earlier this year to support a “millionaire’s tax” ballot initiative in Massachusetts, according to The Boston Globe. The initiative, which will be decided by voters in November, would impose a 4% additional tax on income of more than $1 million effective Jan. 1, 2023. The additional revenue raised by the tax would be spent on the education and transportation programs.

So far, efforts to slap taxes on the wealthy have failed, partly because of questions about their constitutionality and because they have proven to be a difficult sell to Republicans and some moderate Democrats.

“There's not even a consensus among tax professors that something like a wealth tax would be a good thing,” Choi said. “It’s an unusual kind of tax. It imposes a lot of new administrative burdens.”

Biden’s proposal gets around questions about constitutionality because it’s an income tax. The Constitution gives Congress the power to tax income, but whether that power also extends to taxing wealth remains the subject of debate.

Whether Biden’s “billionaire’s tax” can win approval in Congress also remains in question. The day after Biden unveiled the proposal, Sen. Joe Manchin, a moderate West Virginia Democrat, said he won’t support the plan because it would tax the unrealized gains of assets that have increased in value before they are sold and converted into cash.

“You can’t tax something that’s not earned,” Manchin told The Hill newspaper.

Given the Senate is split 50-50 among Democrats and Republicans, Manchin’s opposition would appear to doom Biden’s tax plan. But the White House signaled recently it isn’t ready to give up yet.

Biden and Manchin share a fundamental belief that the rich should pay their fair share, White House spokeswoman Kate Bedingfield said when asked to respond to Manchin’s opposition. The administration will continue to work with the senator to move the proposal forward, she said.

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‘Buy, borrow, die’

If you buy a stock, chances are you’re not going to make a profit until you sell it for more than you bought it for. Any gains you see in your portfolio are an illusion since they could change at a moment’s notice during the trading day.

Economists refer to that as an unrealized gain. And under the current tax code, Americans don’t have to pay any taxes on assets that have appreciated until they sell them. But while average investors stress about figuring out the optimal time to sell a stock, the wealthiest people already have the answer: never.

If they never sell, they never pay taxes. When they die, their heirs won’t have to pay any taxes if they sell the assets they inherited. What’s more, they can borrow money at minuscule interest rates using shares that they never intend to sell as collateral.

The strategy is referred to as “buy, borrow, die.” It’s one of the reasons why Buffett said he paid a lower effective income tax rate (17.4%) in 2010 than anyone else in his office, including his secretary.

Biden wants to close those tax loopholes and ensure that the top 1% pay taxes on assets as they gain value, even if they don’t sell them. Biden’s proposal would require the wealthiest Americans to pay a tax rate of at least 20% on their full income, including unrealized gains on assets that have yet to be sold.

If a wealthy household is already paying 20% on their full income – standard taxable income, plus unrealized income – they will pay no additional tax under the Biden proposal. Taxpayers could choose to pay the first year of minimum tax liability in nine annual installments. For subsequent years, they could choose to pay the tax imposed for those years in five annual installments.

For people like Buffett, who paid below 20%, the remainder of the taxes they pay would come from taxing unrealized gains.

Stock in Buffett’s multinational conglomerate holding company Berkshire Hathaway appreciated nearly 20% annually over the course of 50 years. One analysis found that if Buffett’s shares were taxed at the rate they would be taxed if he sold them, his net worth in 2015 would have been $9.5 billion versus $70 billion.

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Typical Americans at severe disadvantage

Unlike billionaires, the main source of income for most Americans is from their job, and there’s “no easy way to escape tax and salary income,” said David Gamage, a professor at Indiana University’s Maurer School of Law who specializes in tax policy.

The maximum tax rate on what’s referred to as ordinary income is 37%, while the maximum tax rate on selling stocks that have appreciated is 20%, plus an additional 3.8% for the highest earners.

So even if billionaires sell stocks, which they try to avoid, they’re already going to pay a lower tax rate than someone whose main source of income is from their job.

Case in point: The top 400 wealthiest American families paid an average federal individual income tax rate of 8.2% from 2010 to 2018, according to a White House analysis. The average individual income tax rate was above 13% in 2018, according to research published by the Tax Foundation, an independent nonprofit that analyzes tax policy.

Theoretically, anyone can use the “buy, borrow, die” strategy as long as they could get compensated via stocks or other assets that appreciate over time or inherit them, Gamage said. In practice, though, most employers wouldn’t entertain paying their employees in stock or letting them borrow money to buy stock in their business because it’s so complex, he said.

Also, “that would be taking on some amount of risk for an ordinary American who probably needs that salary,” he said.

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Why billionaires have lower tax rates

The taxes billionaires avoid paying by holding onto stocks and other assets have gone unchecked for decades because “there seems to be this idea of ‘well you shouldn't pay them any sooner than you really have it in cash,’” said Richard Kaplan, a tax law professor at Illinois College of Law.

More recently, Democratic lawmakers are waking up to the notion “that some of these big boys and girls – mainly big boys – have been able to get the use out of their increased value of Amazon shares or Tesla shares without having to sell it,” Kaplan said.

But for ordinary people who want “to get the benefit of some stock that's gone up in value, they have to typically sell it, but these guys will just borrow against it,” he said.

Some 75% of unrealized gains are never taxed, said tax specialist Calvin Johnson, a professor at the University of Texas at Austin School of Law. For rich people, the percentage is probably even higher because they can borrow money against those assets, he said.

Taxpayers will go to extraordinary lengths to keep from paying the difference between what an asset actually cost them and what it’s worth now, Johnson said.

“I'm 77. Anybody at my age and above does everything in the world, will run over their grandmother, in order to avoid recognition of that difference,” he said. “They will do economically irrational things just to preserve the non-taxation.”

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‘An incentive to undervalue’

One of the problems of taxing unrealized gains is that assets like artwork or fine wines can be extremely difficult to value, said Kyle Pomerleau, tax policy expert at the American Enterprise Institute, a think tank based in Washington.

“Taxpayers have an incentive to undervalue these assets to reduce their tax liability,” he said.

The Biden administration seeks to work around that problem by requiring taxpayers to value these assets with a formula. Specifically, taxpayers would be required to start with the last known market price of the asset and then assume that it has grown at a fixed rate of return each year to estimate its appreciation.

Taxpayers would still be able to argue for a different valuation and would even have an incentive to do so since that could reduce their tax payments, Pomerleau said.

It’s difficult to gauge whether the Biden tax proposal would generate the $360 billion that the administration projects since many of the assets to be taxed have no known market price, Pomerleau said.

Another factor that could impact how much revenue the tax brings in: Half of the $360 billion in projected revenue would come from a one-time tax on previously untaxed gains that would be paid over nine years.

“After those nine years, however, the proposal will start raising much less,” Pomerleau said, “so $360 billion may overstate the long-term revenue impact of this proposal.”

There’s also a question of whether the Constitution allows the federal government to tax unrealized capital gains since it isn’t allowed to tax wealth. Even among tax attorneys, there is disagreement over whether unrealized capital gains should be considered wealth or income, Kaplan said.

Given that uncertainty, Biden’s tax plan probably would end up facing a legal challenge.

If the administration is looking for a way to generate revenue quickly, “this is not going to be it,” Kaplan said. “Because it’d be tied up in litigation at least until the Supreme Court rules one way or the other.”

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This article originally appeared on USA TODAY: Billionaire tax: How Biden wants to make uber-rich pay 'fair share'