19.07.2024Putting the ‘Finance’ into ‘Public Finance’: A Theory of Capital Gains Taxation

Text by Maura Wyler / UBS Center

Taxing the wealthy has become a hot topic, with various proposals suggesting different methods. Traditional tax models often miss the mark by not considering how asset prices change over time. This study addresses that gap, providing insights that could reshape future tax policies.

Currently, wealthy individuals can benefit from rising asset prices without immediately paying taxes on those gains. For example, Jeff Bezos’ wealth increases as Amazon’s stock price rises, but he only pays taxes when he sells those shares. Many wealthy individuals exploit this by borrowing against their appreciated assets, avoiding immediate tax liabilities.

The authors emphasize the importance of focusing on realized trades rather than taxing the value of held assets. They argue that tax policies should adapt to the various reasons behind asset price changes, such as market conditions and investor sentiment, not just earnings.

Their research suggests that tax rates need to be flexible. When asset prices rise, taxes should target those who profit from selling their assets, while offering some relief to those buying at higher prices. They also recommend closing loopholes like the “stepped-up basis” rule, which allows wealthy individuals to avoid capital gains taxes by borrowing against their assets instead of selling them.

FAZ highlights how the wealthy minimize tax liabilities
An article published in the German newspaper Frankfurter Allgemeine Zeitung (FAZ), refers to the new study shedding light on how super-rich individuals manage to pay minimal taxes on their gains. Wealthy people often have substantial capital income, taxed at lower rates than ordinary income. Moreover, they can borrow against their assets without selling them, thus deferring taxes indefinitely. This strategy, known as “buy, borrow, die,” allows them to pass on assets to heirs with minimal tax liability due to a step-up in basis at death.

The FAZ article discusses proposals like a wealth tax or taxing unrealized capital gains to address these issues. However, the study by Prof. Scheuer and his colleagues raises doubts about these approaches, suggesting they might not achieve optimal redistribution and could even harm economic fairness by taxing unrealized gains that might fluctuate for reasons unrelated to actual income.

A more realistic and effective approach to taxation
This research is particularly relevant as policymakers seek ways to address income inequality and ensure the wealthy pay their fair share. By considering the dynamic nature of asset prices, Prof. Scheuer and coauthors propose a more realistic and effective approach to taxation. Their findings challenge traditional views and suggest that tax policies should be flexible and responsive to market changes.

Source
Putting the ‘Finance’ into ‘Public Finance’: A Theory of Capital Gains Taxation (PDF, 1 MB)
with Mark Aguiar and Benjamin Moll, Working Paper, June 2024

Media coverage
Die niedrigen Steuern der Milliardäre Frankfurter Allgemeine Zeitung, 8.7.24 (mit Abo)https://www.faz.net/aktuell/wirtschaft/arm-und-reich/steuern-fuer-milliardaere-wieso-sie-so-niedrig-sind-19836907.html