Beck Barnett

2 April 2024

Last May, the U.S. federal government narrowly bypassed defaulting on the nation’s debt for the first time in history [1]. Failing to pay the country’s outstanding obligations would have likely downgraded its credit rating, increased unemployment, and crashed the stock market [1]. The agreement, reached between President Biden and then House Speaker McCarthy, resulted from bitter negotiation over how to deal with the country’s consistent deficit and increasing national debt, a growing problem for the country’s fiscal health [1]. According to House Republicans, the hill they were willing to die on required a $1.5 trillion reduction in deficits over 10 years, partially funded by cuts to the Supplemental Nutrition Assistance Program (SNAP) and Temporary Assistance to Needy Families (TANF), yet these changes saved less than 10% of the deficit accrued over that period [1]. For the past few decades, both Republicans and Democrats have primarily discussed spending cuts when balancing the budget. However, more tools exist. Raising revenue provides just as effective of a strategy when balancing the budget, but policymakers seem to have abandoned America’s regressive tax code for other reforms. Current tax avenues like income tax do remain insufficient to capture funding from wealthy Americans. Expanding these avenues to cover their weaknesses remains possible, such as taxing unrealized gains and making existing taxes and fees scale with net worth. 

The U.S. sits well below the average tax-to-GDP ratio of OECD nations, with the U.S. raising around 16% of its gross domestic product worth of taxes compared to 27% in the U.K., 34% in Australia, or 44% in Denmark [2]. The revenue stream in the U.S. seems comparatively inadequate given that the country also spends nearly 10 times more on their military than these countries combined [3]. Another difference these countries share is each of them provides a government-funded universal health care system, a service the U.S. stands as an outlier for lacking [4]. High revenues provide useful functions outside mere budget balancing, and raising them begins with reforming wealth taxation.

Buy/borrow/die: Wealth taxation

The primary way that most of the ultra-wealthy avoid taxes is through borrowing, using their appreciating assets as collateral. Edward J. McCaffery famously identifies the full scope of this issue in his law article, Taxing Wealth Seriously, where he coins the strategy’s term: “Buy, Borrow, Die” [5]. McCaffery covers how the wealthy can avoid taxes completely by borrowing until death, when the debt can be paid by their heirs tax free. The “Buy” step requires that a person buy an appreciating asset without cash flows, like art, land, or growth stock [5]. Since 1920, Supreme Court doctrine established in Eisner v. Macomber limits the definition of income under the Sixteenth Amendment to only include wealth realization, when an asset converts to cash [6]. If the person permanently holds the growing investment, their wealth never faces taxation. The “Borrow” step then requires the person to take out a loan with an interest rate lower than the asset’s appreciation [5]. This firstly provides a mechanism for wealth to transfer into consumption without income tax because debt is not “an undeniable accession to wealth,” another income requirement under Court doctrine from Glenshaw Glass (1955) [5]. Secondly, when the person needs to realize some money to pay the debt, the person will make more than if they paid taxes on the asset’s purchase amount earlier without the “Buy” step [5]. The final step is “Die” [5]. The person passes, and their heirs take their asset and outstanding liabilities tax-free under IRC Section 102, and the base for determining capital gains then rises to the market value of the asset when the person passed under IRC Section 1014 [5].

Adding a tax to any step of this process would fix the loophole. Adding a tax on initial investment, debt, or removing the stepped-up basis would render intended taxes from the wealthy. However, some of these strategies leave unintended downsides. Taxing investment would double tax appreciating assets, dissuading investment, and not address those avoiding taxes on sale. Taxing borrowed money at dispersion may dissuade loaning to everyone. This leaves removing the stepped-up basis as the best option for breaking the cycle, but making the wealthy pay some taxes on death does not stop them from paying fewer taxes when buying and borrowing. Thus, policy strategies reforming taxes other than income warrant consideration alongside this reform. 

Addressing regressive taxation

When you get a ticket for speeding, illegal parking, or littering, the amount in most states is the same for everyone. However, this amounts to a higher percentage tax on the poor. Taxes which do not scale to someone’s relative income or wealth are called regressive taxes, and sales tax and punitive tickets are some examples. Marginal income taxes are intended as a progressive tax, where the percentage taken scales up with income to balance the overall burden off those who can afford it. States can turn current regressive systems into progressive ones by basing ticket amounts to a percentage of a person’s income and wealth, graduating property taxes, and scaling back sales taxes.

As described earlier, flat cash fines, tickets, and penalties in the United States are regressive because they tax a higher percentage as income decreases. Attempting to reform this issue, some European nations like Switzerland pinned fine costs to a set percentage of a person’s income, usually half of the offender’s calculated daily income, a penalty called a “day-fine” [7]. This led to headline-inducing fine amounts for high-income earners, like when the country fined a person over one million euros for speeding in 2010 [7]. While seeming superficially ridiculous, these reforms make the fines effective at dissuading illegal behavior among the rich and avoid bankrupting the poor. Every state should base flat fines off of reported gross income from annual tax returns, with a $5 minimum. States should also collect data from taxpayers on their net worth by requiring them to report their assets’ market appreciation in a category labeled “unrealized gains.” Authorities should then combine this calculation with their gross income to levy a fair penalty to wealthy offenders, adequately assessing their net worth. 

Some flat taxes—taxes which charge the same percentage on all gains—deserve further progressive reform. Property taxes are the most widely used wealth assessment tax in the US, yet tax delinquency disproportionately affects minorities, with a faulty appeals system which often unjustly auctions off inhabited homes [8]. Many states use flat property taxes. However, some states, like Washington, now utilize graduated property taxes, requiring larger percentages from property values over $500,000 [9]. Tax bracketing or graduation is the calculation method used for federal income taxes, where making over a certain amount increases the tax on that higher portion of income. For property taxes, the value assessed is the property’s expected sale value. Implementing graduated property taxes across the nation would greatly reduce the burden on most families while taking a just amount from mansion owners.

All but three states use sales taxes, another flat tax on consumption. However, consumption taxes are another regressive tax due to the wealthy spending most of their wealth on investment [10]. Most states addressed the harmful effects of these taxes by exempting most necessities like food, medical uses, and more. Although, many states are still failing to exempt enough products, such as the pink tax, sales tax on period products, which remains intact in 21 states [11]. Besides reducing institutional sexism, decreasing sales taxes balances the tax burden and decreases prices, increasing economic activity. Businesses also sometimes struggle to claim sales tax exemptions when buying inputs or resale items, incentivizing vertical integration and monopoly creation [10]. Because of sales tax’s many pitfalls, policymakers should avoid this tax type entirely if possible.

Conclusion

State and federal officials should implement the sum of these reforms due to the regressive state of US tax policy. Even the federal income tax, the only progressively designed tax, fails to capture a fair percentage of rich wealth holders. Luckily, these reforms show promise in the progressive-minded countries and states implementing them, and they show promising methods to reduce wealth inequality. The US needs to reduce its budget deficit and increasing debt eventually. Fairly taxing untapped wealth provides the revenue needed to do so and enough excess to finance national priorities. 

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Image via Pexels Free Photos.

Works Cited

[1] Groppe, Maureen. 2023. “Food stamp spending would grow under McCarthy-Biden debt limit deal, CBO predicts.” USA Today, May 30, 2023. https://www.usatoday.com/story/news/politics/2023/05/30/food-stamp-debt-limit-cbo/70271363007/. 

[2] CEIC. 2024. “Tax Revenue to GDP | Economic Indicators.” https://www.ceicdata.com/en/indicator/tax-revenue–of-gdp. 

[3] Peter G. Peterson Foundation. 2023. “The United States Spends More on Defense than the Next 10 Countries Combined.” April 24, 2023. https://www.pgpf.org/blog/2023/04/the-united-states-spends-more-on-defense-than-the-next-10-countries-combined. 

[4] The Economist. 2018. “America is a health-care outlier in the developed world.” April 26, 2018. https://www.economist.com/special-report/2018/04/26/america-is-a-health-care-outlier-in-the-developed-world. 

[5] McCaffery, Edward J. 2016. “Taxing Wealth Seriously.” USC Gould School of Law Legal Studies Research Paper Series 10, no. 16 (November). https://deliverypdf.ssrn.com/delivery.php?ID=2831250780961020970951101031211250670250050330820610590740690710940800651071140661111261060011270410580000111041210950021150650250540090580010001250030811171270700000121241161271140230830900821160981190680010820. 

[6] “Eisner v. Macomber :: 252 U.S. 189 (1920).” 2024. Justia US Supreme Court Center. https://supreme.justia.com/cases/federal/us/252/189/. 

[7] Euronews. 2023. “Finland’s “progressive punishment” when it comes to speeding tickets.” January 4, 2023. https://www.euronews.com/2023/01/04/finlands-progressive-punishment-when-it-comes-to-speeding-tickets 

[8] Grotto, Jason, and Caleb Melby. 2021. “Property Tax Debt Scheme: Minority Families Lose Homes to Money Machine.” Bloomberg, December 20, 2021. https://www.bloomberg.com/news/features/2021-12-20/minority-families-lose-homes-to-real-estate-property-tax-debt-scheme. 

[9] Nguyen, Joe. 2019. “Senate passes real estate excise tax reform, reducing rates for majority of Washingtonians.” Washington Senate Democrats. https://senatedemocrats.wa.gov/nguyen/2019/04/26/senate-passes-real-estate-excise-tax-reform-reducing-rates-for-majority-of-washingtonians/. 

[10] Gale, William G. 1998. “Don’t Buy the Sales Tax.” Brookings Institute, (March). https://www.brookings.edu/articles/dont-buy-the-sales-tax/. 

[11] Bendix, Aria, and Joe Murphy. 2024. “Where tampons, pads and other period products are taxed: map.” NBC News, January 9, 2024. https://www.nbcnews.com/health/womens-health/where-tampons-pads-period-products-are-taxed-map-rcna132874.