In the last few weeks there has been an intense string of discussions in Silicon Valley about the future of taxation. The debate has primarily sprung from Elizabeth Warren’s comments about adding a wealth tax, and Alexandria Ocasio-Cortez's comments about a 70% marginal tax rate.
There is high engagement around these issues in Silicon Valley for a few reasons. First, people in the Valley are very conscious of the difference between entrepreneurs who are compensated and build wealth through equity appreciation versus employees who are compensated in cash and closer-to-cash instruments like RSUs. It is lost on no one here that the wealthiest entrepreneurs with appreciated stock generate little to no income and are able to broadly avoid taxation with extremely low-interest loans to finance their consumption, where otherwise well-off wage-earners are footing large tax bills.
Second, with the income tax rate in California exceeding 50% for many and with the loss of historical advantages like mortgage tax deductibility, taxes seem an increasingly high-stakes issue for many. It’s one that cuts against the otherwise broadly Democrat-leaning political tendencies of the population. I have heard many people repeat—rightly or wrongly—that once taxes get beyond one-for-me-one-for-you, it starts to feel unfair. Proposals aimed at getting away from income taxes in favor of other tax options (consumption, land, wealth) start to become of real interest.
The challenge, however, is that even if a lot of people are theoretically sympathetic toward the concept of a wealth tax (especially in lieu of distortionary income or consumption taxes)—there is one seemingly insurmountable problem: How do you assess someone’s wealth correctly and fairly in order to tax them properly?
The answer might be simple enough for those who hold just public company stock with a deep market. But in the real world of Silicon Valley, where people hold private company stocks, real estate and countless other illiquid asset classes, it seems nearly impossible to come up with a practical standard of accounting that allows you to fairly and efficiently calculate wealth to know how to tax.
You obviously cannot ignore private assets. They’re a huge percentage of overall wealth, especially for more well-off people. And if you only taxed publicly traded assets, you’d see a flight away from public assets and toward private ones.
The Solution
In the world of real estate partnerships, co-owners of assets frequently have to define terms upfront for how they would end the partnership down the line and buy each other out if they no longer wanted to partner.
The problem they face is that there usually is not a market price for their illiquid real estate asset, and it is hard to agree upon an objective valuation metric or system.
One lightweight solution to this problem is a buy-sell agreement, which can specify that at any time, one party can make an offer to buy out the other partner’s shares at a specified price. Contractually, the partner receiving the buyout option has the right to either sell their shares at the price offered, or they reverse the offer by buying out the other partner’s shares at the same price.
This strategy prevents one partner from lowballing the other partner on an offer. At a minimum, any offer has to be economically rational against the backdrop of the broader market. But if one partner values the asset in excess of what the broader market would, for whatever strategic or emotional reason, they need to be honest about the full value of the asset to them, or risk being bought out against their interest.
A wealth tax could follow this same concept. Every year, each person would have to disclose their assets and list a price at which they value each asset. They would have to specify private company holdings and their price-per-share, art, real estate, etc., all in one national registry, and then anyone could—at some interval—buy that asset at the listed price if they wanted—forcing the owner to sell at the price they indicated.
This would force each person to accurately value the things they care about. If you like the home you live in, for instance, you would have to fully state its value for the purposes of taxes—lest someone else might buy it from you.
If you have private company stock where many people believe that the ultimate outcome of the company is going to be a massive IPO, but you also believe the stock will appreciate, then you would have to mark the “value” of the stock to reflect that potential—or someone else would simply buy it away from you.
If you owned private market stock with preferred voting rights that you valued, then you would have to be willing to decide exactly how much those extra voting rights are worth to you beyond the value of the common shares.
The upshot: The problem currently with any wealth tax concept is that most assets don’t have a clearly established market value. The incentive is to understate the value of assets, unless people are forced by some procedure to think fully about how much different things are worth to them.
If you want to have a wealth tax, then basically everything has to be listed and put into the market in order to establish a price with which to calculate wealth. If the market is thin (which it will be for most assets), the owner will have a strong incentive to price the asset fully versus. under-marking it.
What this implies is that if you want a wealth tax over an income tax, it isn’t just a matter of asserting a new tax law. It requires a new approach to valuation and even the way we as a society treat the idea of ownership and wealth.
As an example of the impact, take the case of Donald Trump. He has often declared his net worth at what seem like wildly inflated numbers, presumably based on his own assessment of the value of his brand. In the world we are describing, Trump would be free to continue doing so—but he would have to be willing to pay the associated taxes based on the claimed value. It would be interesting to see, with such a framework in place, what he would ultimately decide to declare.
The Nettlesome Details
Even if a buy-sell agreement helps you price fairly, the details still get complicated. Disclosure requirements are, for instance, very challenging. If—hypothetically—there were a global asset registry and you saw a Porsche listed as worth $100, is that some game the owner is playing or was it wrecked?
It is very difficult to set the rules of disclosure for such an open-ended market. Markets are information machines, and if you are creating some sort of market pricing mechanism for all assets, then the pressure falls to the information systems that support the markets.
There are also practicalities around privacy and transfer to consider. Privacy is reasonably easy to deal with: you simply need to list the assets without noting ownership in a secure way.
Transfer, however, is a bit more complex. Consider homes. For a rental property it is easy enough for the owner to switch, but if someone buys your primary residence through this auction mechanism, things get a bit more challenging to manage. Do they get to own the financial asset and you still have occupancy rights? Does there have to be a primary residence exclusion? (Likely.)
On the flip side, this approach would have an interesting impact on private company stock. All shares of all companies would, all of a sudden, be publicly purchase-able in some form. In this world, anyone who was allowed access to this market could buy lots of private companies like Uber or Airbnb annually from the founders, investors, etc.
This has big implications for what it means to own private company stock and how wealth appreciation might work. There is also an argument that it is more fair, opening access to ownership to all comers, and potentially sharing the upside of rocket ship companies more broadly.
Ultimately, the details around who is allowed to participate in the market and how assets are practically disclosed and exchanged really matter.
Tradeoff Between Privacy and Information
The first income tax in the U.S. was instituted during the Civil War in the North to help pay for the war. It was a tax only on the absolute wealthiest Americans—and just like the discussion with wealth taxes today—there was a huge problem people had with information. The government had no way of knowing how much people made and, therefore, if they were paying their taxes fairly.
The solution in that era was fully public tax records, where people had to publicly list how much money they told the government they made—and therefore how much tax they should pay. The idea was then that neighbors would snitch on each other if they thought they were underreporting their income.
Making income tax records public is unthinkable today. It would be the ultimate privacy violation by the government—perhaps something China’s government could pull off, but never in the United States.
But the reality we have to digest is that if people have an interest in moving toward a wealth tax, we have a very large information problem. The solution can either be introducing market forces and a public registry of all assets, or giving a central authority the power to value all assets rather than just objective income.
A registry of all assets would historically have been impossible, but in our information-enabled age it both seems possible and to offer some clear benefits. The challenge, of course, is that it also has some serious drawbacks and requires us to digest a redefinition of private ownership, at least to some degree.
Pick your practical poison.