Strangling American Capitalism with the Zuckerberg Tax

When American progressives go to bed at night, do they dream of new ways to raise taxes?  The latest tax incarnation from America's left was floated in a February 8 New York Times op-ed entitled "The Zuckerberg Tax."  Under this scheme, new taxes would be imposed on the mark-to-market values of publicly traded companies.  The new tax would apply only to America's "ultra-wealthy," defined in the article as the top 0.1% --those "individuals and married couples who earn, say, more than $2.2 million in income, or own $5.7 million or more in publicly traded securities." 

In particular, the long-term capital gains rate (currently 15%, but slated to rise to 20% next year) would be applied to all increases in the market value of equity securities held.  As a result, if the market value of the Microsoft stock held by Bill Gates rose by $1 billion during a calendar year, he would pay at least an additional $150 million in taxes, even though no real gain had been recognized.  In the event that Mr. Gates did not have a spare $150 million in liquid cash sitting around to pay Uncle Sam, the author contends that Mr. Gates could simply "sell shares" or "borrow" the money to meet his new tax obligation.

In contrast, if the mark-to-market value of Mr. Gate's Microsoft stock fell by $1 billion, he would be entitled to a $150-million federal tax refund.

The author further contends:

A mark-to-market system of taxation on the top one-tenth of 1 percent would raise hundreds of billions of dollars of new revenue over the next 10 years.  The new revenue could be used to lower payroll taxes, extend the George W. Bush tax cuts, repeal the alternative minimum tax, reduce the budget deficit, prevent military cuts or a combination of all of these.

This tax would not affect the middle class, or even most wealthy Americans. Nor would it affect small-business owners.  It would affect only individuals who were undeniably, extraordinarily rich.  Only publicly traded stock would be marked to market.  

This article truly represents the ramblings of a man who clearly does not comprehend how world capital markets work.

If adopted, this tax proposal would likely raise very little revenue.  In fact, if the United States were to adopt this proposal, it would trigger a number of corporate management decisions that would significantly hurt American competitiveness. 

For one thing, owners of a public company could simply avoid the tax by taking a public company private.  Accordingly, large corporate shareholders, many of whom are CEOs or CFOs, or hold other high-level management positions, would have every incentive to sharply increase corporate debt levels in an effort to take their firms private to avoid paying the tax.

Once this corporate leveraging occurs, corporate managers (out of necessity) would refocus their efforts on maximizing cash flow in order to service their firms' higher debt levels.  A highly levered firm would likely reduce its inventory levels, curtail corporate research and development expenditures, and/or reduce business expansion in order to maximize free cash flow.

These developments alone would likely trigger a U.S. recession, since business inventory growth alone accounted for 1.94% (or nearly 70%) of the 2.8% GDP growth rate recorded in the United States in Q4 2011.  Moreover, reductions in R&D spending or forestalling the construction of a new office or manufacturing facility would hurt American competitiveness and job-creation for years to come.    

In a similar fashion, if corporations were to sharply increase their debt levels, the demand for savings would sharply increase.  In normal times, at least in a period where the Federal Reserve were not manipulating the level of interest rates through unabated bond purchases and money printing, this new supply of corporate debt would push interest rates higher, thereby further retarding U.S. economic growth.

For those companies that choose to remain public, many larger shareholders, many of whom initially founded these companies and who have much of their wealth tied up in firm stock, would be forced to sell shares in order to meet their tax obligations.  Such government-forced liquidation would destabilize the continuity of corporate management structures and artificially push stock prices lower, thus hurting the wealth of all investors.

The creation of such a system would also sharply increase the complexity of tax compliance and by default increase the cost of tax preparation.  Although this would be a gold mine for CPAs and tax attorneys, this system would do nothing to improve our national productivity.  Rather, many tax professionals would simply find themselves wasting more time to comply with yet another manifestation of government ineptitude.

But perhaps the biggest loss would be the further erosion of our capital markets -- an area where America still holds a comparative advantage over most nations.  By adopting this proposal, our tax code would place into direct conflict the interests of entrepreneurs, who wish to maintain control of their firms while protecting their wealth, and angel investors (including endowments and private equity firms), who wish to have a liquidity event (such as an initial public offering) so that they can recover their invested capital and earn a suitable return on their invested funds. 

By creating this inherent conflict, the ability of America's markets to freely direct capital to the places it is most needed would be jeopardized.  As a result, the ability of entrepreneurs to attract capital under mutually agreeable terms in order to start and expand their businesses would forever be stymied, and the appeal of America as a land of unlimited opportunity would take yet another setback.

During the 2008 presidential campaign, Barack Obama promised to "change America as we know it."  Let us all hope that this NY Times op-ed was just another left-wing trial balloon and does not foreshadow what's in store should Obama win re-election.

Paul B. Matthews is a Texas CPA and holds an MBA from the University of Texas at Austin.  His website is Paul4Texas.Com.