The Democrats’ proposal to tax unrealized capital gains for about 700 of the richest Americans would raise the stakes on the inexact science of valuing municipal bonds.
The specifics of a slimmed-down version of what was once a $3.5 trillion reconciliation bill are expected to be released this week, but a new proposal released Oct. 27 hopes to raise $200 billion over a decade by taxing unrealized capital gains on those with at least $1 billion in assets or at least $100 million in income for three consecutive years.
The legislation would impose a 23.8% capital gains tax, plus an interest charge (applicable federal short term rate plus one point) on the gains and take deductions for losses annually on liquid assets, encompassing stocks, bonds and cash, based on the original price of those assets. Those assets that fall within scope would be marked-to-market every year and non-tradable assets such as real estate or business investments would not be taxed annually.
The proposal does provide a transition period, as the first time a billionaires’ unrealized gains are marked-to-market, they may elect to pay the tax over five years and may also elect to treat up to $1 billion of tradable stock as a non-tradable asset.
It is difficult to measure how many individuals with $1 billion in assets or those who’ve reported at least $100 million for three consecutive years own municipal bonds. But it could still present some operational difficulties for how the muni market works today.
“For assets like equities, it would be pretty easy to implement because every stock pretty much trades every day and you know what the closing price is every day,” one lobbyist who asked not to be identified said.
“It's easy to value your portfolio on an accurate basis,” the lobbyist said. “In the municipal market, it's not as easy.”
Like equities traders, municipal bonds traders conduct daily valuations, typically through third party evaluated pricing services that estimate the value for each individual CUSIP. But unlike equities, not all municipal bonds trade every day and the value of each security reflects more of an estimate than an executed trade.
If this proposal becomes law, the question then becomes whether the Internal Revenue Service would rely on estimates of market value for determining how much a billionaire owes or whether more scrutiny and more resources are required to accurately assess bond valuations.
But this proposal will have a much more muted effect for the municipal bond market than if Congress were to just raise taxes on individuals and corporations, which was included in the original reconciliation package.
“Municipal bond prices are most sensitive to the top income tax rates,” Steven Rosenthal, senior fellow at the Urban-Brookings Tax Policy Center said.
Maintaining those top income tax rates as Congress appears to be doing, is “probably harmful, as the municipal bond market would probably prefer our tax rates to increase so that municipal bonds would be a more attractive investment,” Rosenthal said.
Following the failed proposals for raising the individual tax rate as a means of paying for these large investments in infrastructure, Democrats are hoping that taxing the richest 700 Americans will gain enough support from Sen. Joe Manchin D-W. Va.. and Sen. Kyrsten Sinema D-Ariz., to get the reconciliation package over the finish line. The two conservative Democrats are key holdouts against spending desired by more liberal members of the Senate.
But part leaders are trying to be careful about how they’re presenting the plan. Over the weekend, House Speaker Nancy Pelosi mentioned that they will probably “have a wealth tax” and yet Secretary of the Treasury Janet Yellen, in discussing the provision over the weekend, denied that it was such a tax.
“I wouldn't call that a wealth tax, but it would help get at capital gains, which are an extraordinarily large part of the incomes of the wealthiest individuals and right now, escape taxation until they're realized and often they're unrealized in the death benefit from a so called Step-Up basis,” Yellen said.
Senate Finance Committee Chairman Ron Wyden, D-Ore., as part of the announcement, focused his comments on the divide in tax obligations between working people and billionaires.
But there are great risks, especially for the municipal bond industry, if this proposal doesn’t do what it says it can.
“We can debate it in principle for a long time but if it doesn't satisfy the dollar figures, they might look at other things they might cut out of the legislation,” said Emily Brock, director of the Government Finance Officers Association’s Federal Liaison Center.
If it doesn’t, then the municipal bond market’s priorities in the bill - a direct pay bond program, restoration of tax-exempt advance refundings and the expansion of bank-qualified debt - may be under increased pressure to be cut from the legislation.
“We're in serious risk of getting cut,” Brock said. “Serious.”
