A Progressive System of Mark-to-Market Taxation

1. A Progressive System of Mark-to-Market Taxation President’s Advisory Panel on Federal Tax ReformMay 11, 2005 David S. Miller

2. Description of the Proposal • The following taxpayers would pay tax each year on any appreciation in the value of their publicly-traded property and derivatives: • All public companies • Private companies with $50 million or more of net assets • Individuals and married couples with $1.6 million of adjusted gross income or $5 million of publicly-traded property • Represents the 0.1% highest income and 0.1% wealthiest households • These taxpayers would “mark” their publicly-traded property to “market” values (i.e., treat them as sold and immediately repurchased). • All other taxpayers would remain on the current “realization system.”

3. Description of the Proposal • Corporations: • Mark-to-market gains taxed at current 35% rate. • Mark-to-market losses fully deductible. • Individuals: • Mark-to-market gains (and qualified dividends) taxed at 15% long-term capital gains rate. • Interest and other ordinary income taxed at current 35% rate. • Mark-to-market losses: • Fully deductible against prior mark-to-market gains, current qualified dividends, and current capital gains • May offset 43% (15% divided by 35%) of ordinary income • May be carried forward indefinitely.

4. Description of the Proposal • Significant additional revenue without raising rates or imposing new taxes. • If in place in 2004, the Google IPO alone would have generated over $2.2 billion of additional revenue. • The revenue generated by mark-to-market taxation would be used to: • Repeal the alternative minimum tax • Eliminate all tax on investment income for low-income taxpayers or expand 401(k)s for all Americans.

5. Benefits of the Proposal — Simplification • Eliminates the alternative minimum tax. • Eliminates tax planning and a number of anti-abuse rules for mark-to-market taxpayers. • “Straddle,” “short sale,” “wash sale,” “constructive ownership” and “constructive sale” rules, and capital loss limitations unnecessary for mark-to-market positions.

6. Benefits of the Proposal — Closes Loopholes and Eliminates Shelters • Renders a number of the most prominent tax shelters impotent. • For example, “tax loss generators” are impossible under a mark-to-market system. • Tax losses arise only if the taxpayer’s securities in fact decline in value.

7. Benefits of the Proposal — Progressivity • Uses the “incidence” of tax to achieve progressivity. • Public and large private corporations, and top 0.1% wealthiest households subject to mark-to-market taxation on publicly-traded property and derivatives. • The tax burden is increased for these taxpayers. • Other corporations and most individuals remain on realization. • The tax burden remains the same for these taxpayers.

8. Benefits of the Proposal — Fairness • Ensures that large and wealthy investors taxed similarly to wage earners. • Wage earners cannot avoid tax on the wages they receive. • Large investors can avoid virtually all tax on their appreciated securities by hedging their risk with derivatives and monetizing their positions by borrowing against their hedged securities indefinitely. • If estate tax is repealed, appreciation will never be taxed. • Proposal eliminates this “loophole” and prevents deferral of tax for large investors.

9. Benefits of the Proposal — Eliminates Inefficiencies and Enhances Liquidity in the Capital Markets • Eliminates the “lock-in effect” • Current law artificially discourages taxpayers from selling their appreciated securities • Eliminates the “lock-out effect” • Current law artificially discourages taxpayers that sell their depreciated securities at a loss from repurchasing them within 30 days. • Properly taxes complex financial instruments • Derivatives cannot be used to minimize tax under a mark-to-market system.

10. Benefits of the Proposal — Encourages Work Effort, Savings and Investment • Permits middle-income Americans to retain more of their wages by eliminating the alternative minimum tax. • Encourages savings by eliminating all tax on the investments of low-income taxpayers or expanding the scope of 401(k) plans. • Complements the President’s “progressive indexing” proposal for Social Security: • Enhances retirement savings for low-income taxpayers.

11. Benefits of the Proposal — Book/Tax Conformity • U.S. corporations are required to mark-to-market their securities and derivatives under GAAP. • Proposal taxes these corporations on the earnings they report to their shareholders. • The United Kingdom already requires taxpayers to pay tax on the securities and derivatives they mark-to-market under GAAP.

12. Summary A progressive system of mark-to-market taxation achieves all of the President’s tax reform objectives: • Simplifies. • Enhances progressivity. • Eliminates alternative minimum tax. • Retains home mortgage interest and charitable donation deductions. • Closes loopholes and eliminates tax shelters. • Encourages saving and investment. • Revenue neutral. • Does not raise rates, deny deductions, or impose new taxes.