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

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A Progressive System of Mark-to-Market Taxation

President’s Advisory Panel on Federal Tax ReformMay 11, 2005 David S. Miller


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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.”


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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.


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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.


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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.


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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.


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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.


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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.


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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.


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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.


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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.


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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.


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