Will Slumping Stocks Doom Mark-To-Market Tax Reforms?

There’s nothing like watching an actual expert school a snarky columnist on Twitter.

It happened last week when Samuel D. Brunson, a law professor at Loyola University Chicago, explained some basic income tax to Matthew Yglesias, a smart, policy-forward writer with a long-standing interest in tax — but a weakness for half-baked proposals and snide commentary.

The exchange began with a sardonic observation from Yglesias, whose Twitter feed has grown ever more snarky in recent years: “The fad for articles that treat unrealized capital gains as equivalent to personal income has largely evaporated now that the stock market is down, since it obviously makes no sense to say that Jeff Bezos has a lower income than a guy who drives an Amazon
AMZN
van.”

Some of what Yglesias seems to be saying in this tweet is defensible. But to the extent that he treats mark-to-market tax proposals as faddish and misconceived, he’s wrong. And Brunson minced no words in saying so: “This is dumb on so many counts.”

I’ve written about Yglesias a few times over the years, and he deserves to be taken seriously. He has reasonable policy chops for a mainstream columnist, having cut his teeth writing data-heavy articles at The American Prospect, The Atlantic, Slate, and Vox. At each of these publications, he made a name for himself by taking ideas and policy seriously.

Yglesias now publishes independently — and very successfully — on Substack, where he has continued to make thoughtful, progressive, but increasingly centrist arguments about a range of policy issues, including tax.

Yglesias has always shown a special interest in tax policy, offering consistent support for progressive revenue reforms. He has been a vocal critic of Republican tax policies, including the 2017 tax cuts; no surprise for someone who got his start working at left-leaning publications and think tanks.

But Yglesias has also displayed a heterodox streak from time to time, pushing back on various liberal orthodoxies around tax; in 2013, for instance, he counseled progressives to “just give up” on the corporate income tax.

Replace it, he suggested, with levies less vulnerable to sophisticated avoidance strategies — something like a cap-free Social Security payroll tax, for instance.

Now to be clear, Yglesias traffics in a lot of half-developed ideas. Like that plan for abandoning the corporate income tax: He didn’t waste any ink on the wreckage that might be left behind, including the levy’s lost role as a backstop for the individual income tax. Despite having once co-hosted a podcast called The Weeds, Yglesias is not always interested in hacking his way through the underbrush.

To be fair, that’s a forgivable sin. Some superficiality is unavoidable for someone like Yglesias, blessed with a large but nonspecialized readership. Spend too much time sorting through details and you risk losing your audience to writers making fewer demands on their readers’ patience.

Plus, no columnist can hope to master the substance of every policy domain, especially when many (including tax) are deeply technical. Ultimately, even the wonkiest columnist is a “jack of all trades, master of none.” I think it’s in the job description.

But still, a casual disregard for actual expertise is not one of the qualities you want in a thoughtful policy blogger. And sometimes, the rush to be pithy, timely, and provocative can lead Yglesias to shoot first and think carefully later.

In his takedown, Brunson made much the same point. “As best I can tell, not doing the research is a critical qualification of being a pundit,” Brunson tweeted. “Actual knowledge isn’t the important thing — speaking out of turn is.”

Getting Policy Wrong

Let’s return to the point Yglesias was trying to make about unrealized income. His phrasing and word choice suggested that mark-to-market proposals are somehow unserious, their popularity simply a “fad” spurred on by excitable progressives.

Brunson challenged the suggestion that mark-to-market proposals (including, presumably, those offered up in recent months by Senate Finance Committee Chair Ron Wyden, D-Ore., and President Biden, among others) were faddish, misconceived, or even particularly novel. Indeed, the fundamental notion of taxing unrealized gains is as old as the modern income tax itself.

“Unrealized gains are income under the Haig-Simons definition of income,” Brunson responded, invoking the gold standard of income definitions.

Brunson added that that definition dates to the 1920s, or even earlier if we broaden our gaze to include German tax experts. “So if it’s a fad, it’s longer-lived than even Pokémon (which itself is pretty long-lived),” Brunson added with his own dose of Twitter snark.

Brunson objected to the idea that champions of mark-to-market taxation were somehow chastened by a late-breaking realization that stock losses might reduce the tax liabilities of wealthy investors.

“That a mark-to-market system allows deduction for losses when an asset’s value falls isn’t a bug of the system, and isn’t something advocates were unaware of. WE KNOW THAT’S WHAT HAPPENS,” he explained. (Emphasis in original.)

Yglesias richly deserved this schooling in the basics of income taxation, especially because he lays claim to (columnist-level) expertise in the subject.

Getting Politics Right

Now, though, having established what Yglesias got wrong, we should pause to consider what he also got right. He’s correct, broadly speaking, about the political effects of a falling stock market on some elements of tax policy — and specifically on the treatment of capital losses.

As Brunson points out, loss deductions are a feature, not a bug, of mark-to-market tax schemes. But that’s true only if we constrain our view to theory. If we try to incorporate politics into our view of tax policymaking, the treatment of losses gets a little buglike. Maybe a lot. Case in point: the Great Depression.

The stock market crash and its political aftermath prompted the adoption of strict new limits on loss deductions. Not so much because those limits were good policy, but because they were good politics in the context of 1930s America.

In the spring of 1933, the Senate Banking Committee conducted a famous series of hearings on the causes of the Great Crash, headlined by the panel’s theatrical chief counsel, Ferdinand Pecora. Tax policy was a relatively small part of that overall investigation, but it garnered outsize headlines — especially when committee investigators discovered that many of Wall Street’s most famous investors hadn’t paid income taxes during the early, darkest days of the Great Depression.

“Morgan Paid No Income Tax for 1931 or 1932,” announced The New York Times
NYT
on May 24, 1933. It was a bombshell — and not the last. Over a series of days, similar revelations confirmed that capital loss deductions had left many Wall Street titans with no income tax liability, often for several years running.

Outrage surged through official Washington and the nation’s editorial pages. “A cry of anguish ascended to high heavens, when millions of white collar workers discovered that they had been nicked for a considerable percentage of their earnings for 1930 and 1931 when J.P. Morgan and partners had paid no income tax at all,” observed Business Week.

The Washington Dai

DAI
ly News shared in the popular outrage: “Rich men of the country should not be able to escape income taxes at the very moment when the rest of the country is burdened with increased taxes and when the Government is so desperately in need of revenue.”

Called to testify on the state of his tax liabilities, J.P. Morgan Jr. initially claimed ignorance of his own tax affairs, only later acknowledging that he had paid nothing for the two years in question. Neither, for that matter, did any of his partners at J.P. Morgan & Co., owing to the firm’s dramatic losses in the market crash.

But Morgan was unrepentant, insisting that the losses were real and the absence of tax liability entirely justified. “I am not responsible for these figures,” he insisted dryly to the Banking Committee’s skeptical members. “I viewed them with great regret when they appeared.”

Congress eventually responded to the Morgan revelations by substantially limiting deductions for stock market losses. Progressive lawmakers and liberal editorial writers hailed these limitations, viewing them as a triumph for economic justice and tax fairness.

Tax experts, by contrast, considered many of the new loss limitations grossly inequitable. Even liberal experts working in Franklin D. Roosevelt’s Treasury Department were appalled by the effort to curb legitimate losses. As one expert wrote to Treasury Secretary Henry Morgenthau Jr.:

“Numerous provisions passed by Congress at the last and previous sessions so distort the income tax and so bring in question its fairness that they cannot be approved even if they do raise some revenues. Among such inequitable provisions are several of the limitations on deduction of losses. In fact the tendency of Congress with respect to the 1934 Act appeared to be to resolve all doubtful cases against the taxpayer and in favor of more revenue for the government. This makes for a spirit of general opposition to an unfair Government, a spirit that renders administration very difficult if it is bitter and widespread.”

The “lesson” of this historical snapshot is clear: Falling stock markets can be dangerous to any tax law that allows for large loss deductions. That’s something that mark-to-market champions should probably keep in mind.

And to be fair, many of them do; not every modern mark-to-market proposal would necessarily open the floodgates entirely. As Greg Leiserson and Will McGrew observed in a 2019 piece for the Washington Center for Equitable Growth, capital gains are a volatile source of income. “Thus, the treatment of losses under a mark-to-market system can be important,” they offered in a moment of true understatement.

However the deductibility of losses might be structured, it’s almost certain to encounter impressive political headwinds from progressive forces eager to limit those deductions even further. There will always be another Pecora to stoke the fires of outrage.

But if those deduction limits are severe, as they were in 1934, we may find ourselves revisiting the “spirit of general opposition to an unfair Government” that so worried New Deal tax experts. Unless, of course, we are facing that spirit already.