SouthernWorldwide.com – A tax strategy colloquially known as “buy, borrow, die” has become a focal point in the discussion surrounding wealth disparity. This is following California Governor Gavin Newsom’s recent call for lawmakers to close what he terms a loophole benefiting the extremely wealthy.
The strategy’s name reflects a three-step process aimed at minimizing tax obligations. Wealthy individuals first acquire assets expected to appreciate, such as stocks, real estate, or art. They then leverage these assets as collateral to secure loans, which are used to finance their lifestyles. This allows them to avoid selling assets, a transaction that would typically trigger income taxes.
Finally, upon the owner’s death, these assets are transferred to their heirs. This transfer benefits from a “stepped-up tax basis.” Because the borrowed funds are not classified as taxable income, borrowers can utilize the loan proceeds without incurring capital gains taxes.
The “step-up in tax basis” at death provides an additional tax advantage. Heirs generally receive these assets valued at their market price on the date of the owner’s demise. This effectively eliminates any capital gains taxes on the asset’s appreciation throughout the owner’s lifetime.
Notable figures who have reportedly utilized this loophole include Tesla CEO Elon Musk, who recently achieved the status of the world’s first trillionaire following the initial stock offering of SpaceX. Cable magnate John Malone has also been cited as a user of this strategy, according to reports from The Wall Street Journal.
In a June 26 post on Substack, Newsom characterized the approach as a “tax-free lifestyle loan” exclusively accessible to the wealthiest Americans. He urged Congress to take action to close this loophole.
“The affluent possess their own distinct tax code, replete with exemptions and loopholes that remain largely unknown to the general public. They are relying on Washington politicians to preserve this system and maintain silence,” Newsom articulated in his Substack post.
However, an analysis conducted by the nonpartisan Tax Policy Center has suggested that this strategy is not as widely employed by the nation’s wealthiest families as often portrayed. Their research, which examined the annual borrowing patterns of the top 1% of U.S. households by net worth over two decades, indicated that this strategy accounted for only 1% to 2% of their economic income.
Adam Michel, director of tax policy studies at the nonpartisan Cato Institute, commented to CBS News, “The narrative that billionaires exploit ‘buy-borrow-die’ more than anyone else is not strongly supported by evidence. The super-rich typically spend less than their taxable income, meaning they have less need to borrow against their gains.”
He further elaborated that, consequently, this method of tax avoidance represents a “limited problem.”
How the Rich Build Their Fortunes
The observation that the “buy, borrow, die” strategy is not extensively utilized suggests that the wealthy are not heavily borrowing against their assets, according to Edward Fox, a law professor at the University of Michigan, and Zachary Liscow, a law professor at Yale. They co-authored a Tax Policy Center analysis on June 15 detailing these findings.
Instead, the ultra-wealthy tend to retain their assets. This allows for the compounding of unrealized gains on stocks, bonds, and other investments over many years without incurring taxes. The U.S. tax system defers capital gains taxation until an asset is actually sold.
By holding onto their investments, individuals can continue to grow their wealth while postponing tax liabilities, thereby accelerating their financial growth over time. This strategy capitalizes on the power of compounding returns without immediate tax implications.
“Therefore, the predominant tax strategy of the super-rich is not some elaborate scheme of borrowing against stocks,” Fox and Liscow stated. “Rather, they save a substantial portion of their liquid, taxable income, while the unrealized gains on their assets grow untaxed.”
The wealth of the nation’s richest individuals is indeed on the rise. As of September, the collective net worth of the country’s 905 billionaires reached $7.8 trillion. This represents an increase of over 25% compared to the previous year, according to data from the progressive think tank Institute for Policy Studies.
Given this escalating wealth concentration among the nation’s wealthiest individuals, some lawmakers are advocating for new tax measures targeting unrealized gains. For instance, a proposed tax in California would impose a 5% tax on the value of billionaires’ stocks and other holdings. This would effectively tax all their assets, including those they possess but have not yet sold.
Other states are opting to implement new income taxes on their wealthiest residents rather than taxing assets directly. For example, a law enacted in Massachusetts in 2023 imposes a 4% tax on individuals earning over $1 million annually. Similarly, Washington state introduced a new tax on income exceeding that threshold earlier this year.
Calling for a Federal Billionaire’s Tax
Governor Newsom expressed concerns that a state-level tax targeting billionaires might prompt California’s wealthiest residents to relocate to other states. He posited that a more effective approach would involve the implementation of a federal tax on the nation’s richest citizens.
“The foundational system established by America’s founders was designed to prevent the concentration of power in the hands of a select few. However, we have allowed this concentration to occur gradually, openly, and over many decades,” he wrote. “It is now time for a national tax on billionaires.”
Legislators have previously proposed such a tax, though any such measures would encounter significant hurdles in Congress. In March, Senator Elizabeth Warren, a Democrat representing Massachusetts, introduced a bill proposing an annual 2% tax on the net worth of households and trusts exceeding $50 million, with an additional 1% tax for billionaires.
To discourage the ultra-rich from expatriating to evade the proposed tax, Warren’s bill includes a provision for a 40% “exit tax” on individuals with a net worth exceeding $50 million who renounce their U.S. citizenship. This measure aims to mitigate potential tax avoidance through renunciation.
According to estimates from economists Emmanuel Saez and Gabriel Zucman of the University of California, Berkeley, Warren’s wealth tax has the potential to generate $6.2 trillion over the next decade. This projection highlights the significant revenue potential of such a policy.
However, the Tax Policy Center has indicated that imposing a tax on unrealized gains is likely to face legal challenges. Opponents argue that such a tax could be unconstitutional. Fox and Liscow suggest that a more straightforward alternative would be to increase existing tax rates.
“Increasing the ordinary and capital-gains tax rates for those top earners would generate substantial revenue without requiring Congress to devise a constitutionally contentious wealth tax or a mark-to-market system for illiquid assets,” they concluded.
