TW/CW: meansphobia, landphobia
Background
Whenever the topic of the tax burden currently falling on billionaires comes up, the immediate instinct of people is to go "umm, sweetie, actually did you know the rich can avoid taxes by taking up loans, using their stocks as collateral, and perpetually rolling them over"—the so-called "buy, borrow, die" method, apparently unpatched by US tax law. (Maybe this supposed commonness is just warped perception, but I've definitely internalized it—before people cancel me, I've already apologized to the PoM and PoL I've harmed, although I know that is not enough✊. Capital Forever!) So blatant an injustice is apparently committed by such an accounting trick that redditors have begun defending taxing collateral as a realized gain (how would mortgages work? lmao), among other nonsense. Below, I propose a simple solution. (Much simpler than what weird succish think tanks can propose).
Also, Stiglitz has a paper on this (and related accounting tricks). But even a Nobel prize winning succ is still a succ, so whatever.
Problems with the strategy
One extremely obvious problem is tail risk. If you realize your gains, and put them into safe bonds, you will have a lot more liquidity and a lot less risk. But for those who adopt the "buy, borrow, die" strategy, if things go awry (exposure to bad tail risk), it often becomes a "buy, borrow, pray" (as the Financial Times put it): their collateral is exposed to the same risks as their overall financial health. So, simply realizing your gains mitigates tail risk, and is therefore (often) advantageous.
Furthermore, this effect leads to a high(er) interest rate under the "buy, borrow, die" strategy. Indeed, if the situation at which you are most likely to default is when your stocks (put up as collateral) have a low value, potential debtors will ask for a higher interest rate R than if you had a less risky (or, at least, something less correlated with you being in a bad financial situation) asset as collateral. This higher interest rate R will become relevant later on.
The law surrounding estate tax, and a simple solution
My solution: abolish the step-up basis. If you don't know what that is (to the succs: take accounting), read about that before proceeding. (Note: I am not a lawyer. If you are a lawyer, and I am wrong about something, please don't correct me. I don't want to be embarrassed. Thanks!)
The "buy, borrow, die" method merely postpones payment of taxes after the step-up basis has been abolished. Indeed, suppose you die (morbid, isn't it?). Your estate must pay off all outstanding debts. And so when you've taken out loans, your estate has to find a way to pay them. That includes realizing gains by selling your former assets (and not at the stepped-up basis, but as if you were actually alive and were the executor this whole time). Furthermore, the government gains more capital gains under the "buy, borrow, die" strat than they otherwise would have (in terms of net present value): to make up (money received by you from the debt holder) times (1+R)^(time of death minus time of buying your stocks), the executor has to sell off more stock (realizing more capital gains) than if they had to make up (money received by you from the debt holder) * (1 + risk free rate)^(time of death minus time of buying your stocks). (Note: I assume here that debt is structured as a zero-coupon bond. Something something Modigliani-Miller theorem.)
In the current system, such a sell-off doesn't incur much capital gains, since the capital gains only applies to the following:
(number sold) times ((stock price at time of sale by the executor) minus (stock price at time of your death))
This number is probably small (the time between the date of sale by the executor and time of death will be relatively small compared to a whole lifetime). But under the reformed system, without a stepped-up basis, the change in stock price would be measured relative to the time of purchase, not date of death.
Some final ruminations on the estate tax
The RINO ping has told me to stop encouraging an increase in the death tax. Whoops. Also, apparently, "just tax death lmao" works.
Posted by BorelMeasure