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I've fallen behind on regular blog posts and this one will be longer than usual. It is on the California Prop 40 proposal for the 2026 Billionaire Tax Act. I'm not taking a position on it here, but raising some policy considerations about this proposal that calls for a one time tax to address funding shortfalls in California primarily for health care.
I'm looking forward to participating in an "anti-debate" on this proposal with Jenny Stefanotti and Professor Brian Galle on Tuesday October 27 in the evening at The Commons in San Francisco - click here for info. And thanks to Stephanie Lepp for the anti-debate concept.
Here goes on some background and thoughts on ways to understand and evaluate this tax proposal ...
First, no doubt California and other
states face budget challenges due to cutbacks in federal funds for health care.
No doubt, existing tax systems were not designed with billionaire level wealth
in mind that can enable the very wealthy to have moderate income levels, borrow
against their wealth for living expenses and pay a small percentage of their
wealth in annual taxes. Thus, in recent years in the US and other countries,
some attention has been given to various forms of wealth taxation.
The proposed tax base on the 2026
Billionaire Tax is different relative to other taxes. It is not an income tax
based on annual earnings less some deductions, it is not a sales tax based on what
you pay for goods, it is not an excise tax based on what a seller or
manufacturer charges for something, it is not a property tax measured by the value
of property (ignoring any debt). Instead, it is a one-time “excise tax imposed
for tax year 2026 on the activity of sustaining excessive accumulations
of wealth by applicable individuals with net worth of one billion dollars
($1,000,000,000) or more, and on applicable trusts.” [Secretary of
State info] The proposed new tax is measured at the valuation date
(12/31/26) and imposed on individuals and trusts at the tax obligation date
(1/1/26).
Funds generated are primarily for health care spending (90%) and food assistance and education (10%) + funds needed for FTB to administer this complex new tax. The tax dollars go into a special fund rather than the general rund.
Chapter 2 of the Act defines “net
worth” and how to measure it and is the longest part of the Act with special rules
for the effect of debt, what is not included such as real property, valuation
methods which is particularly relevant for assessing hard to value items such
as a non-publicly traded company, certain exemptions such as for up to $5
million of “other assets” including art and collectibles, FMV can’t be less
than insured value, exclusion for tangible personal property located outside California
for at least 270 days during 2026 unless it was relocated temporarily with a
substantial purpose of avoiding the tax. Consider the work needed by billionaires,
their tax advisers and the FTB to figure out whether tangible personal property
moved outside of CA in 2025 or 2026 was relocated to avoid the new tax. How
would a property settlement of a billionaire who divorces in 2026 with the
spouse taking personal property outside of CA be treated?
Some observations:
·
The
text of Prop 40 refers to “federal” 42 times usually in the context of federal spending
cuts, to explain why California needs a one-time tax on certain taxpayers and uses
term a few times to not that billionaires pay in little in taxes in relation to
their wealth. For example:
o
First
reference: “The cascading impacts of looming federal funding cuts for health
care, education, and food programs now threaten these foundations and place the
welfare of all Californians at risk.”
o
Medi-Cal
expected to lose up to $19 billion of annual federal funds.
o
“In
addition, current federal budget proposals for 2026 would impose deep cuts on
overall funding to public schools, particularly for high-need students, rural
schools, and disadvantaged communities.”
o
Federal
cuts to SNAP.
·
Why
try to fix a federal issue with one-time state funds and with a proposal likely
to get litigated and possibly found unconstitutional (issues of effective date,
retroactivity (possibly similar to federal gift tax and pre-Public Law gifts in
Untermyer v Anderson (276 US 440 (1928)))?
·
Why
not try to fix the federal funding issue with a federal solution? There are
numerous federal tax changes that could restore the funding. To name just a few:
o
Increase
the §4501 stock buyback excise tax from 1% to 5% or more. Given current stock buyback
levels, the higher rate seems supportable (for example, among many large
buybacks announced, see Nvidia’s $150 billion announced
9/28/26).
o
Tax
carried interests as ordinary income.
o
Repeal
the step-up in basis at date of death for individuals with over $5 million of
assets at date of death.
o
Limit
the tax break for itemized deductions to 28% rather than the current 35%.
·
A
new tax sends a signal that the state’s existing taxes are perfect when they
are not. There are lots of “holes” in California’s tax system and they
primarily benefit high income/high wealth individuals. For example, California
doesn’t impose sales tax on household utilities. They should be with an
exemption for average utilities on a 1500 square foot home. Why is the cost of
heating and air conditioning a 4000 square foot or greater size home considered
a “necessity of life” so not subject to sales tax? Also, some of the federal changes
listed above can be enacted in California whether or not enacted at the federal
level.
·
If
Prop 40 gets enough votes to become law, and works as sponsors and authors
desire …
o
It
may send message to Congress – cut California funding some more.
o
Many
of the roughly 200 billionaires subject to the tax would likely need to sell part
of their stock or other assets to pay the new California tax even though they
can pay it over 5 years with a 7.5% annual charge. The federal tax they pay on
the gains will be shared with all states. Why not find a way to keep all or
most of this wealth in CA? I think there are ways – more on that at a later
time.
·
Marriage
penalty – it is not unusual for a tax to have this. The 2026 Billionaire Tax
Act applies the same $1 billion net worth threshold whether married or single.
o
Query:
Any issue of a California couple with only $1.9 billion of net worth divorcing
on 12/31/26?
·
Taxes
can change behavior. For example, if there is a large tax credit for buying an
electric vehicle, someone might now opt to buy an EV over a non-EV. Cigarette
excise taxes are designed to discourage young people from buying them. The
billionaire tax might dissuade some people from moving to or staying in California
or expanding their business operations in California. The tax could have a
negative impact on job growth in California.
· What will be proposed the next time the feds cut state funding? What if the billionaire tax is not enough to cover California’s budget issues? A one-time tax can generate a lot of revenue but funding issues are usually not one-time.
· A few more points to ponder: The new tax will tax wealth not located in California such as intangible property. Of course,
intangible property really isn’t located anywhere so why not tax it where the owner
is. But if that property is subject to legal restrictions in another country
perhaps it should not be treated as California property.
· If someone moves to CA on January 2, 2026 or later,
they are not subject to tax because the tax incidence date is 1/1/26. But if a person
was in California on 1/1/26 and only becomes a billionaire afterwards, then on
12/31/26 (valuation date) they are subject to the California 2026 billionaire tax.
o What if an individual was in California on 1/1/26 and left
on 10/1/26 but became a billionaire in December 2026? Seems they would be
subject to the tax.
· There are details to track down such as:
o
Tangible personal
property that left state for tax purposes.
o Is insured value greater than FMV on 12/31?
There is a lot to consider as the proposal has several definitions and special rules, valuation is not an exact science, legal issues including location of assets and effective date exist.
What do you think?
