Mark Zuckerberg and Tax Policy

By James Kwak

Some people have been claiming that Marc Zuckerberg is subject to a high tax rate, with Robert Frank even claiming,

“Mr. Zuckerberg’s tax bill will also provide an important counter-point to the notion that the rich pay lower tax rates than the rest of America. That may be true for professional investors and private-equity chiefs, but not for dot-commers and many entrepreneurs.”

I’m surprised that Robert Frank, whose column “looks at the culture and economy of the wealthy,” made this mistake, assuming it’s an honest mistake. He’s right about the specific transaction. Zuckerberg is exercising 120 million options with a strike price of 6 cents. Those are non-qualified options (not ISOs, for which the tax treatment is different), so the paper gain is taxable as ordinary income (35 percent) at the moment of exercise.

But Zuckerberg also owns more than 400 million shares free and clear already. Those are probably shares that he bought for a token amount on the day that Facebook incorporated. Zuckerberg’s primary contribution to Facebook has been labor, not capital: the man had an idea, and he worked at it for years. But as a company founder, most of his compensation has taken the form of capital gains (appreciation of his founder stock). If he ever sells that stock, he will pay tax at the capital gains rate, which is currently 15 percent, not 35 percent.

In short, the only reason Zuckerberg is paying 35 percent on his option exercise is that he got more options in 2005, after getting founder stock worth $20 billion today. If he hadn’t gotten those options, he would be paying tax at a 15 percent rate. So yes, Mark Zuckerberg does pay taxes at a lower rate than most Americans.*

In the Times, David Miller tells the real story. It’s likely that Zuckerberg will never sell any of his stock; even if he does sell, we can be sure he’ll only sell a tiny fraction of it. (If he does sell, he will be sure to sell some of the 120 million shares from his option exercise, since those will have a cost basis equal to the market value on the date of exercise. Since that would net him several billion dollars, it’s hard to imagine why he would ever sell any of his founder stock.)

Instead, other people will inherit it, and no one will ever pay tax on the appreciation during his lifetime. Or he’ll donate it to charity, and no one will ever pay tax on any appreciation, ever. (But he’ll be able to take a tax deduction for the full value of the stock on the date of donation, even though he won’t have paid tax on that stock.)

Miller suggests that we switch to mark-to-market taxation, so we pay tax on the appreciation of our assets each year. There are various technical problems with mark-to-market taxation, but he gets around them by limiting his proposal to the super-rich and to  publicly traded securities, which would be easy to liquidate in order to pay the new annual tax. It sounds like a good idea to me. Another possibility would be to eliminate step-up of basis at death, which allows the very wealthy to escape tax by passing assets on to their heirs.

Sure, Mark Zuckerberg is warmer and more cuddly than Mitt Romney or John Paulson. But let’s not make him out to be a martyr to the Internal Revenue Code. All rich Americans get gifts from the tax code.

* And speaking as another entrepreneur, albeit a much less successful one, I can say that we do just fine by the current tax code.

15 responses to “Mark Zuckerberg and Tax Policy

  1. Umm % is nice and all. But that I checked the IRS collects dollars not %. Please reconsider this also when someone lies and says Buffets secty pays more taxes that Buffet. Same for Zuckerberg.

  2. At what point does percentage matter? If he pays 2x total taxes on 100x your income, does that matter? I’ve heard your talking point before. You’re talking about the media. We’re talking about policy.

  3. Wait. So is the new conservative talking point that a flat tax (everyone pays the same percentage) is unfair to the rich, and instead we should have a head tax (everyone pays the same dollars)?

  4. Miller’s idea goes against a very basic accounting idea – you need an actual transaction to take place and income or loss to be realized before it’s taxed. His idea of hitting the “super rich,” whatever that might mean, is absurdly subjective, and I don’t think you’ve thought through what it would do to the public equity markets (vaporize them). Sounds like a super idea.

  5. “Miller suggests that we switch to mark-to-market taxation, so we pay tax on the appreciation of our assets each year. There are various technical problems with mark-to-market taxation, but he gets around them by limiting his proposal to the super-rich and to publicly traded securities, which would be easy to liquidate in order to pay the new annual tax. It sounds like a good idea to me. Another possibility would be to eliminate step-up of basis at death, which allows the very wealthy to escape tax by passing assets on to their heirs.”

    Well done. You’ve just destroyed the chance of there being any more Facebooks, Apples, Microsofts or Googles in the USA ever again. Talk about cutting off your nose to spite your face………………….

  6. A head tax is precisely where conservative thinking on taxes leads. You are catching on, James.

  7. A head tax, being the most regressive of all, is precisely where the conservative thinking, if you can truly call it that, leads.

    From their perspective, it’s the “fairest” tax of all.

  8. I didn’t know about the step-up of cost basis at death. What sort of estate tax is due when such assets are passed on to heirs? Does anyone know?

  9. @Anonymous: mark-to-market accounting is quite well established. If there’s an easy way to establish an objective price, and I would hope you agree in the case of most exchange traded products, then you can tax that as income without terribly much difficulty. Your assumption that all accounting is transaction based is wrong.

  10. Oh!!! Mr. Kwak, you were so close!!! So close….. The REAL conservative talking point is use tax rates that largely benefit the wealthy, use every tax loophole snuck into the tax code by lobbyists representing the wealthy to pay a 13.9% federal tax rate,
    See here: http://www.latimes.com/news/politics/la-pn-romney-releases-tax-returns-20120124,0,4945167.story
    Then open up 11 funds/partnerships located in foreign countries such as Luxembourg, the Cayman Islands, and Bermuda to escape more taxes: http://www.latimes.com/news/politics/la-pn-romney-swiss-bank-account-disclosure-form-20120203,0,3745673.story

    Then whine about how “big government” is “stifling” you— “And F*CK EVERYONE ELSE!!!!”

    But your explanation of the new conservative talking point was in the ballpark Mr. Kwak…. it was in the ballpark.

  11. I am surprised that all these pundits did not see the most likely reason why Mark Zuckerberg decided to exercise his options, even if it means paying higher taxes. It wasn’t altruistic or anything, just logical.

    Every option grant has a TERM, at the end of which the options expire worthless. Most grants with start-ups have a 10 year term. So, if the grant took place in 2005, he is already 70% down the road. Why take a risk with the value of these options ( $5B Billion!!) in case by 2015 they are worth substantially less ??

    Regardless, judging by his intentions of selling some founder stock to offset his taxes of about $2B , it is pretty clear that he wants to net ( in his pocket) $5B with new investors’ money without having to worry about another dot.com.bomb like in 2001.

    That being so, it’s hard to blame him for the opportunity to be super-rich on the back of dreamy investors who have valued this company (with a lot of help from fee-hungry investment bankers) to $100 Billion. Dreams always come to an end — it is called disillusion

    C’est la vie… like the French say.

  12. “Zuckerberg’s primary contribution to Facebook has been labor, not capital: the man had an idea, and he worked at it for years.”

    IMO, the key factor shouldn’t be labor vs capital, but rather, the question of risk-taking. An employee, or even a contractor exchanges labor for income without any risk-taking. They’re not acting in an entrepreneurial way and don’t need the incentive of the lower tax on profits from risk-taking that we offer entrepreneurs. Zuckerberg’s investment of labor is more like a capital investment because he’s not exchanging labor for income, he’s taking huge risks in building a business.

    The real injustice in this area of taxation are the carried interest rules that allow hedge fund managers to convert their labor, without any risk-taking at all, into a capital gain.

    IMO, the distinction shouldn’t be capital vs labor, but rather the extent of risk-taking on the part of the investor/entrepreneur/laborer. Interestingly, the tax code doesn’t entirely agree with me. Except for business owners, and even here there are reasonable compensation rules, if someone gets paid in stock they usually have to value the stock and count it as income, even when the future prospects of the company are highly in doubt an in fact they are investing with their labor.

  13. I hear the arguments on both sides and the truth is that they all have some merit.

    Capital owners should pay a decent amount of taxes, IMO, for various reasons.

    Also, capital ownership should absolutely not be allowed to pass into the next generation’s hands without enormous penalties. That is the main issue here. Passing capital across the generations is the kind of thing that solidifies aristocracies and diminishes social mobility by empowering people through birthright.

    I am fine keeping a 15% capital gains rate without mark-to-market as long as we have a punitive 60-70% estate tax OR the option of donating 60-70% of the assets to qualified charities.

    This should be a nation where people succeed or fail on their own merit. There is nothing meritocratic about a society in which entire dynasties are funded by the success of one person.

  14. Magellan seems to think laboring to keep your family from starving is only mild risk-taking, while betting 2% of your fortune on the price of a stock that has mostly gone up over a few decades is taking big risks. Try again for a concept that works. Let’s see, how about income is income? That’s very easy to understand, and it cuts 10 billion pages out of the tax code.

  15. I can give you a lot of reasons why he would sell his founder stock. Supercalc, Lotus 123, Symphony, Ami, CPM, MPM, Charter, …
    Hair today, gone tomorrow.