Are Wealth Taxes A Good Idea?

On the Pros and Cons of a Net Worth Tax

large luxury yacht
Photo: Pixabay

Imagine you are a participant in a large race.  However, unlike an ordinary race, this race never ends, participants come and go every day, and no one starts the race at the same spot.  This might seem like an odd kind of race to participate in, but you (like everyone else) don’t have a choice in the matter.

The “race” I am talking about is wealth accumulation in the United States.  In this race, you can think of your position (relative to others) as your current wealth and your speed as your current income.  Today, the United States is going through a period where a small group of racers is far ahead of everyone else (i.e. wealth inequality).

Historically, the U.S. has dealt with inequality by progressively taxing income.  Those with higher incomes are taxed at a higher rate than those with lower incomes.  Using the racing analogy, the IRS tries to slow down the fastest racers.  If you look at the share of total taxes paid versus the share of total income earned in 2018, you will see that the IRS is achieving this goal to some extent:

taxes paid versus income earned by income group for 2018

And when you include deductions and credits, the U.S. income tax system looks even more progressive:

tax rate versus income group including deductions and credits for 2017 and 2018

However, there is a new kind of thinking in town.  Rather than slowing down the fastest racers, the new thinking suggests that we should take those racers that are the furthest ahead of everyone else and pull them back in the race.  Enter the wealth tax.

The wealth tax has gotten lots of attention recently after Bernie Sanders came out with a policy proposal to “Tax Extreme Wealth.”  Like Senator Elizabeth Warren’s “Ultra-Millionaire Tax” plan, Bernie’s proposal would progressively tax larger fortunes at higher rates.  Bernie’s plan has the following marginal tax rates for married individuals (the brackets would be cut in half for single filers):

  • 1% on all wealth greater than $32 million
  • 2% on all wealth greater than $50 million
  • 3% on all wealth greater than $250 million
  • 4% on all wealth greater than $500 million
  • 5% on all wealth greater than $1 billion
  • 6% on all wealth greater than $2.5 billion
  • 7% on all wealth greater than $5 billion
  • 8% on all wealth greater than $10 billion

So, a couple with $32.5 million would have to pay an annual tax of $5,000 [($32.5 million – $32 million) * 1%] while a couple with $1 billion would have to pay close to $32 million annually.  Visually, the effective annual wealth tax due (for those households worth up to $1 billion) would look like this:

sanders effective annual wealth tax by net worth up to 1 billion

As we increase a household’s net worth up to $10 billion (the largest bracket mentioned in Bernie’s plan) the effective annual tax due would be:

sanders effective annual wealth tax by net worth up to 10 billion

As you can see, a wealth tax would raise a lot of money (in theory) and would raise it from those individuals that have seen the largest wealth gains in the last half century.  This is one of the benefits of a wealth tax over an income tax—it taxes those who already have wealth versus those who are currently trying to earn wealth.

For example, it’s easy for someone like Warren Buffett to say, “Raise my incomes taxes,” because he is already rich.  He has won the race and is essentially asking to slow down other participants from catching up to him.  However, a wealth tax changes the position of the players, which is far more effective and, dare I say, fair to those people who are trying to get rich now.

However, there remain three major issues I see with implementing a wealth tax: measurement, evasion, and efficacy.

What is it worth now?

My biggest issue with a wealth tax is how difficult it would be to accurately measure and assess a tax on someone’s net worth fairly and predictably.  For example, how do you value something with few comparable assets?  Or, what do you do when you owe wealth taxes on an asset that has decline significantly in value?

If someone owned WeWork when it was valued at $47 billion, would it be fair for them to pay $3.6 billion in taxes when WeWork is now valued at $10 billion?  And how do you value assets with extreme volatility?  For example, what is the value of Bitcoin for tax year 2017 in the year 2018?

Though Bernie’s proposal doesn’t perfectly answer these questions, it does provide the following guidance:

For assets that are difficult to appraise, the Treasury Department would have the option of allowing taxpayers to have appraisals done periodically instead of annually. The Treasury Department would establish the average rates of appreciation for several classes of assets. Those appraised only every few years would be assumed to appreciate in the intervening years at the average rate established for their designated class.

This is a good start, but this entire line of questioning illustrates the difficulty of wealth taxes—wealth is hard to measure.  While income is a knowable quantity, asset valuation is far more elusive.  If we want wealth taxes that work effectively, we will have to figure out a way to accurately answer the question, “What is it worth now?”

Why there are so “few” swimming pools in Greece

Let’s pretend that a wealth tax was passed in the United States.  What would happen next?  Would the ultra-wealthy just smile and pay the tax?  Of course not.

Overnight an army of tax lawyers and consultants would begin pouring over the new law looking for loopholes and other ways to save money for their clients.  Page after page would be dissected and analyzed until the impact of the new law was minimized.

And for those individuals where the tax burden was still too great, they might simply take their assets and leave the country.  Of course you can impose penalties for those that try to leave, but think about what message this sends to those considering bringing their assets to America from other countries?

Evasion is a central problem for taxation authorities across the globe.  As Josh Brown recently pointed out, “Only 324 people in Athens paid the “swimming pool tax” in 2010. There were 16,974 swimming pools that year.”  So before we can determine whether a wealth tax would “raise an estimated $4.35 trillion over the next decade,” we have to consider the likelihood and cost of evasion.

Can the U.S. eradicate polio?

I recently saw Inside Bill’s Brain, the Bill Gates documentary on Netflix, and was astounded by the size of the challenges that Bill and Melinda are taking on with their foundation.  Eradicating polio, inventing ultra-cheap toilets, and creating safe nuclear energy are not easy problems to solve.  However, Bill and Melinda have a chance of solving them because of the immense wealth that they have accumulated since Bill founded Microsoft.

Naturally, this leads to a question surrounding the implementation of a wealth tax: Can the United States government use Bill Gates’ money as efficiently as Bill Gates?  Given the amount of scientific and technological breakthroughs that the U.S. government has been responsible for historically, I cannot answer this question with a definitive “Yes” or “No.”  However, it is a question we need to ask when considering how a wealth tax would affect private philanthropy.

For example, in 2017 Americans gave over $400 billion to charitable causes with the largest growth in contributions coming from foundations created by major philanthropists (i.e. the ultra-rich).  If a wealth tax were implemented, how large of a reduction would we see in private philanthropy and would this reduction be worth it?


What Does the Data Say?

While I am all for discussing the pros and cons of a wealth tax, we must also consider what the empirical results say for those countries that have actually tried to implement a wealth tax.  Fortunately, an article from NPR did just this:

In 1990, twelve countries in Europe had a wealth tax. Today, there are only three: Norway, Spain, and Switzerland. According to reports by the OECD and others, there were some clear themes with the policy: it was expensive to administer, it was hard on people with lots of assets but little cash, it distorted saving and investment decisions, it pushed the rich and their money out of the taxing countries—and, perhaps worst of all, it didn’t raise much revenue.

The results of these wealth tax experiments in Europe suggest that wealth taxes have limited effectiveness, but Elizabeth Warren argues that those wealth taxes had too many exemptions, allowed for easy capital flight, and were imposed on people who weren’t rich enough.

All of Warren’s arguments might be true, but I am still not convinced that wealth taxes will have their intended effect.  First Congress creates taxes, then the ultra-wealthy try to avoid them.  It’s a financial arms race that will never end.

Big thanks to Bill Sweet for discussing this issue with me during March for the Fallen.  I could not have written this post without him.  Lastly, thank you for reading!

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This is post 144. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

 
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30 Responses

  1. Anonymous commented on Oct 01

    Do you think there is any way to effectively tax the super-rich, or is it simply futile by nature?

    • Nick Maggiulli commented on Oct 01

      I don’t think it is futile, but I don’t think it is easy either. Most of the super-rich have skin in the game though such that they will lose their fortune with time as their business enterprises naturally decline.

  2. Anonymous commented on Oct 01

    Sticking with your “race” analogy.. can you list some instances where some racers are rewarded resources or other advantages?

    On your comparison of the effectiveness of B&MG foundation vs USG could not private sector be a 3rd party?

    • Nick Maggiulli commented on Oct 01

      Some racers are born into wealthy families that can gift them $15,000 a year tax-free. That’s $270K by the time they are 18. If you include trusts and other educational advantages, it is easy to see how some racers will start way ahead of others.

      Private sector could be a third party as well, but part of the private sector is controlled by the ultra-rich.

  3. Anonymous commented on Oct 01

    The rest of the world has a VAT tax. If it can’t be passed through by corporations or b2b transactions then it’s a tax on margins… so kind of indirect tax. If it can be passed through it’s a tax on consumption. US is one of a handful of countries that doesn’t have a VAT.

    https://www.nytimes.com/2019/09/27/business/yang-warren-taxes-mankiw.html

    Offer even payments to everyone and it becomes progressive.

  4. Anonymous commented on Oct 01

    Isn’t State Tax (Death Tax) a kind of Wealth Tax?
    400 Bi in philanthropy per year is 4 trillions in a decade, which would amount to almost the same amount expected with a Wealth Tax… I have a strong feeling that the efficiency of the private sector in allocating resources would greatly surpass that of the public sector, specially taking into account the bureaucracy of government.

  5. Anonymous commented on Oct 01

    What is your opinion on a Tax system based not on the amount you earn, but on the amount you hoard? (I.e. cash not used)
    Since the race is, hypothetically, won by those that hoard the most, taxing unused capital seems more reasonable. You get punished (taxed) for not employing you capital on the economy.

    • Nick Maggiulli commented on Oct 01

      There is a tax on this already. It’s called inflation and it’s roughly 2-3% a year.

  6. Anonymous commented on Oct 01

    Extreme hypothetical: If a HNW individual has $30MM in annual income on his multi billion dollar portfolio and the wealth tax comes out to $15MM on the value of his estate,does that person only have state and federal income tax liability on the remaining $15MM?

    • Nick Maggiulli commented on Oct 01

      My understanding is that these taxes (income vs. wealth) would be assessed separately. So they would have to pay income tax on the $30M and then the wealth tax on the “value” of their multi-billion dollar portfolio as well.

  7. Anonymous commented on Oct 01

    Nick, I always look forward to reading your articles. This is another lucid and thoughtful discussion of an interesting subject. I wonder if Milton Friedman ever addressed this issue directly.

  8. Anonymous commented on Oct 01

    Shouldn’t the discussion be also about morality? Is the mere fact that somebody has more money than most of us (money that we all gave to them in exchange for the goods/services they provide us with) a sufficient reason to take it from them?

  9. Anonymous commented on Oct 01

    The Netherlands has a wealth tax. Citizens of the USA would not be able to escape the wealth tax by moving out of the country as they are taxed based on citizenship not residency. They would have to give up their citizenship in order to avoid it!

  10. Anonymous commented on Oct 01

    Any idea how much would be raised, by comparison, by making cap gains taxes the same as income tax rates? The wealthiest mostly pay ( lower ) capital gains taxes, while the merely affluent have most assets in tax qualified accounts, where they already pay ordinary income tax rates as they take distributions…
    Curious how much revenue this would be in comparison. Taxing labor and capital equally is a sensible approach to inequality I think?

  11. Anonymous commented on Oct 02

    Be careful not to conflate tax avoidance with tax evasion.

  12. Anonymous commented on Oct 02

    The philanthropic argument holds little weight. There’s evidence that a lot of private foundation money goes to propping up bottom lines and expanding corporate interests both domestically and in developing markets, under the guise of philanthropy. Very little ever reaches or even benefits the general public, let alone the impoverished. The government couldn’t do worse.

  13. Anonymous commented on Oct 03

    Taxes apply to Citizens of Washington DC (10 square mile foreign entity), “UNITED STATES and its Territories” only.

  14. Anonymous commented on Oct 03

    France has had a wealth tax for a long time. President Macron pushed through a change to have it apply in large part only to real estate holdings as they are viewed as serving mostly to just pass down wealth rather than create jobs.

  15. Anonymous commented on Oct 07

    I note you “scare” people off with Bernie’s plan without giving details of what Warren’s would entail, although I concede the avoidance issue remains. The real problem is a combination of (i) long-term accrual of capital gains not being taxable until the owner chooses to sell and (ii) step-up in basis at death. Wealth tax should be combined with elimination of step-up and elimination of estate tax (which only the weatlhy without good advisers end up paying) and seen as a prepayment of unrealized capital gains.

  16. Anonymous commented on Oct 07

    Charitable deductions are tax deductible for the larger donations and dramatically lower the amount of taxes US and state governments are able to collect to fund themselves and their initiatives. Our governments are running large ongoing budget deficits approaching trillion dollars a year on annual basis. Charitable dollars are not effectively utilized with tremendous waste and largely fund special interests of donors while robing government of much needed revenue. Charitable giving should not be tax deductible. We should pay the government and if we want to do charitable giving with can do that just not at a cost to the government and our nation. Tax deductibility of charitable giving is a tremendous hindrance to ability of government to collect the funds needed to operate and fund much needed initiatives.

  17. Anonymous commented on Oct 15

    The government is not smarter than you. They don’t know more than you. They cannot solve your problems or anyone’s problems. Those in power constantly scream crisis… then push to take away our freedom. The government is incredibly inefficient with our dollars. If you want to encourage people to support programs to help specific groups of people, then encourage direct support of private programs that are effective. Seriously, when has the government got it right? The DMV? Healthcare? You really want these people deciding how to use your money? We need to help people, but not in the dumbest way possible.

  18. Anonymous commented on Oct 24

    Your arguments regarding Measurement and Evasion is bang on.

    The Efficacy argument is weak. Ex: The $400 B donations per year is unreliable given that most of it flows back to the donor organizations or donors in form of self-dealing, tax write offs, and so forth. For every Bill Gates Foundation, there are probably 1000s of Trump Foundations enriching their “donors”.

  19. Anonymous commented on Nov 13

    This is a great and fair article, thank you.
    I agree with others who have said that the Efficacy/Philanthropic argument is weak.
    There’s no reason why the mega-rich should have all of the power to do charity at their discretion and be accountable to no one. Plus, they will still have plenty of money left to do charity even after heavy taxation.