Is a Wealth Tax a Good Idea?

One of the hot-button issues of the Democratic Primary is Elizabeth Warren's proposal for a wealth tax levied on the rich. Proponents of the plan argue that it would levy enough money to fund an expansion of government assistance. Detractors counter that the tax is very difficult to implement in practice, and that Warren has vastly overestimated the amount of money it would raise. In this article, Rowan McGarry Williams and Owen Sherry further this discussion and argue about the merits of a wealth tax.
James DailManaging Editor

FOR

The wealth tax is having a moment, and a lot of very rich people are very scared. Recent years have been good to the wealthy—the fruits of America’s decade-long economic recovery have funneled largely into their pockets, and the current president has joined in the fun by slashing taxes on corporations and high-income individuals [1]. These individuals might not like Trump himself, but it would appear that they like the idea of the government curtailing their economic power even less. 

This attitude is clearly visible in their reaction to the proposed wealth tax of presidential candidate Elizabeth Warren, which would leverage “an annual 2% tax on every dollar of net worth above $50 million and a 6% tax on every dollar of net worth above $1 billion [2]. A series of billionaires have stepped forward to call Warren’s proposal “complete bull” and accuse her of “misleading” the public with “shiny objects [3].” In a remarkable display of class solidarity, many have instead expressed support for one of their own: finance billionaire Michael Bloomberg, who recently jumped into the 2020 fray. These billionaires, along with a minority of Americans, express a variety of fears about the wealth tax: it is punitive, scapegoating the rich, difficult to implement, and perhaps even unconstitutional. Plus, it will force wealthy people to leave and ultimately slow the whole economy down. However, such arguments are not only self-interested—they are wrong. 

Let’s begin with some things the wealth tax would not do. First, the wealth tax is unlikely to lead to a mass exodus of the 1% across American borders. The United States is a fantastic place to live, especially if you run an enormous corporation, as many people with more than $50 million do. The wealth tax would not change America’s status as the world’s financial hub. If the ultra-rich chose where to live based solely on tax rates, far fewer of them would live in high-tax states like California and Hawaii, both of which rank in the top 10 for millionaires per-capita [4]. Indeed, researchers have found little to no correlation between low tax rates and where rich people are moving [5]. What holds at the state level would logically hold at the international level as well. For those who do decide to leave, Warren has proposed a“40% ‘exit tax’ on the net worth above $50 million of any U.S. citizen who renounces their citizenship [6].”

Second, the wealth tax would not be unconstitutional, though it is impossible to predict exactly how the Supreme Court would rule. The issue at play here would be whether a wealth tax is direct. The Constitution states that direct taxes must be apportioned in a way that is equal across states. In other words, each state must pay the same amount per-capita. It is unlikely that the wealth tax would be considered direct. As legal scholar Calvin Johnson argues, “apportionment was designed to reach wealth by taxing states according to a proxy for relative wealth,” such as real estate [7]. However, real estate values are no longer roughly even across states, so the Court has found it legal to institute a progressive estate tax. Similar logic applies to the wealth tax, which Johnson states is “clearly constitutional.” This view has been affirmed by 17 other legal experts, who have confirmed the tax’s constitutionality in two public letters addressed to Senator Warren [8].

"Ultimately, the merit of the wealth tax boils down to the need to restructure an economy that has worked wonderfully for extremely rich people and poorly for everyone else."

What, then, would increasing taxes on the rich do? First off, it would raise trillions of dollars—$2.75 trillion, according to Warren’s proposal [9]. This money, as detailed by Warren and Bernie Sanders in their respective platforms, would fund a broad array of services to help poor and middle-class Americans succeed in the modern economy. The tax would deliver universal childcare and pre-K, thereby eliminating an enormous expense for families and ensuring that every kid comes into elementary school prepared to learn. It would finance a sweeping reform and broad cancellation of the student debt that has trapped millions of Americans in a predatory cycle of charges and prevent future debt by making public colleges free for all. Most importantly, revenue from a wealth tax would help fund a single-payer healthcare system that would guarantee access to all, lower costs, and stop hundreds of thousands of preventable deaths each year. Such a tax would also receive the approval of a robust majority of Americans. According to a recent poll, 63% of Americans say they support a “2% tax on households with a net worth over $50 million,” including, remarkably, 57% of Republicans [10]. This result is in line with previous polls [11].

That said, the wealth tax will only bring maximum gains to the economy if it is effectively enforced. Fortunately, this enforcement can be achieved by reinvigorating the Internal Revenue Service so that it can more effectively catch tax cheats and evaders. Every dollar invested in the IRS brings in about $4 in revenues, but the agency has been gutted in recent years [12]. Disinvestment in the IRS has led to a sharp decline in audits of the top 1%, who are now audited at around the same rate as the poorest Americans [13]. About $600 billion in wrongly unpaid taxes are left on the table every year [14]. Increasing funding to the IRS would help bring in government revenue and faithfully implement a wealth tax. 

Ultimately, the merit of the wealth tax boils down to the need to restructure an economy that has worked wonderfully for extremely rich people and poorly for everyone else. A billion dollars is a lot of money—you could make 5,000 dollars every day for 500 years and you still wouldn’t be a billionaire—but we insist on acting as if every one of those billion dollars was earned through some individualistic process of merit and hard work. This, without exception, is false. Wealth at that level is accumulated in large part thanks to public goods like schools that train workers and roads that move products. Yet, incredibly, the 400 wealthiest Americans pay a smaller percentage of their wealth to the government than any other income group, including low-income Americans [15]. Our tax system, in other words, is upside down. A wealth tax would help put it right-side up again.

AGAINST

Not since Milton Friedman has an economist enjoyed such celebrity status as University of California, Berkeley’s Thomas Picketty. Through his Capital in the Twenty-First Century and collaborations with fellow Berkeley economists Emmanuel Saez and Gabriel Zucman, Piketty has helped bring issues of income inequality and redistribution to the forefront of academia and politics. By charting the rising concentration of wealth among the ultra-wealthy which has accompanied the opening of global markets, Piketty, Saez, and Zucman have presented significant evidence of the need for policy that would address rising domestic inequality. However, Piketty’s chosen remedy for this issue, a levy on personal capital, would face intractable problems in its implementation, create a host of harmful unintended consequences, and fail to realize the incredibly optimistic promises of progressives. 

Many critics of the wealth tax primarily point to the problem of determining the value of assets. Wealthy individuals often possess property such as rare art, unique real estate, and stakes in private companies that would present difficulty to tax collectors. Under the current tax regime, such items are taxed as capital gains when sold, where the value of the item can be determined by the market. However, a tax on wealth would require annual valuations of each asset, which could become costly. Even if the valuation issue were to be solved, taxpayers would still face liquidity issues. Individuals with large percentages of their wealth in private stock such as Michael Bloomberg or select executives at unicorn start-ups might be forced to pay their tax using equity in their companies if they cannot produce enough cash, undermining their control over them.

As a consequence of the challenge of determining assets and exempted asset classes, revenues from plans such as Democratic candidate Elizabeth Warren’s wealth tax would likely fall far short of projected revenues. Saez and Zucman found in July 2019 that Warren’s plan would bring $2.75 trillion over the course of ten years. In their analysis, they assumed 15% tax evasion, the average across the entire system, and used estimates of American wealth from their 2018 paper. To estimate the wealth of an individual, they would multiply a given capital gain by the rate of return. For example, a $10 capital gain earned at rate of 5% would yield and estimation of 200$ in assets (200*5%=10) [16]. However, these methods used in their estimates have been disputed by other economists. In a recent working paper, a group of economists --Matthew Smith of the Treasury, Danny Yagan of the University of California, Berkeley, Owen Zidar of Princeton and Eric Zwick of the University of Chicago-- found that Piketty, Saez and Zucman’s model of estimating wealth by analysing the capital gains of the rich significantly overestimates their true net worth because of their tendency to seek riskier investments like corporate bonds than the average person, who mostly owns housing and bank accounts [17]. This tendency, they argue, means that Picketty multiplies the value of capital gains by too high a factor. If the total amount of wealth possessed by rich is likely over-inflated or at least up for debate among economists, then Warren/Sanders’ projections of revenue cannot be relied upon [18].

"By choosing to focus on wealth, a notoriously tough thing to measure, they set themselves up for disappointing results, favoring punitivity and ideology over practicality."

Additionally, to reiterate, because data on wealth is scarcer than data on income, a wealth tax would be easier to evade than an income or payroll tax, both of which would comprise of Saez and Zucman’s 15% assumption about the prevalence of tax evasion under their plan. Lawrence Summers, Harvard University professor and former Treasury secretary, and Natasha Sarin, a professor of finance at the Wharton School, looked at the U.S. experience with estate taxes and found that Warren’s tax would only raise about 40% of the estimated revenue [19]. Because of the enormous incentive to dodge such a high tax and uncertainty about exactly how much wealth the ultra-rich posses, Warren’s “two cents” may not amount to as much as she’d like.  Current advocates of the wealth tax have certainly improved upon wealth taxes that existed in countries like France and Denmark. In France, capital flight during the imposition of their wealth tax eclipsed revenues from the tax [20]. Democratic candidate Elizabeth Warren’s wealth tax proposes that no assets will be exempted from their wealth taxes and that billionaires would face a 40% one-time exit tax if they renounce their citizenship and the IRS is the most powerful tax collector in the world. However, like estate taxes, (which can approach 60% in some states) an exit tax would create massive incentives for evasion and offshoring, which further shrinks the conventional tax base [21]. Also, the tax would discourage future high net worth immigrants that would contribute to the tax base through conventional levies against income, capital gains, consumption.  Piketty and Warren both ardently argue for a no exemption tax, but Congress would water down any wealth tax, just as in every European case study, as it will be impossible to pass something like this without compromise. For example, France exempted agricultural land from its tax, leading many would be taxpayers to borrow against the land, distorting the market and losing revenue.  Ultimately, progressives are right to clamor for increases in taxation on the rich. Because of America’s comparative advantage in high-skill industries, booming stock market, and stratified higher education, wealth inequality has increased significantly, but economists cannot even agree on how much wealth the rich actually possess. By choosing to focus on wealth, a notoriously tough thing to measure, they set themselves up for disappointing results, favoring punitivity and ideology over practicality. Given the overly simplistic discourse around the tax during the Democratic Primary, advocating for a wealth tax seems to be a way to gain populist credentials rather than comprehensively address the issue. Instead, policymakers should look to close existing loopholes in existing tax law and pursue other taxes on the wealthy that have fewer negative externalities on the economy.
Owen SherryStaff Writer

Sources and Notes

[1] https://www.nytimes.com/2015/01/28/upshot/gains-from-economic-recovery-still-limited-to-top-one-percent.html
[2] https://elizabethwarren.com/plans/ultra-millionaire-tax
[3] https://www.nytimes.com/2019/11/12/opinion/elizabeth-warren-billionaires.html
[4] https://www.cnbc.com/2018/02/07/states-with-the-most-millionaires-per-capita.html
[5] https://journals.sagepub.com/doi/pdf/10.1177/0003122416639625
[6] https://elizabethwarren.com/plans/ultra-millionaire-tax
[7] https://www.americanbar.org/groups/taxation/publications/abataxtimes_home/19aug/19aug-pp-johnson-a-wealth-tax-is-constitutional/
[8] https://www.warren.senate.gov/imo/media/doc/Constitutionality%20Letters.pdf
[9] https://elizabethwarren.com/plans/ultra-millionaire-tax
[10] https://www.nytimes.com/2019/11/29/business/economy/economy-politics-survey.html
[11] https://www.vox.com/2019/2/4/18210370/warren-wealth-tax-poll
[12] https://www.brookings.edu/opinions/steven-mnuchin-makes-a-welcome-case-for-boosting-irs-funding/
[13] https://www.propublica.org/article/irs-now-audits-poor-americans-at-about-the-same-rate-as-the-top-1-percent
[14] https://www.propublica.org/article/lawmakers-to-irs-commissioner-charles-rettig-system-stacked-for-the-rich
[15] https://www.nytimes.com/interactive/2019/10/06/opinion/income-tax-rate-wealthy.html
[16] http://gabriel-zucman.eu/files/PSZ2018QJE.pdf
[17] “Capitalists in the Twenty-First Century” (with Matthew Smith, Owen Zidar, and Eric Zwick) Quarterly Journal of Economics 2019, lead article, volume 134(4) pp.1675-1745.
[18] Ibid.
[19] https://www.washingtonpost.com/opinions/2019/04/04/wealth-tax-presents-revenue-estimation-puzzle/
[20] https://www.researchgate.net/publication/228281017_The_Economic_Consequences_of_the_French_Wealth_Tax?enrichId=rgreq-cb8b2f0fd7d57363beac930f1947b244-XXX&enrichSource=Y292ZXJQYWdlOzIyODI4MTAxNztBUzoyNzcxNTA4NzY4ODA4OThAMTQ0MzA4OTMyNjc5NA%3D%3D&el=1_x_2&_esc=publicationCoverPdf
[21] https://www.washingtonpost.com/opinions/2019/04/04/wealth-tax-presents-revenue-estimation-puzzle/

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