Are wealth taxes the answer to rising inequality?  

Rising inequality is one of the most significant challenges of advanced economies.  The U.S. has the highest income inequality of all post-Industrial economies.

In 2018, for the first time in US history, billionaires paid a lower effective tax rate than the working class (23% for the richest 400 families vs. 24.2% for the bottom half of American households). During the pandemic, the average fortune of America’s billionaires increased by 29%.

These are not sustainable outcomes.  There are many ways to address systemic inequality in post industrial economies.  One of them in particular is getting increasing attention: a wealth tax.  

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Wealth Tax Essentials:

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What is a wealth tax?

• Tax on assets, net of debt

Includes:

• Financial assets: corporate equity, private business assets, other fixed income assets e.g. liquid assets and deposits, bonds, mutual funds.
• Non-financial assets: real estate properties, land, buildings, personal property

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How to design a wealth tax?

Exemption threshold, wealth above which assets are taxed annually

• European thresholds all below $1M, ranging from $50k in some parts of Switzerland to $775k in Spain
• Warren’s proposal: $50M
• Sanders’ proposal: $32M

Tax rate

• European rates all below 1% with the exception of higher tax brackets in Spain which caps at 2.5% for assets over $10M
• Warren’s proposal: 1% for $50M to $1B, then 6%
• Sanders’ proposal: increases across 8 brackets by 1% from 1% to 8%, capping at 8% for assets over $10B

Assets classes exempt, if any

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Arguments for it

• Tool to address inequality and redistribute economic gains across society
• Necessary for social stability; Piketty
• Incentivizes productive use of assets (bc need to shift to higher yields lest face decline)
• Reduce deferral and lock-in incentives bc taxed on accrual vs. realization

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Arguments against it

High incentives for tax avoidance and evasion

• Higher as % increases
• Billionaires hire best lawyers and have exceptional capacity to evade taxation

Cost and complexity of administering it

• Valuation of assets is difficult and subjective, could lead to a lot of court cases
• It requires unique expertise to value assets which makes it expensive
• The IRS would need to expand significantly to administer it, both to address valuation challenges as well as evasion. (note: The 2022 Inflation Reduction Act resulted in an $80 billion expansion "to bolster taxpayer services and enforcement of the tax code, among other purposes.")

Liquidity issues

• Significant % of wealth held in illiquid assets, making it difficult to meet tax liabilities
• Particularly applies to private businesses
• Especially an issue in Silicon Valley

Diminished incentives for innovation

• Increases risk because of valuation volatility and tax liability
• Perverse incentive for startup employees to forego or forfeit shares in the promising companies they work for, further entrenching wealth in the hands of owners, founders, and investors who might have access to more liquidity
• Adverse effects on high skilled immigration

Adverse macroeconomic effects via discouragement domestic savings and investment

• Induces foreign inflows, drives up value of the dollar, increase in trade deficit

Considerable debate in tax policy field and academic community about how much revenue could be raised

• Due to estimates of tax base and assumptions on tax evasion / avoidance rates

Debate over whether or not it is unconstitutional

"The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration." 16th Amendment, U.S. Constitution

• The 16th Amendment is clear about the authority of the U.S. government to tax incomes, but the expansion of that authority falls highly into the interpretation of the U.S. Supreme Court.

Experiences in other countries

Over a dozen European countries have instituted wealth taxes, all but three have subsequently repealed them, because

• Didn’t generate a lot of revenue
• Contributed to capital drain
• High administrative cost
• Distorted resource allocation, particularly involving certain exemptions and unequal valuation of assets.

Why the U.S. proposals are different

• Much higher exemption thresholds
• Citizenship-based tax system is less vulnerable to mobility threats. Warren proposed 40% tax penalty for renouncing citizenship
• No preferential treatment for asset classes reduces avoidance possibilities
• Systematic third-party reporting that builds on existing tax information exchange agreements adopted after the Foreign Account Tax Compliance Act. Less opportunity for offshore evasion
• Modern info tech makes it possible for tax authorities to collect data on market value of many forms of wealth