The Wealth Tax Is a Poor Idea

 

Now that the Republicans have taken control of the House of Representatives, it has become crystal clear that there will be no federal wealth tax on high-net-worth individuals for at least the next two years. Unfortunately, as with so many bad policy proposals, the push for a wealth tax has instead generated renewed interest in blue states. California, Connecticut, Hawaii, Illinois, Maryland, New York, and Washington are considering introducing their own wealth taxes. Through joint effort, they hope to make it more difficult for wealthy individuals to flee high-tax states for more favorable jurisdictions. This strategy represents wishful thinking at its finest. If this quixotic endeavor should become law, it will only hasten the exodus of wealthy individuals from blue California and New York to red Florida and Texas.

Today’s aggressive progressives hope to stall that movement by imposing an exit tax on these would-be exiles. These efforts should evoke oppressive regimes like East Germany, which erected the Berlin Wall to keep malcontents at home. It will surely face a fierce constitutional attack, as our Constitution has long been understood to have created a nationwide free-trade zone. In the United States, goods, services—and individuals—can move easily across state lines to promote economic development and growth. An exit tax imposes an explicit barrier on that project and is likely to be struck down as an impermissible burden on interstate commerce, as it is a direct descendant of the taxes and regulations that Chief Justice John Marshall struck down in such notable cases as Gibbons v. Ogden (1824) and Brown v. Maryland (1827).

Ironically, the rosy revenue projections that wealth-tax supporters such as Emmanuel Saez and Gabriel Zucman made in 2021 for its revenue potential—starting in 2023—are now hopelessly out of date. Two years ago, at the height of the pandemic, billionaires accumulated capital at near-record rates. Now, potential gains from a wealth tax have fallen because of the enormous declines in wealth (toward greater income equality!) experienced by virtually all newly minted tech moguls. Elon Musk leads the pack, with capital losses of $115 billion in 2022 alone. He has good company in Jeff Bezos ($80 billion); Mark Zuckerberg ($78 billion); and Larry Page ($40 billion). In sum, the American billionaires lost $660 billion this past year, about one-third of the $2 trillion in losses worldwide. Nothing guarantees that they will recover those losses any time soon, if ever. Considering a hypothetical 3 percent wealth tax rate, close to $20 billion in domestic wealth-tax revenue disappeared in 2022; this number would be far higher if the wealth tax also reached foreigners.

Pass the tax and those losses will only get larger. Killing the goose that lays a golden egg is to be expected in any system that stresses redistribution first and growth second.

It should not, however, require this large a dose of reality to warn progressive states off yet another institutional blunder. The effort to impose a wealth tax runs afoul of the fundamental principles of taxation put in place throughout the course of the income tax era, which now spans more than a hundred years. The economic, or Haig-Simons, definition of income—the increase in net worth plus individual consumption—does not work when applied to any real-world tax system that must collect taxes from millions of people in a quick and efficient fashion. Instead, the standard way to tax wealth starts with the notion that the receipt of certain elements of wealth is taxable as income. In principle, that covers earned income and the realized gain from the sale or other disposition of property. However, it is widely known that certain kinds of benefit are so difficult to value that it is better not to recognize that gain upon receipt, so the tax is postponed until some later time when the taxpayer receives either cash or marketable securities.

For instance, receiving a partnership in a business may vastly improve your financial prospects, but it doesn’t result in the taxation of that anticipated stream of income today. Instead, each year the tax is imposed as the owner takes money out of the entity as profit distributions. Similar logic applies to stock received in corporate reorganizations like mergers, spinoffs, and recapitalizations. By design, the law does not force taxpayers to calculate difficult asset values or dispose of some illiquid asset to pay the tax.

The wealth tax stands in sharp contrast to this long-standing practice. Generally, rich people have diverse holdings because they have the resources to cultivate them. Many such assets, like artwork or fractional interests in a family corporation, are nearly impossible to value, impossible to sell, or both. The nonrecognition rules thus keep them out of the tax system. Today, however, we have an estate tax that requires individuals to include in their gross estate all of these difficult-to-value items, which often makes it impossible to settle a tax dispute on large estates in less than several years. Think of the wealth tax as if it were an estate tax imposed on an annual basis, but with the added logistical headache of being impossible to calculate in year two until the tax liability for year one has been established, and that establishing the tax for year one may take multiple years. These administrative burdens pile up in individual cases, and they become larger the wider the net is extended around the asset base.

At this point, the acute tradeoff becomes clear: the only reliable asset class for wealth-taxation purposes is publicly traded stocks and bonds, which of course can decline rapidly in value after the tax is imposed, but also before it is collected. (Think of the position of Elon Musk and others in the class of 2022.) Necessarily, that type of tax will miss the portion of their wealth that they hold in unlisted and illiquid assets, and thus will not satisfy progressives for whom depriving the rich of wealth is every bit as important as providing additional income to the poor.  National wealth taxes face this difficulty, which poses an even greater challenge for a state wealth tax, with its more limited territorial reach.

The revenue collected will fall short of expectations. Worse, the tax will damage the economy. Today’s ablest entrepreneurs will be forced to devote their time to defending their fortunes against the predation by the one or more states that lay claim to their wealth. Wealth creation and income from other sources will both fall as administrative expenses and high-stakes litigation rise. An overall decline in social wealth will likely lead to a reduction of investment and wages and consequently to a lower standard of living and a loss of tax revenues from other sources.

Wealth taxes less ambitious than the current crop have uniformly failed. Defenders of the tax like Elizabeth Warren and Bernie Sanders have long claimed that it will not touch ordinary people. But indirect effects matter as much as formal tax liability, and these will touch everyone in society.

The cumulative objections to the wealth tax may lead some of its defenders to offer in its place a more modest change: the removal of the realization requirement for the annual income tax. Asset-price volatility makes this system just as impractical as a wealth tax. In 2022, the stock market tumbled about 9 percent on the Dow, 20 percent on the S&P, and 33 percent on the tech-dominated Nasdaq index. A huge string of unrealized losses—obviously, unpredictable—will now be deductible, leading to large swings in total revenue collections.

One single impulse—to narrow the gap between the rich and the poor—drives these concerted efforts to wring more out of the taxation system, if only from a much-reduced wealth base. But even if the markets were to turn around, the fatal flaw in these onerous taxation programs persists in their initial premise: that closing the wealth gap between rich and poor matters more than increasing overall wealth.

Consider two changes in wealth in a two-person society: one person who starts with $10 and another who starts with $20. In one scenario, the wealth of both double to $20 and $40, respectively. Classical liberals would see an unambiguous social improvement. Equalitarians might ask whether the increased wealth differential should lead us to reject this new state of affairs where both are better off. In a second scenario, the wealth of each person falls to $5. Should an egalitarian prefer this newfound parity because it eliminates the wealth gap even though it makes both sides worse off?

One who perversely prefers the second scenario to the first shows how far modern tax theory has departed from its classical origins. In the classical liberal ideal, a flat tax to fund public improvements allows for complex changes that are intended to create public benefits that cannot be obtained via market transactions, while avoiding senseless partisan conflict over the wealth tax and its close substitutes. The system is both stable and pro-growth. It works far better than today’s never-ending set of progressive tax gimmicks.

© 2023 by the Board of Trustees of Leland Stanford Junior University.

Published in Economics, Law
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  1. DonG (CAGW is a Scam) Coolidge
    DonG (CAGW is a Scam)
    @DonG

    It is good to churn captured wealth over, but a general wealth tax is impractical.   It would be good to remove the loopholes around the existing wealth taxes (real property, vehicles) and extend that to things the very rich own for personal use (planes, yachts,…)   Stock in publicly held companies is a public benefit.

    • #1
  2. Randy Weivoda Moderator
    Randy Weivoda
    @RandyWeivoda

    I don’t understand how anyone can consider a wealth tax to be fair.  Let’s say two guys each have a lucrative NFL contract and are making $5 million a year for a decade. They are both paying taxes on their income as they earn it. 

    Player A parties like a rock star, lease Rolls Royces, jets, and fancy homes.  By the time his NFL career is over he has very little net worth.  Player B lives on a fraction of his income and invests in businesses, real estate, whatever.  He is paying capital gains taxes on his profits, so the government is already getting more taxes from Player B than Player A.  At the end of his NFL career Player B is worth $70 million and various people think the government should get a big chunk of that?  Why?  Don’t we want people to save and invest?  It’s envy, it’s greed, it’s communism.

    • #2
  3. W Bob Member
    W Bob
    @WBob

    How is a wealth tax not an unconstitutional taking? “You’ve got money, give it to me.” 

    • #3
  4. I Walton Member
    I Walton
    @IWalton

    The discussion, as well as the effort to raise income taxes on higher incomes, should show us that raising government revenue is part of the objective, but not part of the purpose of raising taxes on “wealth” however defined.  Both are highly negative and should be abolished which is what we should be discussing.  If  Californians are dumb enough too destroy their own economy we can’t do anything about it.  Sane and very wealthy people will leave, which should be obvious..  Besides economic ignorance and blind marxism, there is another reason this is being pushed.  The Chinese push it because they plan on replacing us and senile Biden is one of their tools.  They helped put him in place and may only have two years to complete the job.  Is this crazy because we can’t know?  Anyone who doesn’t give it a high probability isn’t aware of what’s going on, doesn’t know China, probably has never lived much abroad nor studied relevant matters.

    How could we eliminate income taxes?  We are already funding government with massive borrowing, i.e.printing and will continue to do so until we’ve destroyed the economy, but what destroys the economy is the dead weight bureaucrats and perverse incentive created, not the borrowing.    Everyone should pay taxes, whether they have income or not and everyone should pay taxes based on what they spend.  We need a sales tax, no exceptions, no goods excluded, not medicine, baby milk nothing.  Crazy?  Difficult maybe close to impossible, but it’s probably the only way to preserve the country as originally designed.   Besides being the way to get folks to worry about government spending, it’s the most efficient way to raise revenue while creating powerful forces to reduce non essential government spending and activities. 

    • #4
  5. Stad Coolidge
    Stad
    @Stad

    Just like the income tax, a wealth tax will start with the truly wealthy.

    But you know what’s going to happen.  You and I will wake up one morning and find out we’re “wealthy,” even though we don’t have Porsches and Mercedes Benz’s parked in our garages . . .

    • #5
  6. Columbo Member
    Columbo
    @Columbo

    President Ronald Regan on government taxation:

    “Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.” 

    Tax the rich and the only productive element of your economy will stop moving, like the unproductive citizenry.

    • #6
  7. Raxxalan Member
    Raxxalan
    @Raxxalan

    Stad (View Comment):

    Just like the income tax, a wealth tax will start with the truly wealthy.

    But you know what’s going to happen. You and I will wake up one morning and find out we’re “wealthy,” even though we don’t have Porsches and Mercedes Benz’s parked in our garages . . .

    The end goal of the wealth tax is to achieve the Davos mandate: “You’ll own nothing and be happy.”  While I am sure government can accomplish the first part of that statement, I am equally sure it can’t deliver on the second part.

    • #7
  8. DonG (CAGW is a Scam) Coolidge
    DonG (CAGW is a Scam)
    @DonG

    Randy Weivoda (View Comment):

    I don’t understand how anyone can consider a wealth tax to be fair. Let’s say two guys each have a lucrative NFL contract and are making $5 million a year for a decade. They are both paying taxes on their income as they earn it.

    Player A parties like a rock star, lease Rolls Royces, jets, and fancy homes. By the time his NFL career is over he has very little net worth. Player B lives on a fraction of his income and invests in businesses, real estate, whatever. He is paying capital gains taxes on his profits, so the government is already getting more taxes from Player B than Player A. At the end of his NFL career Player B is worth $70 million and various people think the government should get a big chunk of that? Why? Don’t we want people to save and invest? It’s envy, it’s greed, it’s communism.

    We “means” test a lot of government benefits including college financial aid that penalizes wealth.  We also have liability laws that penalize wealth.  The “fairness” of a wealth tax is that wealth can be translated into political power and that can be used for rent-seeking and a small wealth tax compensates.   It small doses it actually improves capitalism.

    • #8
  9. DonG (CAGW is a Scam) Coolidge
    DonG (CAGW is a Scam)
    @DonG

    W Bob (View Comment):

    How is a wealth tax not an unconstitutional taking? “You’ve got money, give it to me.”

    The 16th Amendment allows for taxation of income.  The Constitution also allows for national taxes apportioned by state (not individual) and import duties.  The states can do as they please.   So, a national wealth tax is not allowed.  Of course asset forfeiture should not be allowed either.   

    The Constitution does allow fees for services (eg, FDIC insurance, stock transactions,….).   Although a potential mechanism, I think it would be hard turn fees into a national wealth tax.   What if insurance companies operating across state lines paid a very high fee?   People with wealth use insurance and that might be a way to backdoor a wealth tax.  Or maybe a fee on spending US dollars in a foreign country as a backdoor wealth tax?  We should certainly discourage government from doing more backdoor taxes.

    In summary, my position is that a small wealth tax is fair and improves the health of capitalism, but is not practical to implement. 

    • #9
  10. Red Herring Coolidge
    Red Herring
    @EHerring

    They are coming for corporations, too. https://www.bloomberg.com/news/articles/2023-01-25/class-action-wave-is-coming-for-esg-claims-green-insight?utm_source=website&utm_medium=share&utm_campaign=twitter

    • #10
  11. Misthiocracy has never Member
    Misthiocracy has never
    @Misthiocracy

    Richard Epstein: It will surely face a fierce constitutional attack, as our Constitution has long been understood to have created a nationwide free-trade zone.

    It’s too bad that this isn’t spelled out explicitly in the text of the document. After all, it grants Congress the power to regulate interstate trade, not to facilitate interstate trade.

    • #11
  12. Caryn Thatcher
    Caryn
    @Caryn

    There are only two legitimate methods of wealth transfer from rich to poor.  First is for the former to hire the latter to do a job for an agreed upon wage.  The second is out-right charity, given willingly to the recipient deemed to be deserving by the payer. I would hope that a wealthy and decent society will not permit those truly unable to work to starve.  The people who refuse to work and choose a life on the streets (on drugs, on alcohol) should either be given charity by idiots to find shelter and food or be arrested for vagrancy.

    Taxation for the limited purposes outlined in the Constitution is only legitimate if applied to all at the same rate.  That still results in the rich paying more than the poor, in absolute dollars, for the same services, but it’s still “fair.”  What we have now is high payers who are accused of not paying enough despite paying a large proportion of the overall tax bill, a large number of free-riders, and a middle-class that’s proportionally overtaxed because they can neither free-ride nor afford to pay for loopholes. 

    • #12
  13. Randy Weivoda Moderator
    Randy Weivoda
    @RandyWeivoda

    Richard Epstein: Today, however, we have an estate tax that requires individuals to include in their gross estate all of these difficult-to-value items, which often makes it impossible to settle a tax dispute on large estates in less than several years. Think of the wealth tax as if it were an estate tax imposed on an annual basis, but with the added logistical headache of being impossible to calculate in year two until the tax liability for year one has been established, and that establishing the tax for year one may take multiple years.

    This is something that people don’t think of.  If it takes years to figure out the net value of a rich dead person’s estate, how bogged down is the IRS going to be if they have to also do that calculation for every rich person every year?

    • #13
  14. DonG (CAGW is a Scam) Coolidge
    DonG (CAGW is a Scam)
    @DonG

    Misthiocracy has never (View Comment):

    Richard Epstein: It will surely face a fierce constitutional attack, as our Constitution has long been understood to have created a nationwide free-trade zone.

    It’s too bad that this isn’t spelled out explicitly in the text of the document. After all, it grants Congress the power to regulate interstate trade, not to facilitate interstate trade.

    I am thinking about Article X.  California taxing people for leaving the state could be considered a duty/impost/tax and disallowed.

    No State shall, without the Consent of the Congress, lay any Imposts or Duties on Imports or Exports, except what may be absolutely necessary for executing it’s inspection Laws: and the net Produce of all Duties and Imposts, laid by any State on Imports or Exports, shall be for the Use of the Treasury of the United States; and all such Laws shall be subject to the Revision and Controul of the Congress.

    • #14
  15. Zafar Member
    Zafar
    @Zafar

    Interestingly:

    The US imposes an ‘Exit Tax’ when you renounce your citizenship if you meet certain criteria.

    Generally, if you have a net worth in excess of $2 million the exit tax will apply to you. This tax is based on the inherent gain (in dollar terms) on ALL YOUR ASSETS (including your home). You will also be taxed on all your deferred compensation—such as pensions at the time of expatriation.

    • #15
  16. Full Size Tabby Member
    Full Size Tabby
    @FullSizeTabby

    DonG (CAGW is a Scam) (View Comment):

    Misthiocracy has never (View Comment):

    Richard Epstein: It will surely face a fierce constitutional attack, as our Constitution has long been understood to have created a nationwide free-trade zone.

    It’s too bad that this isn’t spelled out explicitly in the text of the document. After all, it grants Congress the power to regulate interstate trade, not to facilitate interstate trade.

    I am thinking about Article X. California taxing people for leaving the state could be considered a duty/impost/tax and disallowed.

    No State shall, without the Consent of the Congress, lay any Imposts or Duties on Imports or Exports, except what may be absolutely necessary for executing it’s inspection Laws: and the net Produce of all Duties and Imposts, laid by any State on Imports or Exports, shall be for the Use of the Treasury of the United States; and all such Laws shall be subject to the Revision and Controul of the Congress.

    I recall hearing while I was in law school (late 1970s) of some then relatively recent court decisions (preceding ten years?) that found it a violation of the equal protection provisions of the U.S. Constitution, including the right of interstate movement, for a state to require a new resident to reside in the state for a period of time (such as 6 months or a year) before the new resident could claim welfare benefits. The logic was that a person moving across state lines was not treated equally to a person who did not move across state lines. The same principle should lead to a finding that a tax applicable only to a person who moved across state lines is also a violation of the equal protection provisions of the U.S. Constitution. But I don’t know that I’d want to count on today’s courts being quite so consistent on such principles as applied in somewhat different situations. 

    A number of years ago (early 1990s?) California (followed by New York) tried to tax the pensions of people who had been employed in the state but subsequently moved to a different state (such as a California retiree who had moved to Arizona, or a New York retiree who moved to Florida). California’s theory was that the pension was simply deferred compensation for the person’s employment in California, and thus had been “earned” in California, and so California was entitled to tax it. Congress in 1996 changed the tax code to prevent states from doing that. 

    • #16
  17. Illiniguy Member
    Illiniguy
    @Illiniguy

    This idea has festered its way into the mind of an Illinois State Representative who’s introducing a bill in the House. From my blog:

    Since the recent election I’ve had a chance to talk to some of my colleagues on the Democrat side of the aisle, and what I’m hearing is that the drift to the left over there is nothing short of profound. One way to measure that is to hear them say that Representative Will Guzzardi is no longer the gold standard for the progressive cause and is now considered a moderate in that caucus.

    Don’t get me wrong, I like Will. He’s a very amiable fellow and serves as a good foil during debate because he’s a true believer and always comes well prepared. His problem is that he’s never signed the front of a paycheck, and a degree in comparative literature has not prepared him to understand where money comes from. But that doesn’t stop him from proposing all sorts of ways to spend it and find whatever means he can devise to take it from others because there’s never been a need that government can’t satisfy. His plan calls for any revenue raised by this tax to go into a new “Working Families” state fund, with the money going to three specific purposes: ending homelessness, paying for universal child care and fully funding public education. But if you look at the priorities on his website, you’ll know that he won’t stop there.

    He’s now ventured into the world of tax policy (another area about which his understanding is suspect) by proposing what he calls a “wealth tax”.

    You can read the rest of the post by clicking here.

    • #17
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