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The Toxic Warren Wealth Tax
In my lastcolumn, I explained how Senator Elizabeth Warren’s wealth tax violates well-established constitutional limits on income and transfer taxes. Ever since the Sixteenth Amendment legalized the income tax, all taxes on income have been based on some fraction of the amount earned within a given year. And all taxes on capital are imposed only once, namely at their transfer during life or upon death. In contrast, the Warren wealth tax would be imposed annually on all forms of wealth at rates that start at 2 percent for households whose net worth is between $50 million and $1 billion, and 3 percent for households who hold amounts of wealth in excess of $1 billion. The tax applies in both rich and lean years, whether a person makes or loses money.
To defend this dubious scheme on economic grounds, Warren, now a presidential aspirant, relies on a letter prepared by two prominent economists from Berkeley, Emmanuel Saez and Gabriel Zucman, both experts on the economics of inequality. Indeed, it is just there that the problems begin, for any fixation with equality or, as Saez and Zucman call it, equitable growth, rests on shaky premises.
It’s not clear why we should worry about inequality of income or wealth. Both concentrate solely on the gap between those at the top and those further down in the distribution. To be sure, the gap is striking. As Saez and Zucman point out, the yearly increase in wealth for the top 0.1 percent between 1980 and 2016 has averaged about 5.3% compared to the general average of 2.5%. But where is the social problem? Why am I worse off because someone else has become better off? The superrich have made their money by providing goods and services to their fellow citizens. Rather than just engaging in massive consumption, the rich, especially at the billionaire level, typically reinvest or give a large fraction of their wealth, often to charitable enterprises. The upshot is that the distribution in consumption is far more equal than that in income.
Nor is it possible to protest the very rich for their undue political influence. Per person, their influence is great, but on many social issues their views are hardly monolithic. In a world of majoritarian politics, moreover, that isolated 0.1 percent, even if unified, has less in aggregate influence than the unions, civil rights, environmentalist, and consumer groups aligned against them. That differential influence is most evident on taxation. The fraction of total taxes paid by the 90 percent of the population has shrunk over the last 35 years, from over 50 percent to about 35 percent. Currently, about 40 percent of taxes are paid by the top one-percent, which earns just over 20 percent of the income. Piling a wealth tax on top of that tax burden, year after year, is a big deal. Thus, if the wealthy earn about 8 percent return per year on their investments, a wealth tax of 3 percent is like an income tax of 37 percent, on top of the tax on current income. And there’s no reason to think that a Warren wealth tax is necessarily limited to two and three percent. If established, the tax will likely expand.
If income inequality is indeed a problem, the wealth tax is the wrong way to deal with it. The wealth gap can be closed by raising the income or wealth of the poor or lowering the income or wealth of the rich (or some combination of both). The former requires growing the economy. The wealth tax would supposedly raise $2.75 trillion, but Saez and Zucman seem unwilling to address whether, and if so how, such a tax would impede growth. A one percent decline in GDP ($200 billion) could largely wipe out the supposed revenue gain of the wealth tax. Most rich people do not idly count their wealth sitting under palm trees; they continue to reinvest it in new projects that require both equity and debt capital. When a wealth tax of $5 or $10 million comes due, it could require an entrepreneur to liquidate part of his business—or to divert his assets from investment and business growth to the payment of taxes. Perhaps Saez and Zucman believe the government makes better use of capital than our most successful entrepreneurs, but that’s an economic pipedream. There is no way that the rate of return from public investment will approach that of startups. We should be lowering income tax rates on the rich, not raising them.
The negative growth effects are likely to be compounded by the reach of the tax. Saez and Zucman tout that one of the virtues of the wealth tax is that it “has a comprehensive base with no loopholes and is well enforced through a combination of systematic third party reporting and audits.” They also note that through the enforcement of the tax, society “will generate much more accurate data to estimate and track the wealth of the wealthiest Americans.” Of course, this would only come about by a systematic misuse of data. Right now the IRS treats all data as strictly confidential. It would require a massive change in policy to allow it to be shared with state or federal enforcement agencies or outside research firms, especially in individually identifiable form. From their letter, it is clear that neither economist has spent a single second thinking about the administrative burdens in running a tax system.
Take the income tax. The income tax does not tax all increments of wealth, however derived. The wealth of the superrich includes not only publicly trade stocks and bonds that have precise market values, but also working assets such as interests in start-ups that are not traded at all. Those business interests are typically not alienable, and their valuation can fluctuate extensively over time. Banks are reluctant to lend against assets in new ventures that have a high chance of going bust. Similar valuation problems frequently arise for people who have complex interests in legal, medical, or banking practices; their wealth, too, is not in readily taxable form. Accordingly, income tax law has made the sensible decision never to tax annually the increment (or decrement) in value of these interests. Instead, that income is taxed only when it is converted into cash or marketable assets. Similarly, the government does not tax the unrealized appreciation of such key personal assets as homes and art work, for which there is no ready market. That institutional decision to defer the collection of income taxes has two virtues. It avoids these multiple and costly valuation problems, and it does not require successful citizens to sell or borrow against their assets to pay any tax.
One of the reasons why I am firmly opposed to any estate tax is that it cannot duck these valuation problems. When someone dies, it becomes necessary to attach a value to all property that passes at the time of death. At this point, the valuation problem is acute for all different asset classes. In order to administer a complex estate, it is necessary to comply with the voluminous requirements of Section 706 of the Internal Revenue Code, which for requires detailed information about every stock and bond that is found in a given portfolio. Thereafter, it is necessary to untangle a web of unique financial assets—interests in partnerships and closed corporations, patents, royalties, options, leases, mortgages, and more, from which must be offset the full range of immediate and contingent liabilities. The entire process often takes years to resolve, given the high level of valuation uncertainty.
But at least the administrative costs are worth incurring, because estate tax rates quickly zoom up to 40 percent on the taxable estate. It is sheer madness, on the other hand, to incur these costs to collect 2 percent of a total, as Warren’s wealth tax would do. The administrative costs of imposing a 2 percent wealth tax on persons whose net worth is, say, $55 million would surely surpass the $100,000 the tax would generate. Yet just imagine how much it will cost the IRS to process the 75,000 returns that Saez and Zucman predict will be filed annually. Unfortunately, the government will have to cast its net even wider to determine which households have assets exceed that Warren’s $50 million exemption. Few disputed estates can be closed within a year, especially if any dispute goes to litigation. In each subsequent year, the wealth tax will have to be reduced to take into account the unresolved, deferred liabilities from past years. It is a senseless use of government resources to require our ablest citizens to take valuable time supplying documents and undergoing audits and grueling examinations that carry with them the risk of civil and criminal sanctions.
So we are back to the original question: why do Saez and Zucman put such emphasis on minimizing the gap in wealth between the rich and poor? A sensible strategy puts growth before equity, which will produce larger gains for people at all points in the overall wealth distribution. The classical liberal approach wants to simplify taxation and reduce regulation to spur growth. Plain, old growth is a much better social tonic than the toxic Warren wealth tax.
© 2019 by the Board of Trustees of Leland Stanford Junior University
Published in Economics, Politics
I heard somebody else raise the concern that the wealth tax combined with a high income tax rate (say, 70%) would destroy a person’s accumulated wealth pretty quickly, since, in order to come up with 2% in cash, the person would have to liquidate 10% of his accumulated wealth, since most of the proceeds of the liquidation would go to income taxes if the person built the assets from a near zero value, such as Jeff Bezos of Amazon.
Many assets are not particularly liquid, and therefore a tax on the value of the assets presents many problems, one of which is the valuation problem Prof. Epstein mentions. But also is the problem of coming up with the cash to pay a tax.
An influence leading me to oppose the estate tax was when a business I really liked and used as a young man was forced to close because one of the two men who owned it died. Only by closing and selling off the assets was the family able to pay the estate taxes. It was not the type of business that could easily integrate a new owner who could bring cash to the table. Sure, you could argue that they should have had a plan in place (with insurance on each owner to pay estate taxes), but the business had grown quickly, and why should we force people growing a successful business have to worry about estate taxes? I later saw several families have to spend substantial money for elaborate estate planning out of fear that the value of their small business might grow to become subject to the estate tax (this was particularly the case for some families that owned motels and other modest businesses sitting on California real estate that was rapidly increasing in value – i.e., the land alone might subject them to the estate tax).
On a wealth tax, near where I used to live was an elderly farmer who kept growing strawberries on his fields as the surrounding land was turned into shopping centers and high rise office buildings. He just wanted to farm. Because of the development around him, his land was “worth” many millions of dollars. Would he be required to sell off parts of his land each year to pay a wealth tax? He knew his family would sell the land, but he insisted that as long as he was alive, what kept him alive was growing strawberries. It would have broken his heart for the government to force him to sell off bits of his land each year to pay a wealth tax.
How does a family that owns a privately held business (i.e., there is no regular market for fractions of the business) that they have built up come up with the cash to pay a wealth tax every year?
The wealthy are already fleeing high tax states. Wait till they start fleeing the country . . .
The real problem with a wealth tax is it will, as with all taxes, eventually creep down to hit everyone. Especially when the Democratic party is against suburban and exurban growth. A perfect weapon against houses deemed “to large” by the green crowd would be a wealth tax which would eventually make them totally unaffordable. Except for the right people of course, I am sure such a wealth tax would never be applied against Mrs. Pelosi’s vineyard for example.
They already have exit taxes, at the country level, now. States are looking at it.
We have had bad governance for decades and now whoever either did the right thing or took the right countermeasures has to pay.
All of this is so capricious.
One telling measure of a tyranny is the barriers erected to prevent exit.
I don’t know how to Google it anymore, but I’ve heard some good podcasts and seen some articles about how the government has put the screws to the Swiss banking system, maybe Singapore that really reduces privacy and security in the name of financial repression. It really causes a lot of complications even for an honest person. They’re doing all kinds of things because they know they’re going to need more revenue in the future.
I mean why shouldn’t you get 2% over inflation on a savings account? Why shouldn’t you get more on the longer bond? It’s because the government can’t afford it. Inflation is regressive taxation, and the central banks are forcing artificial low interest rates to keep the government funded. The wealthy’s assets go up, so they’ve so they can spend and borrow out of that.
Then people wonder why Trump and Bernie and similar people are popular all over the planet.
Worth repeating:
I think everyone knows the answer to that: Because the economy is a zero-sum game and wealth is only gained at some other poor schmuck’s expense.
No, of course not. Everyone knows they are developing their next evil scheme.
All wealthy people are evil and go about seeking whom they may devour. Except of course for Bill and Melinda Gates and Wallis Annenberg and Michael Bloomberg and George Soros and…
Yes. All taxes eventually apply farther down the scale. The federal Alternative Minimum Tax was written to apply to something like 50 people who were reported to have high income but paid no income tax. By 2017 millions of people with upper middle incomes were having to calculate AMT.
The income tax itself was sold to the American people by assuring everyone it would apply to only a tiny fraction of the wealthiest people, and that it would be only for a couple of percent of income. [Though after the changes in the 1990’s, the proportion of people to which it applies has dropped again to a minority of people. I have a philosophical problem with a large group of people being able to vote a tax that applies only to a small number of people.]
Good article, Professor Epstein. I already hated the concept of a wealth tax just based on the unfairness of it, but you make an excellent point about the difficulty of even calculating what the assets are.
So we are back to the original question: why do Saez and Zucman put such emphasis on minimizing the gap in wealth between the rich and poor?
Let’s answer that last question first. Basically, Envy. Those academics envy the wealth that entrepreneurs accumulate, and the standard Progressive response is “if you have it, and I don’t, you must have stolen it from me in some way, and that makes me entitled to a portion of it”. A rational person would go to the wealthy person and as “how did you get where you are today?” and emulate that person. But the standard Progressive response is to confiscate wealth from those who have earned it, to bestow upon those who have not.
About that gap. The gap between rich and poor should be an incentive for the poor to improve themselves so they can earn and accumulate their own wealth. So what happens if that gap is artificially narrowed or eliminated? Why would anyone have incentive to improve themselves in any way, if it would only get their wealth or earnings confiscated?
The problem is a ton of wealth is accumulated by just having assets or levering up to buy some assets when central banks are easing like crazy, like they have been for 20 years. It’s not all from productivity. I’m not saying the government should steal it back. I have read the article after article about how that won’t improve anything, but the whole system really does cause problems. A lot of people really aren’t rewarded enough for being productive and saving money.
The only reason this happens is the government spends too much money and the central banks accommodate it.
Part of the hubris of the academy is that they think they should have lots of money because they are smarter than everyone else. Their belief that the rich entrepreneur stole the money is based on their conviction that a “fair” world would not allow a “dumb” entrepreneur (“My goodness, he has only a Bachelor’s degree from State University” – or worse, “He didn’t even graduate from college”) to make more money than the “smart” academic.
[Now if someone wants to do an interesting “privilege assessment,” have academics examine not the “privilege” of being white, but the privilege of being smart.]
Yet while putting such emphasis on the gap between rich and poor they apparently fail to notice that the gap is bigger in places in which their preferred approach (greater government control) is more prominent than in places in which people are left alone to build wealth as the people themselves see fit.
That’s true. And instead of wagging our fingers at envy, it’s time we learned to accept it as a fact of life. Isn’t that what conservatives do — deal with the world that is rather than the one they’d prefer?
Rather than dealing with inequality by taxation, I see it as a necessity that we deal with inequality by ensuring that Congress can no longer be bought and paid for by Corporate interests and rich individuals.
You get to petition the government.
The only way to solve this is, blow up the Eccles Building.
You should probably include all special interests, but the thing is easily accommodated. I’m always tickled (sardonically tickled) when people go on about campaign finance reform. No need for it if you simply remove all subsidies (direct ones or bonbons in our traditionally idiotic methods of taxation) that don’t serve ALL of us. If pigs at the trough are the problem, trough removal is the solution. This also suggests a consumption tax as the sole means of taxation (or Henry George’s long-ago suggestion of taxing the unimproved value of land). Congress, strangely enough, and their enabling voters (us) have never seemed to have worried much about such things since about 1825. Apparently we’re either fond of corruption or the problems involved in deciding what serves ALL of us are not only difficult but insurmountable.
Note this type of equality isn’t what a wealth tax seeks, for whatever reason, to address. You’re talking equal treatment under the law; Warren and the economists aim for equality of (material) condition. For their concern, universal poverty will definitely work.