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Monday, November 25, 2019

Why a Wealth Tax Can’t Solve Our Problems

The unforeseen consequences of a wealth tax would inevitably come back to haunt the American people.

Photo courtesy of Edward Kimmel via Flickr

Progressive politicians have made a habit of proposing costly new government programs. By costly, I am referring to programs that are estimated to cost tens of trillions of dollars. Some time ago, these figures were unthinkable, but today they are thrown around as if money grows on trees.

Politicians from Senator Bernie Sanders to Senator Elizabeth Warren are counting on increasing federal revenues from wealthy taxpayers, using an “Ultra-Millionaire Tax” to cover their vast expansions of entitlements. As Jonah Goldberg writes at National Review, when taxes come overwhelmingly from the rich, sometimes called “the donor class,” the rich are more inclined to care about rule-making.

What Is a Wealth Tax?

A wealth tax, according to US News,

would require the ultrawealthy…to pay an annual tax on the assets they hold, which may include property, business interests, investments, yachts, fine art and other possessions.

Imagine how difficult it would be for the Internal Revenue Service (IRS) to establish guidelines for assessing the value of an obscure painting or sculpture. Wealthy taxpayers are likely to challenge the IRS’ valuation of their assets in courts. For example, as the Washington Examiner noted,

in the years after Michael Jackson died in 2009, the IRS said that the value of the pop star’s name and image, the total value of his “estate,” was more than $434 million. The estate’s own valuation? Just $2,105.

This disparity jeopardizes hundreds of millions in taxes for the state.

A wealth tax differs from income or sales taxes in that it focuses on assets “regardless of whether they’re sold, traded or earn a dividend.” This concept relies on the value of one’s assets assuming they were to be sold right now. Unlike general income or capital gains, wealth is reliant on the market value, unlike general income from wages. Think of a wealth tax along the lines of a property tax or an estate tax.

A wealth tax matters to the public writ-large because wealth is not stagnant. For example, I may hypothetically own $5 million in shares of Amazon stock that I purchased for $1 million, but I do not have $5 million in cash on hand. A wealth tax requires the government to assess my current wealth ($5 million) and tax me accordingly. Let’s say the wealth tax is four percent. A wealth tax not only violates the basic principles of fairness, but it is also highly impractical and difficult to enforce.Assuming the value of all of my assets is accrued into the value of my Amazon shares, I would owe $200,000 in taxes on $5 million I don’t have in cash.

The so-called monolithic “ultra-wealthy” have diversified assets, so they would be more likely to have cash to cover the cost of the wealth tax. However, it is not certain that their assets are liquid. Liquidity is the ease of converting an asset to cash. For example, a wealthy landowner might own farmland valued at over $60 million but otherwise may only have $450,000 in liquid assets.

A wealth tax of four percent would require this individual to pay $2.4 million in tax; however, the landowner does not have sufficient cash to cover the tax. In order to afford this tax, the landowner may have to sell a portion of his farmland depending on the statutory requirements. Essentially, this form of tax not only violates the basic principles of fairness, but it is also highly impractical and difficult to enforce.

Indirect Consequences of a Wealth Tax

By now you are probably wondering why the remaining 99.95 percent of Americans care about a wealth tax. For one, we should understand the indirect consequences of implementing such a tax. Evidence from other countries points to the conclusion that these taxes are largely failures. As Matt Palumbo writes,

Twelve European countries [had] wealth taxes in 1990, yet today only three remain (in Norway, Spain, and Switzerland), with those taxes accounting from as much as 3.62% of total revenues in Switzerland to only 0.55% in Spain.

The socialists in France introduced a wealth tax on individuals with assets over $1.5 million in the 1980s; however, this tax was repealed in 2017. This tax “led to thousands of rich French families” moving to other countries to “avoid paying the tax.” Palumbo cites French economist Eric Pichet’s estimates. Pichet estimates “that 42,000 French millionaires left the country between 2000 and 2012.”

Sweden had a wealth tax of 1.5 percent on households with over $200,000 in wealth. The Financial Times noted that Sweden’s repeal of the tax

will have virtually no effect on government finances. The tax raises around 4.5 billion Swedish krona a year from just 2.5 per cent of all taxpayers.

To no surprise, the tax has been blamed for “massive capital flight from the country” with estimates up to 1.5 trillion krona.

In an article titled “Democrats Love a Wealth Tax, But Europeans Are Ditching the Idea,” Laura Davison writes that Germany, Sweden, Austria, and the Netherlands have all abandoned a wealth tax. The common grievance with a wealth tax is the difficulty in enforcing it. As I previously noted, wealthy taxpayers will likely dispute the IRS’s assessment of their assets, thus leading to lengthy legal battles.

Can a Wealth Tax Work in the United States?

The United States is in a fortunate situation. We have evidence of the failures of the wealth tax in other nations. Theoretically, the idea is too complicated for the IRS to effectively enforce. Additionally, the United States has an inherent protection: the Constitution. Aside from the practicality of enforcing this tax, any such proposals will be subject to political and constitutional constraints.

There is a dispute among legal academics as to the constitutionality of such a tax; at New York Magazine, Josh Barro writes:

That is, if the federal government is going to levy a direct tax, it has to do so in such a way that an equal amount of tax is collected per capita in each state — except the 16th Amendment says Congress doesn’t have to do this if the direct tax is an income tax.

Currently, the Supreme Court has yet to give a clear answer as to what a direct tax is. If passed, a wealth tax will be immediately subject to litigation.

With the Ultra-Millionaire Tax, Senator Warren seeks to remediate the problems of “income inequality.” Emmanuel Saez and Gabriel Zucman are two left-leaning University of California-Berkeley economists leading Senator Warren’s policy proposal. The wealth tax is but one of the senator’s proposals to increase taxes; however, this tax stands out as the most dubious. As I previously mentioned, a wealth tax is difficult to assess and to enforce. Additionally, there are inherent complications given that not all assets are liquid.

As one reader at The Wall Street Journal correctly notes,

While very few taxpayers will be hit with a tax on wealth starting at $50 million, it will eventually be the responsibility of all taxpayers to itemize their wealth to prove they don’t meet that threshold. And when the funding for all the social programs being planned fall[s] short, as [it] always [does], will the thresholds be reduced?

In the end, the unforeseen consequences of a wealth tax will inevitably come back to haunt the American public.

At The Wall Street Journal, Andy Puzder addresses the indirect, financial consequences of a wealth tax:

  1. Most wealthy people have illiquid assets. While the wealthy are often framed as hoarding cash or “like Scrooge McDuck swimming in a giant pool of gold coins,” they are in fact not doing so. “Ms. Warren plans to solve that problem by letting taxpayers tend a portion of their illiquid assets to the government, rather than forcing them to sell and pay cash.”
  2. A wealth tax would increase the cost of capital, as investors subjected to this tax would seek a higher rate of return.
  3. Puzder writes, “So investors subject to the wealth tax, unable to preserve capital by investing in Treasurys, would require higher-yield investments, making it harder for Washington to fund its deficits.”
  4. A wealth tax will produce an incentive to invest in illiquid assets rather than in publicly traded stocks and bonds. This disincentive will lead to devaluation in the values of 401(k) plans for many Americans as many retirement funds are reliant on the steady growth of stock markets over time.
  5. As the value of the stock market decreases, investors will be forced to find new sources of growth. The new avenues of growth may be less open to the public, leading to less prosperity for all.
  6. The wealthy already use an array of financial tools to evade the full effect of taxes, such as trusts. The wealthy can afford to hire professional expertise, namely quality lawyers and accountants. Keep in mind that trusts are just one legal method that wealthy individuals use to avoid taxes.

The reality is that a wealth tax may provide an inconsequential amount of revenue to the federal government while simultaneously costing the IRS a significant amount of resources. Senator Warren and Senator Sanders greatly overestimate the income generated from their wealth tax, but this is not unexpected. After all, they are politicians; politicians need to mobilize voters so that they can win elections. While it would be unfair to accuse both senators of purposefully omitting relevant information, it is fair to state that their projections are misleading as even fellow progressives are berating their plans. The far-reaching economic impact of a wealth tax will likely outweigh any benefits or revenue obtained through it.

  • Mitchell Nemeth holds a Master in the Study of Law from the University of Georgia School of Law. He also holds a BBA in Finance from the University of Georgia. His work has been featured at The Arch Conservative, Merion West, and The Red & Black. Mitchell founded the Young Americans for Liberty chapter at the University of Georgia, and he served as Co-President of Students Supporting Israel at UGA. His favorite writers are Professor Jonathan Haidt and Thomas Sowell.