Massachusetts Sen. Elizabeth Warren would like to tax wealth.
You read that correctly.
In a thread on Twitter, the Senator has proposed levying a tax "on the wealth of the richest Americans." Warren calls it the "Ultra-Millionaire Tax" and adding that it applies to "that tippy-top 0.1%" - those with a net worth over $50 million.
Warren's proposal is called a "wealth tax," and it has entered the conversation more in recent years.
What Is a Wealth Tax?
A wealth tax is a tax on the assets that an individual currently owns.
Implementation can vary, but in general a wealth tax is based on the market value of the taxpayer's major property at the time of taxation. The taxpayers then owes a certain percent of that value to the government.
So take a taxpayer who had $10 million in cash and investments, and property assessed at $40 million as of midnight on Jan. 1. He would have $50 million in taxable wealth, and under a 1% wealth tax would owe $500,000.
Wealth Taxes vs. Income Taxes
In the U.S., state and federal governments use income taxes, which attach to income as the taxpayer earns it. An income tax is distinct from a wealth tax in a few key ways:
Trigger for Taxation
An income tax is triggered when the taxpayer collects money or other assets of value. A wealth tax is triggered by the taxpayer holding money or other assets of value at the relevant date (typically the end of the calendar year).
Cycle of Taxation
An income tax attaches only once to any given money or property. If someone earns $1 million, an income tax applies when the taxpayer gets it and then never again. A wealth tax can attach to the same money or property for as long as the taxpayer holds it.
Taxation of Purchases
Income taxes don't apply to purchased property, only to net gains in value. Wealth taxes do apply to purchased property because the new asset still contributes to the taxpayer's net worth.
So, for example, consider a taxpayer who was gifted a $1 million house. She would owe taxes on that property because her net worth increased by $1 million. If she purchased that house she would owe no income taxes, because her net worth did not go up. She would, however, owe wealth taxes because it still contributes to her net worth.
Taxation of Non-Liquid Assets
The income tax does not apply to unrealized gains in property value. It only triggers if you sell an asset and make money off it. The wealth tax typically does apply to unrealized gains, since the market value of the asset contributes to the individual's net worth.
For example, consider a taxpayer with stocks worth $10 million. A wealth tax that includes stocks and mutual funds would apply to the entire current value and this investor would pay taxes on it every year. An income tax does not. It applies only to the profit a taxpayer makes off her investment, and wouldn't trigger until she sold her stocks.
Implementing a Wealth Tax
The scope of a wealth tax depends entirely on the nature of its legislation. Like any other tax lawmakers can write the law around the incentives they would like to create. Significant issues for consideration generally include:
1. Wealth Brackets
As Warren suggests, most (if not all) wealth tax proposals suggest phasing it in on holdings above a certain threshold. This is the same basic structure as an income tax, with each tax level only applying to wealth within its bracket.
Virtually all wealth tax proposals target only very high levels of wealth, meaning that they only apply to taxpayers who currently have millions of dollars in cash and assets.
2. Targeted Assets
A wealth tax can identify which assets to exempt and include in its scope.
Commonly, this policy applies to virtually all personal property above a certain value. While the IRS doesn't want to line-item the contents of someone's refrigerator, exempting any categories of major assets would encourage tax structuring. For example, if the wealth tax exempted works of art, millionaires would collect as much as possible in an effort to hang tax shelters on their walls.
Investments are a more significant question. One of the purposes of a wealth tax is to reach the assets of extremely wealthy individuals, who typically make most of their money off their portfolios. However, at the same time, the government doesn't want to dissuade productive investment.
It is common for wealth tax proposals to try and balance the need for revenue against draining capital out of the investment marketplace.
3. Retirement and Charity
Wealth taxes may also sometimes avoid areas considered good public policy. Retirement and charity, for example, are subjects that the government wants to encourage. As a result, the wealth tax may exempt any such holdings.
That said, many economists disregard this concern given the high caps of a typical wealth tax.
The Existing American Wealth Tax
Astute readers will notice that the wealth tax sounds familiar. That's because, while America has never adopted it as a comprehensive policy, most towns and cities rely on a version of wealth taxation called property taxes.
The property tax is a limited wealth tax. Every jurisdiction defines it differently, but usually, it applies to major physical assets owned by either a company or an individual. This will typically include real estate, cars, boats and other property of significant value.
The taxpayer owes taxes based on the assessed market value of their property as of, typically, Jan. 1. The key difference between a property tax and a general wealth tax is that property taxes only attach to physical assets. A wealth tax applies to all financial holdings, so it would include assets such as cash, investments and high-value property not typically reached by property taxes.
Purpose of a Wealth Tax
The stated purpose of a wealth tax is threefold.
1. Create a Policy That Can Reach Wealthy Taxpayers
Wealth tax advocates argue that income taxes are poorly structured to reach the wealthiest citizens. Unlike working- and middle-class taxpayers, the highest earners typically make most of their money from investments and property holdings.
As a result, it has historically proven difficult to write an income tax policy that can target the wealthy as effectively as it targets salaried and hourly workers. Wealth taxes allow policymakers to reach the assets of the wealthiest citizens more effectively, both increasing government revenue and making the system fairer.
2. Reduce Pools of Stagnant Wealth
One of the problems with wealth concentration is that it encourages productive capital and property to go unused. When a taxpayer has millions of dollars, much of that money is likely to sit unspent in a bank account or an underdeveloped property.
Wealth taxes encourage people to spend and use their capital. If the money that sits in a bank account or third home will get slowly eroded by taxes, then the taxpayer's incentive is to spend and invest that money instead of letting the government seize it.
Rather than having stagnant pools of useless capital, a wealth tax gets money moving, either by encouraging private investment or by letting the government spend it.
3. It Reduces Inequality
A wealth tax would reduce that.
By targeting this massive pool of unequal wealth directly, the government could slowly redistribute it. This would both fund programs that tax advocates support and would reduce inequality by reducing the holdings of the ultra-wealthy.
Criticisms of the Wealth Tax
There are several criticisms of wealth taxes.
It Would Duplicate Taxation
Under these policy citizens would owe taxes on the same money again and again, in the same way, homeowners pay taxes on their house each year. This is referred to as double taxation, referring to the fact that a wealthy taxpayer would pay an income tax on their earnings, then a wealth tax for holding onto that same money.
Critics of a wealth tax argue, among other concerns, that this is simply unfair as a matter of public policy. Eventually, taxpayers should have a right to their money free and clear of government interference.
It Could Discourage Work
Wealth tax critics also urge that it would reduce the incentive for wealthy taxpayers to do additional work.
If the government imposes confiscatory tax schemes, critics argue, then people will have less incentive to earn money that they know will simply get taken away again. This will reduce productivity and make everyone poorer as a result.
It Would Encourage Wealth Relocation
Aside from outright tax fraud, taxpayers can't avoid wealth taxes simply by moving their assets overseas. However, they can do so by renouncing their citizenship.
Critics of a wealth tax argue that it will encourage wealthy business people and investors to simply pack up and leave the U.S., or to never come here in the first place. It's called tax exile, and critics argue that it's exactly what France faced when that nation tried to impose a major tax hike back in 2012.
The oft-repeated cautionary tale of France has generally been debunked. While a few high-profile French citizens left the country, almost all of the stories were of a vein similar to the Democrats/Republicans who swore they'd move to Canada if Trump/Obama took office. Yet it remains a warning nonetheless: wealth taxes target exactly the category of citizens with the means to jump ship if they want to.
It Would Be Difficult to Collect
Finally, critics argue that a wealth tax would simply be incredibly difficult to collect. The rich are adept at hiding their assets. What's more, any effective scheme of taxation would need carve-outs for productive investments and business ventures.
It would cost millions for the IRS to effectively enforce this law, and would put government lawyers against the best tax attorney's a billion dollars can hire.
Of course, tax evasion is a felony. The IRS, when properly funded, is actually quite good at chasing down tax cheats. And it's not like the wealthy aren't doing this already.