What if America Introduces Wealth Tax on the Super Rich?
Updated: Feb 2, 2021
What if America Introduces Wealth Tax on the Super Rich?
Written by: Khyati Gupta
Benjamin Franklin once said nothing is certain in this world except death and taxes and it looks like 2020 will be about at least one of those. In January 2019, Senator Elizabeth Warren proposed something called a "Wealth tax." Most of the taxes we pay only happen when money changes hands, when we earn money or when we spend. But according to Sen. Warren, here's the problem with that. "Two people who may have the same income, but are in wildly different economic circumstances." So, to fix it, Sen. Warren wants to tax the actual wealth people have, but only for the ultra rich, the 0.01%. The policy has, broadly, three aims: to reduce inequality, raise revenue and prevent the accumulation of fortunes so vast that they influence the political process.
Tax revenues in US from Wealth taxation
Here's Sen. Warren's Wealth tax proposal: All the wealth above the line of $50 million dollars would be taxed at 2% each year. All the wealth above $1 billion dollars would be taxed at 3%. So, if you have $40 million dollars, you'd pay nothing. If you have 60 million dollars, you'd pay nothing on your first 50 million, but 2% on the 10 million after that, or $200 thousand. And if you have 2 billion dollars, you'd pay about $49 million (Hemel, 2019).
Revenue estimates for a wealth tax differ based on the components of the proposals and on assumptions about enforcement and evasion. For example, it was estimated that in 2019, Sen. Warren’s wealth tax could have raised $9.4 trillion or 51% of the GDP. Using these estimates, if a 1% wealth tax were imposed on all assets comprising that base above-$50 million threshold and no evasion occurred, the tax would have raised an additional $94 billion, or about 3% of total federal revenues in 2019. Sen. Warren wants to spend this additional revenue generated to forgive most student debt, abolish tuition fees at most public colleges and provide universal child care for children under five. Bringing this tax to American shores might boost Treasury revenues for public welfare, but it would certainly come with a number of challenges and negative economic consequences.
Do rich people Pay Lower Taxes Than You?
The overall tax rate on the richest 400 households in 2018 was only 23%, meaning that their combined tax payments equalled less than one quarter of their total income (Edwards, 2019). As illustrated in Figure 1 below, in 2018, billionaires paid a lower average effective tax rate than the bottom 50%.
Figure 1: Average effective tax rate of ultra rich and bottom 50% of US households
Source: The Washington Post
So, why isn’t the income tax sufficient for taxing the super-rich? Because most of the advantaged members of society possess substantial wealth but low taxable income. Their income stems from capital gains, such as investments like stocks and bonds, which enjoy a lower tax rate than income. Nearly 22% of pre-tax income of the nation's wealthiest households consist of capital gains and not wages, unlike most workers. It's the same reason why Warren Buffett famously said his tax rate was lower than his secretary's.
Sen Warren's Wealth Tax VS. Wealth taxes in Europe
Wealth taxes have failed in Europe. In 1990, there were 12 OECD nations including Austria, Denmark, Finland, France, Germany, Iceland, Ireland, Italy, the Netherlands, Luxembourg, and Sweden, with wealth taxes similar to Sen. Warren's tax policy. Today only four remain. The Swedish wealth tax prompted large outflows of capital and the expatriation of well‐known business people, such as the founder of Ikea, Ingvar Kamprad. (Edwards, 2019) It was the same story in French, wealth tax was imposed in 1982 and repealed in 2017. Over the years, a parade of French business people and celebrities left the country to avoid the tax, many going to Belgium, which is also a high‐tax country but has no wealth tax. The French government estimated in 2017 that some 10,000 people with €35 billion worth of assets left in the past 15 years for tax reasons. Of the remainder, only Switzerland raised significant revenue, about 1% of GDP (Economist, 2019).
Reason why the wealth tax was repealed in Europe is due to poor policy choices. For example, European wealth taxes were levied on households with little cash but substantial illiquid wealth due to low exemption thresholds (Alba, 2019). To avoid this problem, Sen. Warren's wealth tax advocates for a high exemption threshold at $50 million which is 50 times higher than the typical European wealth tax. So, the fact that many countries have abandoned wealth tax is hardly a killer argument against Sen. Warrens’ proposal. What really matters is why they did so, and whether the problem they found with them would apply in the US.
Three primary issues with Wealth Tax: Valuation, Economic Impact and Avoidance.
A net wealth tax requires a reliable estimate of net wealth. Financial investments, which account for about fourth-fifth of the wealth of the rich, can typically be marked to market. The tricky part is the investment portfolios to value include oddities like art and antiques, and more significantly privately held businesses, which account for about a tenth of riches wealth (Economist, 2019). Perhaps, the most prominent example is Koch Industries, an American conglomerate. Another is Bloomberg, a financial date publisher which is 88% held privately by Michael Bloomberg. valuation of assets, can be very challenging but is perhaps not insurmountable. Art is often valued for insurance purposes and business can be valued using their profits. However, putting a value on some assets will be challenging and costly disputes would be inevitable for the tax collectors.
The primary economic effect of a wealth tax would be its impact on saving. A Wealth tax would make the rich consume more today and save less (Zucman, 2019). Saving is the act of putting money aside and delaying consumption for the future. A decline in national saving would initially drive up interest rates and returns, this would attract foreign investors. Foreigners would be willing to lend more to the United States because they would be able to hold assets without being subject to the wealth tax. However, some investments from the ultra-rich Americans. GDP would decline somewhat, but the increase in foreign lending and foreign ownership of the U.S. assets would result in less total income for Americans, or lower GNP (Pomerleau, 2020).
However, if the wealth tax does not lead to this predicted increase in foreign lending, the U.S. capital stock would shrink, leading to lower worker productivity and lower wages for workers. Resulting in a long-run effect on workers with distributional implications. The wealth tax might even worsen the divide between the rich and poor by increasing the sense of entitlement in the lower strata of society (Loopholes, 2019).
In a 2018 article for the International Monetary Fund, economists James Brumby and Michael Keen conclude: “The design of wealth taxes is notoriously prone to lobbying and the granting of exemptions that the wealthiest can exploit (Edwards, 2019). Furthermore, the rich have proved adept avoiding or evading taxes by placing their wealth abroad in low tax jurisdictions. “Sen. Warren and other liberals rightly denounce cronyism and tax avoidance by the rich, but a wealth tax would generate more of those ills. If Sen. Warren’s plans were enacted, the rich that fall under this exempted threshold would descend on Congress to lobby for exemptions while cranking up debt and hiding their taxable assets abroad or simply exiting the country.
What Can Be Done?
Wealth tax may not be able to achieve its first aim- inequality that is most plainly visible: those caused by growing dearth of opportunity for middle- and bottom-income homes. Yet, reducing economic inequality is not the only aim of the proposal. Billionaires have threatened democracy by capturing the political process, curbing their wealth is in part about curbing their political power, succeeding in her third claim. However, based on its failure in other countries and Sen. Warren's failure to address them, there's no compelling evidence that a wealth tax will succeed in the second claim too, to raise revenue.
My unrealistic suggestion would be to go back in time and prevent the accumulation of wealth with no limits. Basically, the progress of capitalism has reached a point of no return because the super wealthy has too much power in this world. Realistically thinking Sen. Warren's proposal does open up a window of policy debates with ideas like raising the top tax rate for the super-rich or closing corporate tax loopholes or raising capital gains rates for assets held under five years or dividend tax to better target the super-rich. Such taxes would help in promoting more competition in the US economy and could prevent successful entrepreneurs from quickly establishing lucrative dominant positions.
A solution to raising revenue could be a new national income tax that would tax all income, whether from labour, capital or other sources as a supplement to the existing income tax (Singleton, 2019). Ultimately, Warren is right that we need to reform our tax system so that the ultra rich pay a larger share. Yet we do not need a wealth tax in order to tax the wealthy, and we can accomplish that objective more effectively by improving upon the system we already have.
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