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Why a wealth tax may be a bad idea

“A slew of Democrats on Capitol Hill” including Sens. Elizabeth Warren and Bernie Sanders have “proposed a 3% total annual tax on wealth exceeding $1 billion” and 2% on $50 million to $1 billion, The Hill reported on Monday, March 1, 2021. Read story here.

   The aim of the so-called “Ultra-Millionaire Tax Act” is to rein in the widening U.S. wealth gap, which has been exacerbated by the Covid pandemic, The Hill said. The argument for it? “The ultra-rich and powerful have rigged the rules in their favor so much that the top 0.1% pay a lower effective tax rate than the bottom 99%, and billionaire wealth is 40% higher than before the Covid crisis began,” Warren said.
   It’s true that repeated Republican tax cuts for the rich have resulted in a rigged tax system, and the pandemic’s economic impact has fallen disproportionately on low-income workers, while a soaring stock market (in spite of the pandemic) has multiplied the paper wealth of the milliionaire class. And the federal government could use the additional revenue to offset its pandemic expenses and deficits.
   But I have reservations about the idea of a wealth tax that go beyond the difficulty of enforcing it (which is why Janet Yellen has reservations about it; see story here). I think it’s better to tax income and gains.
   Many wealthy people hold most of their wealth in the form of businesses they own, real estate, stocks and bonds, and mansions and yachts. Nobody would shed a tear if somebody had to sell a yacht to pay his tax bill (except who would buy it, if everyone who owns yachts are selling them to pay taxes? What you’d get is a collapsing market for used yachts, not cash flow to pay taxes with.)
   Forcing people to divest businesses is more problematical. It’s a safe bet that Elon Musk, thought to be worth about $190 billion, doesn’t have $5.7 billion in cash laying around. To fork over that amount to the IRS every year would require him to sell off chunks of his businesses. Eventually, he’d lose control of those businesses. Will the next owner have his vision and innovative genius?
   Or take the owner of a farming operation worth $50 million, who may be borrowing from banks to finance the cash flow needs of his business, and is in no position to pull cash out of his farming operation. What’s he going to do, sell acreage to pay his taxes? To who, his neighbor, who’s in the same boat? What you’d get is shrinking farms and a shrinking food supply.
   How do you establish valuation for wealth tax purposes? How do you know what a farm is worth, unless you sell it? Who’s going to walk through the farm, Blue Book in hand, writing down a value for every tractor, plow, and milking machine?
   Another big problem is that the value of non-cash assets can fluctuate, sometimes rapidly and drastically. An obvious example is a stock portfolio worth $55 million on April 14 but $48 million on April 15, and $52 million on April 16. No tax owed? Or how about the owner of a Kentucky Derby winner worth $20 million, until it drops dead? Trying to figure out how wealthy someone is on any given day is unworkable.
   And then there are issues like this: What if a famous artist has a house full of his own work? How do you value it? Should you force him to sell it to pay taxes on it?
   If the aim is to de-concentrate wealth, so that nobody is too rich or powerful, it makes more sense to start with the giant corporations, because they wield the most over the economy. But I doubt you could make Elon Musk more productive by making the IRS a co-owner of his ventures.
   I have a better idea.
   Reverse the Republican tax policies that coddle the rich. They argue cuts for the richest taxpayers “trickle down” to all of us, and create jobs, but neither of those things actually happened. I’d go even further. Do away with the so-called “carried interest” deduction that allows hedge fund billionaires to pay the same tax rate as their cleaning ladies, and eliminate the “basis step-up” for heirs.
   Republicans want to eliminate inheritance taxes. I’m fine with that, if they’re willing to tax inheritances as income. They’re not. They want a free tax ride for rich heirs, who are the only heirs paying inheritance taxes. (Their ads depicting granny being put out of her house are b.s.) Let’s be clear about something: Most large estates include unrealized capital gains, and the inheritance tax is the only tax that will ever be paid on those gains; do away with that tax, and those gains become tax-free. This isn’t acceptable in a tax system that doesn’t allow a cleaning lady to deduct her bus fare to her job.
   To explain whythat works, let’s say John Smith bought a warehouse for his business for $1,500,000. Years later, that property is worth $15,000,000, but John Smith never paid a capital gains tax because he never sold it. When he dies, his heirs get a tax basis “step-up” to current market value, so there’s no taxable gain, even though there’s an actual gain of $13,500,000. Without an inheritance tax, that would be tax-free income. I don’t care how you tax it, inheritance tax or income tax, but tax it somehow as a matter of fairness.
   Apologists for our unfair tax system claim the rich pay most of the taxes. Even if this were true, which it isn’t, why shouldn’t the people who have most of the money pay most of the taxes? In any case, this is a half-truth. While it’s true half of Americans pay no federal income tax, and Mitt Romney lost a presidential election by calling them leeches (or words to that effect), this overlooks the fact those folks pay a slew of other taxes (watch video below). The progressive federal income tax is offset by regressive state and local taxes. The overall tax system is still slightly progressive, but not as much as most people think. (The federal government collects about two-thirds of total taxes, state and local taxing authorities one-third.)
   Progressives argue the tax system should be more progressive. I don’t get too excited about that. Soaking the rich for its own sake isn’t high on my list of critical social reforms. I think increasing wages does a lot more for income equality. Raising a billionaire’s taxes doesn’t put more food on the cleaning lady’s table. Raising her wages does.
   An obvious question to ask is whether wealth taxes have worked in other countries. They flopped in Europe, where most countries that experiented with wealth taxes eventually dropped them, because they cost a lot to enforce, encouraged rich people to leave the country, and didn’t raise a lot of revenue. (Read a 2019 NPR article on that topic here.)
   Two Berkeley economists who helped design Sen., Warren’s wealth tax proposal argued in a 2019 Washington Post op-ed (read it here) that argument is “superficial” and Warren’s scheme doesn’t make the European countries’ mistakes, e.g. tolerating tax evasion “to a foolish degree.” They wrote, “We recently calculated that, considering all taxes at all levels of government, the richest 400 Americans pay 23 percent of their income in taxes, a lower rate than the working and middle classes pay.” If that’s the problem they’re trying to solve, you can accomplish the same thing by reforming the income tax code, which is where my thinking is on this subject.
   While the primary purpose of any tax is (or should be) raising revenue to pay government’s expenses, there’s no question the public is highly sensitive to the fairness of the tax system. Many people are offended by the idea of a billionaire enjoying a lower tax rate on his massive income than the cleaning lady on her meager income. The solution, I think, is not to take farm acres or stock or art from the billionaire and give it to the cleaning lady (actually, under Warren’s scheme, the cleaning lady doesn’t gets it), but to adjust the tax rates.

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