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Wealth Tax – What It Is, Pros & Cons of Current Proposals

During any election year, presidential candidates unveil plans and proposals, promising to solve problems ranging from taxes to immigration and health care to job creation. During the United States’ 2020 presidential primary, Sens. Elizabeth Warren and Bernie Sanders both unveiled plans for a wealth tax, which would, in theory, deliver the revenue needed to fund a “Medicare for All” plan.

But Warren and Sanders didn’t create the concept of a wealth tax. In fact, the idea has been put into practice around the world, beginning as far back as ancient Athens. Even today, several European countries, including Spain, the Netherlands, Norway, Switzerland, and Italy, tax net worth or the value of assets exceeding a certain level.

While wealth taxes can come in many forms, there’s a lot of misinformation and misunderstanding regarding how they work and how they differ from income taxes.

What Is a Wealth Tax?

A wealth tax is an annual tax on a person or entity’s assets rather than their income. That can include personal property, cash in bank accounts, real estate, retirement accounts, investments, interest in a business, and anything else of value.

Typically, the taxpayer can deduct any debts, such as mortgages or other loans, from the total of their overall wealth, making it a tax on their net worth. Additionally, most wealth taxes only apply to people with financial assets above a certain level.

For example, say you own $10 million in assets and have a $1 million mortgage debt on your home, making your net worth $9 million. If you had to pay a 2% wealth tax on anything over $5 million, you would owe $80,000.

Wealth tax advocates argue it would be an effective way to raise revenues, address the federal deficit, and fix America’s health care system. It would also address wealth and income inequality because it would encourage the wealthiest taxpayers to use their wealth rather than leaving it unspent in a bank account or invested in underutilized property.

Unlike raising income or other tax rates, it would also specifically target only the richest American households — those who currently have tens of millions of dollars in cash and assets.

Wealth Tax vs. Income Tax

Currently, the federal income tax is one of the primary sources of federal tax revenues. Under our current income tax system, people pay taxes on the money they receive during the year. The U.S. has a progressive tax system, so people with higher taxable income pay higher federal income tax rates.

However, the tax code also includes several tax deductions, credits, and incentives that often mean wealthy people pay a lower effective tax rate than middle-class taxpayers. For example, the long-term capital gains tax rates range from 0% to 20% compared to 10% to 37% for ordinary income, such as wages and income from self-employment.

As a result, a single person with $100,000 of taxable income from wages would be in the 24% tax bracket for 2021. Their neighbor, who lives off a trust fund that pays $100,000 per year in long-term capital gains would pay only 15% on the same amount of income.

That’s why billionaire investor Warren Buffett penned a 2011 op-ed for The New York Times famously claiming to pay a lower tax rate than any of the other 20 people in his office, including his secretary.

Proponents of a wealth tax argue it would make the U.S. tax system more progressive and reduce income inequality by ensuring that wealthy individuals — who earn most of their money from investments — pay their fair share.

Recent Wealth Tax Proposals

President Joe Biden’s tax plan doesn’t include a wealth tax, but Warren recently renewed calls for one. The good news is you and I and just about everyone we know won’t pay anything at all under Warren’s tax plan. That’s because most wealth tax proposals target only the very wealthy.

Warren’s proposal would impose a 2% tax on individual wealth over $50 million with an additional surtax on every dollar of wealth over $1 billion. While the latest press release doesn’t provide a rate for the additional surtax, Warren’s previous proposals have included a surtax ranging from an additional 1% to 4%.

Economists Emmanuel Saez and Gabriel Zucman are professors of economics at the University of California, Berkeley and consulted with Warren. They estimate her plan would affect about 75,000 American households (less than 0.1%), and the tax would raise around $2.75 trillion over 10 years.

Sanders’ version of a wealth tax would impose a rate of:

  • 1% on wealth above $32 million for married couples ($16 million for single people)
  • 2% on wealth between $50 million and $250 million for joint filers
  • 3% on wealth between $250 million and $500 million
  • 4% on wealth between $500 million and $1 billion
  • 5% on wealth between $1 billion and $2.5 billion
  • 6% on wealth between $2.5 billion and $5 billion
  • 7% on wealth between $5 billion and $10 billion
  • 8% on wealth over $10 billion

Federal lawmakers aren’t the only ones talking about a wealth tax. In 2020, California State Assembly members introduced AB-2008, a bill that would impose a 0.4% tax rate on all California residents with a net worth above $30 million.

Pros & Cons of a Wealth Tax

Like any fiscal policy, there are advantages and disadvantages of implementing a wealth tax.

Wealth Tax Pros

If the U.S. puts a wealth tax in place, there are a few potentially appealing aspects — especially for middle-class Americans.

1. Middle-Class Tax Relief

Over the last few decades, middle-class incomes, after taxes and benefits, have grown half as fast as those of the rich, according to an analysis from the Congressional Budget Office. Some wealth tax proposals don’t just increase taxes on the wealthy but reduce the middle class’s tax burden.

For example, Richard V. Reeves and Isabel V. Sawhill, senior fellows of economic studies at the Brookings Institution’s Center on Children and Families, recommend eliminating income taxes for most middle-class households by raising the standard deduction to $100,000. Such a change would relieve much of the tax burden placed on middle-class families.

2. Eliminate Tax Loopholes

Wealthy taxpayers can take advantage of complicated tax planning strategies and tax loopholes that minimize their income taxes. A wealth tax would be harder to work around.

3. Reduce Wealth Inequality

According to the Federal Reserve, the top 1% wealthiest families in the U.S. own a greater share of the country’s wealth (38.6%) than the bottom 90% of families combined (22.8%).

The Peter G. Peterson Foundation found that a wealth tax would help fund programs that would ensure the benefits of economic growth would be more evenly distributed, benefiting lower-income Americans and helping to reduce wealth inequality.

4. Encourage Hiring

Saez and Zucman argue that a wealth tax could disincentivize companies and their shareholders from holding on to wealth and encourage hiring, which could positively affect low- and middle-income families.

Wealth Tax Cons

Of course, not everyone is sold on the idea of a wealth tax. Opponents believe it wouldn’t deliver the promised benefits and could create additional problems.

1. Double Taxation

According to the Tax Policy Center, many wealthy taxpayers already pay corporate income taxes, individual income taxes, and estate taxes. A wealth tax would tax that income again if a business owner decided to hang on to their wealth rather than spending it.

2. Wealthy Residents Could Relocate to Avoid the Tax

There’s a risk that wealthy individuals would relocate to another country to avoid the tax, just as more than 42,000 millionaires left France before the country eliminated its wealth tax in 2018.

Both Warren and Sanders’ wealth tax proposals addressed this scenario by imposing a 40% “exit tax” on the wealth of anyone who tries to renounce their U.S. citizenship.

3. Potential for Tax Evasion and Avoidance

Saez and Zucman acknowledge that tax avoidance and evasion were an issue in many European countries that attempted a wealth tax. In the U.S., wealthy individuals may try to avoid it by sheltering their assets in foreign bank accounts and investments.

However, the IRS’s Foreign Account Tax Compliance Program has been effective at cracking down on U.S. taxpayers who attempt to evade taxes by holding investments in offshore accounts.

4. Administrative Burdens

It’s difficult to determine the market value of many forms of wealth, such as privately held companies, personal and household effects, and some investments.

Would taxpayers need to pay for annual business valuations or appraisals? Would the IRS need to have qualified antiques, jewelry, and art experts to audit tax returns? That could place a significant administrative and compliance burden on individuals and taxing authorities.

Final Word

There are many ways in which the U.S could change its tax system to reduce income inequality and increase tax revenues. Besides enacting a wealth tax, lawmakers could tax capital gains at the same rate as labor income, tax investment gains annually (whether or not they’re sold), lower the estate tax exemption, or double the top income tax rate.

Few Americans believe the rich are undertaxed, and the shrinking middle class can’t shoulder the burden of paying for Social Security and Medicare, improving health care, and safety net programs. While a wealth tax comes with its own challenges, it’s not out of the question to think it could solve some of the issues facing the country today.

Janet Berry-Johnson is a Certified Public Accountant. Before leaving the accounting world to focus on freelance writing, she specialized in income tax consulting and compliance for individuals and small businesses. She lives in Omaha, Nebraska with her husband and son and their rescue dog, Dexter.