Why we need a wealth tax, why it won’t solve the problem and what we can do instead.

Every election cycle, one formerly niche policy proposal gets thrown front and centre as a realistic solution to solving a myriad of current problems. Generally, the policy idea is either vague or its potential impacts are not enormously well-understood by the general public. In the year 2000 (Bush Jr. v. Gore), it was all about standardized testing and classroom sizes as a way to restore American greatness through education. In the year 2016, the big issue was a border wall with a neighbouring country. In this one, at least so far in the Democratic primaries, the niche policy proposal that will apparently save American from its own demise is a wealth tax. Wealth taxes have been pitched by Sanders and (formerly by) Warren as a way to pay for – well, everything. The idea is politically appealing. Simply tax the rich and use the proceeds to fix the country’s problems. The wealthy and Sanders/Warren’s political opponents (who unsurprisingly don’t love the idea) are politically opposed. For supporters, this means that the idea has struck fear into the hearts of the power and it must therefore be a good idea. It also seems simple enough to do, and therefore a realistic proposal to restore American greatness.

Wealth taxes are not a new idea and are fairly theoretically simple. They are a tax on the total value of personal assets (bank deposits, real estate, business ownership, etc.). They only apply to people whose asset valuations exceed a certain threshold (Warren’s now-suspended campaign noted their “Ultra-Millionaire” tax would have applied only to asset value exceeding $50M USD), meaning it does not affect the over 99% of people who cannot afford it – Sanders’ is correct when he claims that the top 1% currently own 42% of national wealth (despite making only 20% of national income). Wealth taxes target this stored wealth and allow for revenues to be recycled back into investments in public education, health care and infrastructure – the tax means those dollars generate far more utility for society than if they simply increased a profit margin, and would help reduce overall inequality in the country to levels where demagogues who like yelling about it wouldn’t seem quite as smart as they do today. In other words: A wealth tax is a policy tool marketed as the key to restoring the American Dream. The Warren campaign noted that their wealth tax would have raised close to $3.75T USD in revenue over a ten-year period, enough to fund their campaign promises of Medicare-for-all, universal child-care and abolishing student debt.

I’ve written about the need to reduce wealth inequality in the past, noted how inequality has destructive impacts on both growth (it reduces the productive deployment of capital in the economy) and society (it fosters popular resentment and corrodes the ideals of democratic representation). I have also come out against a wealth tax as an instrument. It’s not because it isn’t a neat idea – it’s because implementing one in today’s economic climate simply would not achieve the results people say it would. Some of the barriers could be overcome. One major counter-point raised about wealth taxes is that an individual’s wealth is enormously difficult to measure. But assessments of wealth aren’t impossible; the IRS does have a mechanism for assessing wealth that they sue to administer an inheritance/estate tax (a tax on the transfer of assets from one person to another when that first person dies). The major issue that would be faced in administering the tax in the US would be bolstering the IRS’ staff count, given that the department has lost $715M USD in funding and 22,000 full-time staff since 2010 (and has had periods where almost 50,000 employees were working without pay). If the department doesn’t have staff or resources, increasing their workload simply won’t be possible without details and dollars falling through the cracks.

Not all barriers are so easy to overcome. There are still very real reasons why putting a tax on wealth would not work as expected. One is that putting a tax in place doesn’t solve the loophole/tax haven problem. Tax avoidance occurs when corporations and high net worth individuals store their capital offshore to avoid paying US income taxes on it. Corporations can set up offshore subsidiaries and channel profits through them (prominent examples include Panama and the Cayman Islands, which charge no income tax), sell the patents/licenses to offshore subsidiaries, and then lease them back to American firms to avoid paying the profits on its application (tech firms often do this). Another trick is to buy a foreign firm and then use paperwork to “shift” their headquarters out of the US to a lower-tax jurisdiction. In the US, corporations hold approximately $2.1T USD offshore that is not taxed in the US and are estimated to dodge $90B USD in tax payments. Wealth taxes implemented without massive effort to close these loopholes would lead to “capital flight”, where money that would be taxed flows out of the country. This was the French experience; France’s former wealth tax earned the government around $2.6B each year in revenues but lead to over $125B in capital flight from the country over a little more than a decade.

A second reason wealth taxes don’t work all that well is that while they can be administered, they are also enormously easy to game. Take the current President’s ongoing monologue (since a discussion would require more than one person) about his net worth. He has, at various points and on various tax forms, noted he is worth a value that sits in a range between $1B to $10B USD. However, the amount for which his wealth is insured (a more accurate representation of declared wealth) depends on valuations that would differ based on the valuation or assessment method applied by an individual insurance company. Businesses often do not know the full value of their business until they are sold, namely because valuing non-monetary assets (i.e. vehicles, real estate, businesses and intellectual property) is as much an art as a science. Private businesses account for nearly 40% of wealth and are the single largest sub-category of asset holding that would be affected by a wealth tax. This “grey area” means that it is rather easy to under-report overall wealth or values and therefore escape paying the full value of a tax. In France (a country that has experience in this endeavour and a breadth of examples to draw on), a number of government officials either accidentally or intentionally misreport-ed their wealth by 5%-30% over a fifteen year period. And those are just the ones that got caught.

These two reasons that undermine a wealth tax’s potential effectiveness aren’t just historical examples. Independent assessments that show Ms. Warren’s proposal would not have raised anywhere near as much revenue as it claimed. A secondary assessment by Lawrence Summers noted that the actual policy (which Warren laid out in detail) would have brought in less than half of the revenue it is expected to, a point that her campaign did acknowledge. Nevertheless, despite the barriers to implementation, the logic behind the idea remains solid and inequality remains an issue to be addressed. So the better question becomes what might offer a better solution to reducing inequality while overcoming these two barriers to implementation.

The first step is taking a serious step at plugging tax loopholes and minimizing offshore “flexibilities” to avoid evasion of existing and future taxes. A recent essay by economists Stiglitz, Tucker and Zucman noted that multinationals today shift almost 40% of their profits (over $650B USD) to low-tax jurisdictions around the world annually. Getting around this without passing minimum global tax rates (a popular idea amongst academics but a political non-starter) would be tricky, but could happen through a system that requires companies to pay tax based on where profit is generated, instead of where firms are registered. This condition could be woven into trade agreements, and would increase the rate of tax paid for where profits are generated. Other ideas have been tried and are less effective; the US Government has twice now offered a repatriation benefit (a one-time special tax rate for companies that bring capital home, offered in 2004 and 2018). The 2004 one was largely considered unsuccessful; it brought home $300B USD in capital but the money was used for stock buybacks and did not meaningfully increase domestic investment or domestic jobs. That’s because companies already invest in capacity and their workforce to meet demand as it stands today – any capital brought home is a surplus that can be used to benefit shareholders. That isn’t a bad thing, but it does mean that collecting that revenue can’t be done through income taxes alone, and that repatriation isn’t a magic tool to create jobs.

The second step is, as I have previously outlined, doing a better job of taxing the areas where wealth accumulates instead of attempting to capture every dollar under a single system whose loopholes will inevitably be gamed. The three areas where wealth accumulation is highest are private businesses, real estate and financial investments. Better targeting these areas based on net worth would require a restructuring of only four types of taxes: property, corporate, capital gains and estate taxes. Taxing property based on the value of the underpinning land is a good start – this would better target the underlying value of a resource that can’t be shifted overseas and would help target more valuable land (i.e. land in cities) more directly. The next step would be taking each of these tax forms and making them progressive: this means that tax rates increase based on values, similar to income taxes. Currently, none of these taxes have progressive structures – all have flat tax structures. But incorporating a progressive system where AUM above $5M paid a higher percentage towards a capital gains tax on their investments than households valued below $500,000 would go a long way towards preventing a concentration of capital in places where it is used less productively. The same can be said of estate taxes – higher value estates could be taxed at higher rates during sales or transfers. This would all lead to dramatically more revenue in government coffers and could be done by strengthening and tweaking existing taxation schemes, plugging loopholes and preventing corporate cheating.

Wealth taxes are not a new idea and have had a host of unlikely champions including one surprising one: current President Donald Trump. In 1999, Trump proposed the US implement a one-off wealth tax of 14.25% on net worths of $10M or more, claiming that it would generate $5.7T in revenues and could be used to wipe off the national debt. If the current President and self-described champion of “Making America Great” once believed wealth taxes were a good idea (albeit while he was still a registered Democrat), then it’s indicative that the once-niche policy idea has had some sticking power. It unfortunately also speaks to the convenience of the idea as a panacea to inequality. Given how complicated administering it would be, it’s unlikely that it would fix everything. But targeting wealth in general remains a good idea through higher property, estate and capital gains taxes that can be implemented alongside plugging loopholes. It also may be necessary to ensure that the man who once championed wealth taxes is not a harbinger for the future of a country still trying to find a silver bullet to solve its own structural problems.