BackWealth taxes have always been a tempting but unhelpful idea
They’re hard to collect properly and distort the economy too much
PremiumThere is a good reason we do not tax wealth directly. Actually, there are many good reasons. But that’s not stopping some states from giving it a try. The best thing to be said about their efforts is that they probably won’t work. But it’s still a bad idea because even trying to collect this tax require resources states don’t have. There are much more effective options for targeting wealthy people for tax revenue that are better for the economy. Some the US is already doing, such as state property taxes, federal capital gains taxes and estate taxes on inheritances. The last two are collected upon an event, when assets are sold or are transferred to another person.
But new bills this week by California and Washington propose taxing their richest residents 1% to 1.5% each year. Four other states including New York and Illinois propose taxing unrealized capital gains, or taxing wealth based on how much it grew in the last year whether or not you sold any assets. How these states will handle assets that lost value is unclear.
Crafting good tax policy starts with a question: How much will it distort economic behaviour? Taxes that impose the fewest distortions incur the least waste and economic harm. Many economists say that wealth taxes create the most distortions, followed by income and consumption taxes.
The problem with wealth taxes is that they discourage saving and investment. A 1% or 2% wealth tax may sound small, but it’s very large compared with current tax rates. Since it’s levied each year, it’s better compared to current taxes on realized capital income. If your assets return 4% in a year, a 1% wealth tax is the same as a 25% capital income tax, and that is on top of existing federal capital gains taxes. These plans drastically reduce the return on risky investment, and rewarding risk is important for economic growth.
But even if you don’t think it’s important, wealth tax is a bad idea because it will be impossible to implement effectively. Income is relatively easy to measure: Your employer sends you money that is well documented and has an objective value. Overall wealth, especially unrealized capital gains, are much harder to measure. On what day do you assess the tax liability? What if asset values fall between when the tax is assessed and the tax bill is due? If the result of such a tax is that people sell assets around the same time each year to pay their tax bills and just generally lower the return on investments, it can depress asset values for everyone, not just the wealthy. Very rich people also tend to hold a lot of their wealth in assets that aren’t publicly traded, either in private equity, in their own businesses, fine art, gold bars or other possessions. California expects to hire people to make this assessment. But it’s not easy. The arbitrary nature of valuing a private asset is why many think private equity returns are unreliable. And because privately held assets are so hard to value and easy to manipulate, it creates an incentive to keep assets private for longer and avoid public markets. That would deprive other Americans the opportunity to invest in the best public companies and reduces business transparency.
This is why most jurisdictions have abandoned wealth taxes. They are very hard to implement at the federal level, let alone by states with fewer resources to collect and assess data on wealth holdings. A possible model is Switzerland, where individual cantons have their own wealth tax, but the tax accounts for a trivial share of tax revenue.
A wealth tax is a bad policy based on the economics and feasibility. Collecting it will require tremendous resources that states don’t have and it won’t produce the revenue they’re counting on. It’s notable that many states now considering it are those that are losing people to tax-friendlier states like Florida and Texas, and are dependent on the few rich people who already contribute a rather large share of their tax revenue.
But what may be the worst part of these plans is that they inflame the politics of envy, where success is not seen as adding to growth and prosperity, but something to be eliminated. These states all face future fiscal challenges. Promising that a few wealthy people can pick up the public tab is bad economics. States would be better off making their consumption taxes larger and more progressive. They can tax luxury goods like designer clothes, private jet travel or second homes heavily. We can better enforce our existing wealth taxes by eliminating loopholes in capital gains and estate levies.
For now, the odds are these bills won’t get much traction. The legal challenges alone will be a hurdle. But wealth taxes will continue to be in the conversation as states and the federal government need more revenue and are reluctant to raise taxes on anyone who earns more than $400,000 a year. Eventually, everyone is going to need to pay more, but there are good and bad ways to do it. Wealth taxes are bad.
Allison Schrager is a senior fellow at the Manhattan Institute and author of An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk.
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