Senator Warren’s Wealth Tax: A Study in Economic Ignorance

by | BLOG, CONSTITUTION, ECONOMY, FREEDOM, GOVERNMENT, HYPOCRISY, POLITICS, TAXES

On February 2^nd Senator Elizabeth Warren announced that she will join the Senate Finance Committee, the committee tasked with writing this country’s tax laws. She stated, “I’m very pleased to join the Finance Committee, where I’ll continue to fight on behalf of working families and press giant corporations, the wealthy, and the well-connected to finally pay their fair share in taxes.”

Warren has often advocated for a wealth tax in the past, especially during her campaign last year for the Democratic presidential nomination.  But now she is actually in a position to make proposed legislation happen. In fact, she’s promised that it will be her “first order of business.”  This is wrongheaded on many levels, including fairness, constitutionality, impossibility of implementation, history of failure, negative effect on the economy, and morality. 

Fairness:   Senator Warren has always maintained that corporations and the wealthy are not paying their “fair share”. She has never addressed the question of what that “fair share” might be. That is not surprising, since corporations and the wealthy in the US pay a far higher share of the tax burden than is paid in virtually every other country in the developed world – and by a wide margin. This results not from very high rates, but rather from the fact that our poor and middle class –  almost 50% of our population –  pay almost no income tax. According to the Tax Foundation’s 2021 data analysis, in 2018 (the most recent figures available),“the top 50 percent of all taxpayers paid 97.1 percent of all individual income taxes, while the bottom 50 percent paid the remaining 2.9 percent.” Additionally, “The top 1 percent paid a greater share of individual income taxes (40.1 percent) than the bottom 90 percent combined (28.6 percent).” To add a wealth tax on top of the already extremely progressive tax system would be anything but fair.

The grotesque unfairness of a wealth tax is even more evident when it is actually calculated. This can be seen by the following example: Assume that an investor with $100M net worth in the present low interest environment (and because not all of his wealth is appreciating assets) has an average rate of return of 4%. His income therefore is $4 million. The investor would pay an income tax rate of about 45% total combined federal/state/local taxes which would be $1.8 million in taxes. Now consider a 2% wealth tax tacked on, which would be an additional $2 million. This would mean the investor would pay a total of $3.8 in taxes and he would have an effective tax rate of 95%. What’s even more sobering is that if he earns less than 4%, or if his tax rate was more than 45% (which it will be with Biden’s plans), then the investor’s taxes would be in excess of 100%.

Constitutionality:    Our Constitution provides in Article 1, Section 9, Clause 4 that: “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.” 

Both our income tax and a wealth tax would run afoul of this provision. To make the income tax constitutional we had to add the 16th Amendment. But no such amendment exists for the wealth tax. It may be that wealth tax proponents would argue that this tax is somehow taxing income potential using wealth as a proxy. But no Supreme Court, other than an off-the-charts progressive one, would approve of such strained logic.  In fact, there’s currently a case before the Ninth Circuit Court of Appeals challenging Trump’s Mandatory Deemed Repatriation Tax on the ground that it is, in fact, an unconstitutional wealth tax.

Implementation:  Taxing someone’s wealth requires determining the fair market value (“fmv”) of his or her assets, and then (presumably since no details are currently available) subtracting all liabilities. For anyone of considerable wealth, this would be an extraordinarily expensive, time consuming, and complicated effort. Even for assets that might have a publicly available market for valuation, it isn’t that simple. Consider volume. If someone has a substantial amount of something, you normally would apply a discount, since selling large volumes of assets can upset the market and reduce the overall value of an item.

But not everything has a value that can be determined easily. Investment in a closely held business, or real estate, or even paintings are examples of assets that are not susceptible to easy valuation on an annual basis, making it not very economically feasible to try to do so. Additionally, valuation can be determined in any number of ways — such as appraisals, discount rates, and reductions in the lack of marketability– so that valuations may be varied.

Another factor that makes valuations difficult are contingencies. For example, many assets have contingencies backed up with guarantees, and it’s difficult to value those contingencies. Finally, there is a question of liquidity/ability to liquidate or pay. Most people who have extraordinary assets like that often don’t have sufficient income or liquid assets to pay a wealth tax on them. Since many assets are not easily marketable, there could be a liquidity crunch.

Of course, a wealth tax would add even more burdensome complexity to the already byzantine tax code. The IRS would have to substantially increase its number of  agents and its budget just to have the manpower to devote to compliance and enforcement. Given the IRS’s history of being discriminatory and incompetent, this is not a good thing. 

Failure:  It should also be noted that the wealth tax has already been tried — and failed — repeatedly.  At one point, 15 European countries had a wealth tax. To date, all but four nations have since repealed it because it was ineffective in accomplishing its goals and was extraordinarily complicated and expensive to administer. Additionally, the wealth tax induced capital flight and asset hiding.  For instance, in 2017 France decided to abandon its wealth tax after it caused the loss of “10,000 people with about 35 billion euros ($41 billion) in capital abroad” over a 15 year period according to the Prime Minister.  Likewise, Switzerland — one of the four remaining wealth tax countries — experienced substantial tax evasion, noting that a mere “.1% wealth tax lowers reported wealth by 3.4%” according to a study by the National Bureau of Economic Research. As Switzerland has a wealth tax rate of 1%, that amounts to 34.5%  in unreported assets.

Effect on the Economy:  The growth of our economy is dependent on putting capital to productive use. Every time a corporation reinvests its retained earnings, or an individual puts his wealth to work by investing in an ongoing or new venture, the economy grows. This growth results in new purchases of equipment, facilities, hiring of employees, research and development, etc. Conversely, when capital is removed from the economy, such as by requiring the payment of a wealth tax, the economy shrinks. In fact, the wealth tax is a form of double taxation. Wealthy Americans already pay  taxes on their income; under a wealth tax, they would then be taxed again for keeping that income in various assets. This not only punishes success, but discourages investment and savings.

Though progressives may argue that the capital taken out of circulation will be used to redistribute income to those who will spur the economy by consuming those funds, we revert back to Economics 101 – consumption has a much smaller effect on the economy than investment.

Morality:    There is no moral justification to take something from someone just because they have it, even if they have a lot of it. One is reminded of the great scholar Thomas Sowell, who understands this quite well: “Since this is an era when many people are concerned about ‘fairness’ and ‘social justice,’ what is your ‘fair share’ of what someone else has worked for?” The wealthy in this country are an extraordinarily charitable group. But it should be their choice as to how charitable they wish to be with their hard-earned assets. 

Senator Warren has argued that a real benefit of this tax is that it will only affect a relatively small number of people. This reveals what this tax really is – an attempt to foment class warfare by giving a large number of people (read: voters) a benefit through confiscating substantial amounts of money from a small group. 

A wealth tax will certainly not bring in the revenue expected by the progressives – who relish the thought of punishing wealthy Americans in order to throw more money at their failed policies. Wealth redistribution is inherently the antithesis of the American Dream. Bastiat was right. No matter how you spin it, explain it, try to justify it, a wealth tax is simply “legal plunder.” Perhaps Senator Warren is being disingenuous (since the wealth tax would never be passed) but she will nevertheless score political capital among her constituents who do not know any better.  She is taking advantage of the lack of economic knowledge among people who don’t understand the complexity and stupidity of a wealth tax.