A New Wealth Tax? Or Strengthen the Tried-and-True One We Already Have?

Senator Elizabeth Warren has offered up a proposal for wealth taxation – three percent per year on fortunes over a billion, two percent on fifty million and up, with in-kind equivalents for the owners of private companies, so that Bloomberg and the Kochs would simply hand over shares in their firms which the government would then auction to the public, diluting the ownership over time.

The impulse is admirable, to rid America of the vulgar plutocrats who infest our politics, our culture and our very lives. Warren’s tax would hit only seventy-five thousand households a year, the very tip of the iceberg. Its advocates confidently claim that it can be done – most American wealth is in liquid stocks and bonds, most is inside the country, holding and hiding things overseas is hard, and so forth.   While it’s true that thresholds are problematic – the billionaire four times over could save forty million each year by splitting his wealth with a spouse and two children – advocates don’t seem overly worried by that. And they confidently dismiss constitutional objections, possibly with correct legal arguments but more faith in the current Supreme Court than I’m inclined to share.

All that said, the idea does not seem very serious to me. It would have strange incentive effects, rewarding high-risk investors over the cautious, and those whose fortunes originate and may be held offshore (think Sheldon Adelson’s casinos in Macau) over locals. It would depress the price of liquid financial assets in favor of those that are easier to hide or harder to value. Chances are, it would bring us even more gaudy mansions and hidden art collections than we have already.

But there is a deeper problem. How would the Internal Revenue Service even know who has wealth at or above the thresholds and who does not? The only way is for every household, however modest, to maintain an inventory of its wealth holdings – stocks, bonds, houses, cars, art and jewelry – as of some particular date in the year and to report on this annually in a tax filing. Otherwise, how does one know that the girl next door isn’t a dot.com multi-millionaire, an heiress or a discreet drug dealer?

You can’t have a tax without a tax base. To collect this information, and to check it (!) even on a spot-check basis, for all American households would mean constructing an entirely new tax system, far more complex and onerous and intrusive than the one we already have. The present one, in all its complexity, works (to the degree it works) largely because income is a relatively clear-cut concept, possible if not easy to define in law, and because the populace remains (despite considerable evidence) persuaded that income tax is largely fair and effective. It would be very difficult to persuade them on a wealth tax, even though the declaration for most households might be quite simple, and even if one could come up with a good reason, as to why the US government needs to know about everything of possible value that one might happen to own.

Of course, we can and do tax wealth already. We do it through the estate and gift tax, and this has two practical virtues. First, it applies mainly at death of the estate-holder, when assets can be frozen and appraised, once for all, and then taxed before they are distributed to heirs and assigns. Thus it is integrated into a process that has to occur anyway, with any significant estate. Second, it creates a large incentive for the rich to give their assets away while still living – to non-profit institutions – and this recycles accumulations into current spending and jobs in education, health care, religion and the arts. The effect in the United States is considerable: about eight percent of all jobs are in institutions funded in part by estate-tax socialism.

And much could be done to make the estate tax stronger. It should have a higher, tiered set of progressive rates, becoming nearly confiscatory at levels of a billion dollars or more. (No American should die with that much money still in hand.) It should have a high threshold, so that it does not threaten the ordinary middle class. It should have fewer loopholes, less abuse in the valuation of assets transferred, and the trusts and charitable foundations created by the mega-wealthy should be subject to limited life spans, and in the case of foundations higher payout rates.[1]

The underlying principle is that in a dynamic capitalist system the rise of great fortunes is not avoidable, nor entirely undesirable. Schumpeter had a point: the system runs on the competition for large gains. But in a democratic republic, the wealth passed on to heirs and assigns should not be such as to create a caste of hereditary plutocrats, who then direct and dictate the politics of the country. In the next generation, the wealth should be diffused over the society at large – and in such a way that the wealthy are duly and suitably honored for their generosity however tax-induced it may be. In this way, public and para-public institutions ultimately benefit from private accumulations.

Senator Bernie Sanders has been working along these lines and has made a proposal to strengthen the estate and gift tax, with a much higher rate on big fortunes. And while the Sanders proposal can be improved, it’s based on the tried-and-true, and not so much on the attention-grabbing and flashy. So while Senator Warren deserves praise for bringing renewed notice to the curse of plutocracy, dynasty and private power, an effective path to reform lies through channels already well-established in the American democratic tradition and known to work.

Notes

[1]   For a documented list of feasible measures, see the Shelf Project of Calvin Johnson, Professor of Law at The University of Texas at Austin. Other measures that would strengthen our current taxes on wealth include ending the step up in basis at death, along with curtailing real estate shelters and the carried interest loophole, and treating gains on the sale of depreciable property as ordinary income.

James K. Galbraith holds the Lloyd M. Bentsen Jr. Chair in Government/Business Relations at the LBJ School of Public Affairs, the University of Texas at Austin. His most recent book is Inequality: What Everyone Needs to Know (Oxford, 2016).