Wealth Tax

Paris Hilton and Kim Kardashian
Paris Hilton and Kim Kardashian | Source

Actual, estimated and ideal wealth distribution

Estimated and ideal wealth distributions are from a 2010 survey of Americans
Estimated and ideal wealth distributions are from a 2010 survey of Americans | Source

A wealth tax has the potential to ameliorate a variety of problems in debt, deficit, and fiscal policy in the United States. A wealth tax may also reduce inequality much more powerfully than higher income taxes on high earners.

Most economic and fiscal analysis in America focuses on income. While income is certainly important, and income inequality, income distribution, median income, job creation and other related issues are very important, wealth deserves at least as much attention in discussions of economics and fiscal policy.

In 2010, total household wealth in the US was estimated at $58 trillion. By contrast, the economy as a whole totaled $14.5 trillion in that year.

How a Wealth Tax would Work

Using the numbers for 2010, total government revenue from all sources was $2.2 trillion. With a $14.5 trillion economy, this means that government revenue was about 15% of GDP in that year. Government revenue comes in the form of income taxes, corporate taxes, estate taxes and others.

Suppose instead, the government had eliminated all taxes, and replaced it with a wealth tax. How much of a tax on household wealth would be required to make up all the government revenues for 2010? Simply divide $2.2 trillion by $58 trillion, and we get the answer: about 3.8%. So the government would only need to take out 3.8% of the total household wealth in that year to make up its entire revenue stream.

A flat 3.8% tax on all household wealth would accomplish this goal, or a progressive wealth tax where lower wealth brackets pay a lower percentage, or even zero, and higher brackets pay a higher percentage (say, 4 or 5%).

Daniel Altman, professor at NYU writing in the New York Times, suggests another arrangement:

A flat wealth tax of just 1.5 percent on financial assets and other wealth like housing, cars and business ownership would have been more than enough to replace all the revenue of the income, estate and gift taxes, which amounted to about $833 billion after refunds. Brackets of, say, zero percent up to $500,000 in wealth, 1 percent for wealth between $500,000 and $1 million, and 2 percent for wealth above $1 million would probably have done the trick as well.

Regardless of the specific arrangement, it is clear a relatively small wealth tax would be sufficient to provide enough revenue to the government to eliminate many current taxes, including the personal income tax. A very low wealth tax, on the order of 1% applied to the richest Americans, would potentially enable the government to lower other taxes, while simultaneously reducing the national debt.

These calculations are based on American household wealth. But there is much more wealth in America: businesses and nonprofits also have trillions of dollars in assets. Specifically, the Federal Reserve estimates that in the second quarter of 2012, about $63 trillion in wealth was owned by households and nonprofits together. An additional $24.7 trillion was held by nonfinancial businesses of all sizes. This makes a total of at least $87.7 trillion in net worth. Clearly, a wealth tax across all entities has tremendous power to deliver government revenue while reducing or eliminating other taxes.

Taxes, Incentives and Economic Activity

Taxes affect the economic decisions of individuals and businesses on some level. Some taxes affect decisions more than others. Higher sales taxes, by increasing the price of goods, might have more of a negative effect on purchasing decisions than higher income taxes. Income taxes can affect people's decisions as to whether to take a given job or whether to invest their savings, for instance.

A wealth tax that replaces the income tax would help to remove this adverse impact on economic decisions. With lower income taxes or no income taxes at all, a temporary stimulative effect would likely occur as people would have more money to spend and save or invest. With income generation further incentivized, and hoarding less incentivized, value would move through the economy more readily and frequently.

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Income share of the top 10%, 1917-2008

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US distribution of wealth, 2007

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Social Inequality

While an income tax can be effective in reducing social inequality, a wealth tax would be even more effective.

Much of the inequality in society stems from the inequality in wealth. For example, a wealthy person, even with little or no income, has the luxury of sending their children to the very best schools. Their children thus start life with an advantage that middle class or lower class children do not enjoy. This leads to superior economic opportunities throughout life, from access to better jobs, to more valuable professional and social connections, to an easier time starting and funding businesses, to quicker approval for loans (for cars, homes, boats, or businesses). This perpetuates and exacerbates social inequality through the generations.

Income across society rises and falls from year to year, but wealth is much less volatile. As a result, those who already have significant wealth are affected by economic hardship less and less as time goes on. Those with little or no wealth are severely affected by recessions and economic downturns, because their wellbeing depends almost entirely on their income. The working class family that lives "paycheck to paycheck" is the epitome of the income-dependent existence.

The charts at right show the significant difference in income and wealth inequality in America. In 2007, whereas the top ten percent of earners had about 50% of total income, the top ten percent of the wealthy had over 73% of total wealth. And the top 1% in each category earned 24% of total income, versus owning 35% of total wealth, in 2007.

For these reasons, a wealth tax, especially a progressive wealth tax, would help to ameliorate inequality more effectively than an income tax. The top twenty percent of households held over 85% of total wealth in 2007. By contrast, a solid majority of Americans (60%) owned only about 4% of total wealth.

The fact that the national wealth is mostly held in very few hands implies that an actual wealth tax would barely affect the vast majority of Americans.

Wealth Inequality in the US

Challenges with a Wealth Tax

Bernie Kent, writing in Forbes, points out two major challenges in implementing a wealth tax: valuation and liquidity.

How is one supposed to place a value on their assets? It is straightforward for financial assets or other assets that are publicly traded, since prices are readily available. But for many assets, from furniture and artwork, to cars and airplanes, to houses and jewelry, arriving at a specific dollar value is more complicated. The value of an expensive piece of furniture, for instance, or a car, declines over time with use. So even if it was purchased at a very high price years ago, its current value is likely much lower.

One way around this problem is to set out specific rules for depreciation. Most businesses use various methods of depreciation to express the value of their assets--machinery, land, vehicles, office equipment, and so on.

Another challenge is liquidity. Many assets are illiquid in one way or another, including financial assets like stocks and bonds. A Bentley may be very valuable, but Mr. Moneybags cannot break off a piece of his Bentley and mail it to the IRS (doing so would lower the value of the car anyway). The government can only accept cash. This problem is not unique to a wealth tax, of course. The same issue is faced by property taxes and the estate tax. Yet illiquidity has not created significant payment problems for those taxes.

One way to resolve the liquidity issue is to provide for cash loans from financial institutions based on the value of the asset, similar to home equity loans. Also, if income was taxed less or not at all under a hypothetical wealth tax, income earning would be further incentivized, for the purpose of paying the wealth tax in cash, as well as for income generation for its own sake. This would also stimulate more economic activity.

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