Tax Wealth but not the Warren Way

Directly taxing wealth holdings is appealing in part because the rich keep getting richer.  In 1986, the top one percent owned 25 percent of the nation’s wealth.  Now it is about 40 percent.

Surveys show that most people believe that the system is rigged to serve the rich. It is not surprising that a majority of likely voters support presidential hopeful Elizabeth Warren’s proposal to tax households with a net worth exceeding $50 million. 

Her proposed tax is an inelegant and probably unworkable solution to a serious problem. The Warren wealth tax would be difficult to administer, it would be imposed without regard to the actual returns on assets during the year, and is based on the dubious proposition that households with a net worth exceeding $50 million should be taxed but those with $40 million should not. 

Taxing income from wealth is easily accomplished within the existing income tax code.  Some legal authorities question whether a direct tax on wealth is constitutional.

Senator Warren is keen on taxing fine art collections, expensive yachts and other toys of the super-rich.  New funding for the IRS will be required if these hard to value assets are to be taxed.  

We do not need a special tax to reduce wealth inequality.  Well-designed taxes on capital income and inheritance can achieve this goal.  

Long-term capital gains and dividends receive favorable treatment under the tax code. The Joint Committee on Taxation estimates that these tax breaks on income from wealth amounted to $133 billion in 2017. 

The Net Investment Income (NII) tax is currently a 3.8 percent surtax on income from wealth.  Capital gains, interest, dividends, income from rental property, and capital gains distributions from mutual funds are subject to the NII.  Tax returns for married couples filing jointly reporting capital income from these sources and having an adjusted gross income over $250,000 are subject to this levy.

Progressively increasing the NII tax rate can achieve any desired increase in wealth taxation. In addition, it does not require more of our taxes to fund the IRS.

Fixing the inheritance tax is also required.  Three children of Sam Walton are reported to be worth $45 billion.  Imposing some limits on the intergenerational transfer of great fortunes can reduce wealth inequality without imposing the high costs of compliance that will accompany Senator Warren’s proposal. 

There is concern among some economists that taxing wealth will have a negative impact on investment.  Lower wages and reduced employment under this scenario would aggravate the trend of rising income inequality.

To the extent that most wealthy households are not active entrepreneurs, this concern is exaggerated. 

Senator Warren’s proposal is inadequate because it arbitrarily imposes the net worth tax on households with $50 million or more in assets.  It is not a serious attempt to tax wealth.  Targeting the super-rich is a symbolic effort that has widespread political appeal. Her proposal imposes heavy compliance costs that will only add to the IRS bureaucracy.

An equitable and efficient wealth tax will focus on the income from assets.  Reconsidering current tax breaks on dividends and capital gains, coupled with a progressive Net Investment Income tax, can create an equitable and efficient tax on wealth.

David W. Rasmussen is an economist and Dean Emeritus of the College of Social Science and Public Policy at Florida State University.

The feature image is from the Huffington Post.

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