What are the chances of a new wealth tax in the United States?
“Slim to none” is the sort answer, and this would be a very short blog post if not for the recent publication of a book by the French economist, Thomas Piketty, entitled “Capital in the 21st Century.” If you have a year or so of your life to spare, you can read the 900 page book for yourself. Or you could have learned about it by attending a panel of law professors, one economist and one tax lawyer (me) at the American Bar Association Tax Section meetings in Denver on September 19.
By way of background, President Obama laid the groundwork for this debate during the last election when he chose to make inequality a campaign issue. In fact, inequality in the United States has been increasing (especially in the top 1% and .1%) and the statistics are quite staggering. Currently, in the US, the top 10% own 70% of the wealth. The top 1% own 35% of the wealth and receive 22.5% of the total income. The bottom half, however, own only 5% of the wealth and the richest 85 individuals in the US own more than the 3.5 billion poorest people in the world combined.
Closer to home, a typical CEO’s salary is about 200 times the average employee’s salary in that same company (compared to 50 times average in the 1970s). You can partially blame me for that, as the wealth of CEOs in Silicon Valley is directly tied to equity compensation programs, such as the kind you can find on our Legal Wizard website.
Mr. Piketty’s book points out that income and wealth inequality is an essential feature of capitalism and it will always continue to increase, eventually creating political instability. For example, income from labor in the US has decreased from 68% to 62% of total income from 1970 to 2012. Piketty maintains that when the rate of economic growth is low, wealth accumulates faster from capital than labor, and inequality increases. He expresses the idea as the relation: r>g, where r = return on capital and g = income or output. Simply put, when the rate of return on capital exceeds the economy’s growth rate, capital income rises faster than wages, concentrating more wealth in fewer people. Thus, the majority of people become poorer and crises results.
To solve this problem, Piketty proposes a global wealth tax and a high (80%) upper income tax. The wealth tax would be levied like a property tax, but on wealth instead of property which, unlike a property tax, nets out liabilities from the tax base. If a wealth tax reduces r below g, inequality would not increase. Mr. Piketty emailed me last week and described how he would deal with this issue in the United States:
“In my view, the right approach to wealth tax reform in the US might be to start from the existing wealth tax system, namely the property tax, which raises a lot of tax revenue in the US (as compared to other developed countries). My proposal would be to keep the tax revenues constant, but to transform the property tax into a progressive tax on net wealth. In effect, this would reduce significantly the tax burden of the bottom 90% of US households who have very little net wealth. Everybody would clearly see that the primary objective is to increase wealth mobility and access to wealth, not to tax the rich per se (although this would imply taxing the rich more). The point is that it makes no sense to tax heavily indebted households as much as those with huge financial wealth! The problem is simply that the property tax was created at a time when financial assets and liabilities did not matter as much as they do today. Of course I understand that this is constitutionally impossible to do such a property tax reform at the federal level. But (i) this was the same [problem] with the creation of the federal income tax a century ago, and finally it happened; (ii) state [governments] can move in this direction if they so wish.”
Obviously, the idea of a national wealth tax has attracted some criticism, and some proponents. Our ABA Panel had the following thoughts on the subject.
Professor Richard Lavoie of the University of Akron School of Law likes the idea of a wealth tax. Professor Lavoie believes that the wealth tax should be used as a tool to directly curb wealth inequality and notes that inequality has been rising since the “greed is good” 1980’s. Although John F. Kennedy may have said that a rising tide lifts all boats, the actual experience has been that the wealthiest boats rise more that the boats in the lower percentiles. For example, from 1978 to 2011, the S&P 500 increased by 349% while CEO pay rose at twice that rate.
Economic studies show that high inequality at the start of a decade negatively impacts economic performance in the ensuing period. This trend has both political and social ramifications. Politically, the fact of having great wealth can influence the political process because the power to spend may threaten the actions of elected officials. This, the wealthy can use the mere existence of wealth (without actually spending anything) to influence the process.
Socially, the divergence of society between rich and poor undermines social cohesion and the shared values necessary for a well-functioning economy and democracy. Social mobility decreases as inequality rises and classes become more stratified.
To address these issues, Professor Lavoie proposes an equality tax. The Equality Tax would be aimed at directly reducing inequality rather than revenue raising. Revenue from the tax would be used to reduce the roots of inequality via education and retraining programs. The tax would be levied at a rate of 5% tax on net worth over $100 million, increasing to a 10% on net worth over $500 million. Anticipating the potential objections to such a tax (unworkable, un-American, unconstitutional and un-thinkable), Professor Lavoie notes that the tax would affect relatively few who would not leave the country because of it, and concludes that Atlas would likely not shrug if the US adopted an equality tax.
Professor John Plecnik of Cleveland-Marshall College of Law points out that similarly situated individuals should be taxed similarly. By that standard, the income tax is not fair. For example, a taxpayer who sells an appreciated asset will recognize a taxable gain. If that taxpayer borrows against that asset instead of selling it, he does not have a taxable gain, even though the taxpayers are similarly situated. Further, at death, a decedent’s tax basis in his assets is stepped up to fair market value so that the gain inherent in the assets may never be taxed. There may be an estate tax at death, but the step up in basis costs the US Treasury more in taxes than it earns though the estate tax. Warren Buffet, for example, need never pay taxes as long as he simply borrows against his appreciated assets.
The sales tax may seem fair because it is a flat rate across the board. However, the sales tax is very regressive and, since it is based on consumption, does not tax pre-existing wealth. A very wealthy person might pay very little sales tax if he does not consume very much. Think of Ebenezer Scrooge. A person’s ability to pay has nothing to do with their consumption. Oddly, liberals and conservatives both like consumption taxes, albeit for different reasons. Conservatives often promote the flat tax, for example, and the value added tax (VAT) is a liberal idea. Professor Plecnik believes that both groups have it wrong, but for different reasons.
A tax on wealth, however, is fairer than a tax on either income or consumption because it falls most heavily on those who derive the greatest benefit and have the greatest ability to pay. It is also pragmatic and necessary because it reaches the largest and most obvious source of revenue – pre-existing wealth.
Would a wealth tax be constitutional? The Apportionment Clause of the US Constitution provides that “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.” In other words, taxes must be imposed among the states in proportion to each state’s population in respect to that state’s share of the whole national population. Income taxes are not subject to this apportionment due to the 16th Amendment, which expressly allows income taxes without apportionment.
Is a wealth tax a direct tax, subject to apportionment? There are a few arguments that could be advanced in support of a wealth tax. The wealth tax could be recast as an income tax, which is expressly allowed. That would be a risky form over substance argument. Or the wealth tax could be conceded to be a direct tax but then apportioned to the states in accordance with Article 1, Section 9.
Diana Furchtgott Roth is a Director, Economics, and Senior Fellow at the Manhattan Institute for Policy Research and her paper is entitled “Piketty’s Inequality Conclusions Inaccurate, Recommendations Impossible” lest there be any confusion as to where she stands on the issue. Her main points are that a wealth tax would slow worldwide economic growth and hurt rather than help, lower income individuals. Ms. Roth disputes Mr. Piketty’s data and believes that his conclusions are exaggerated. More specifically, Mr. Piketty uses the terms wealth and capital interchangeably whereas they are not the same, and taxing capital and taxing wealth are two very different things.
Another problem is that there is no single rate of return, r, on capital (or wealth). The rate of return on T-bills is less than the return on stocks, and the return on some risky assets may even be negative. Most Americans will have capital during their lives, in the form of retirement plans, which would be diminished by a wealth tax.
Mr. Piketty contends that inequality has increased since the 1970’s. That conclusion suffers from some problems. First, the Tax Reform Act of 1986 resulted in a movement of income away from corporations and onto individual returns, because individual rates were lowered. Secondly, Mr. Piketty measures income before taxes. The top 1% wealthiest persons pay 35% of all income tax. The top ½ pay about 98% of taxes and the bottom half pay about 3%. A more accurate measure would be based on after-tax numbers.
Mr. Piketty does not take into account the movement of women into the workplace in the 1980s. This has changed demographics. The size of households has also changed – more are one person or non family households and tend to be in the lower quintile. Also, the data ignores mobility between quintiles (which is substantial) and focuses on the extremes.
Professor Alice Abreu of Temple University Beasley School of Law believes that we should look to the income tax, not the wealth tax, to address inequality. In other words, tax labor less. Proponents advocate for a wealth tax over an income tax for two reasons. First, a tax on wealth would incentivize wealthy people to maximize returns. This is a weak argument. Secondly, an income tax can never go far enough because income is a small percentage of wealth. Those arguments also assume the income tax as it exists. Practical and policy reasons support considering a differently designed income tax. It is hard to add a new tax to the system and there is little support even for expanding the estate tax. Taxing accretions to wealth (rather than taxing wealth) is the “devil we know” (and prefer).
The Camp proposal basically adopted the alternative minimum tax (AMT) as the tax base. It was scored revenue neutral (with dynamic scoring) and reduced the tax at all brackets with the greatest reductions in the lowest quintile and the smallest at the top 1%. At the top quintile, all of the reduction would have gone to the top 1% (and particularly the top 0.1%).
At the other end of the stick is the social security tax – a tax on labor, not capital, which is a cause of rate disparity between the top and low income earners. It would be the easiest tax to cut (we have done it recently with the 2010 holiday). Professor Abreu suggests reducing the employee rate (which can be recouped by increasing the cap) and using the 2010 payroll tax holiday as a model. It is likely the most achievable means of addressing tax inequality through the tax system.