The Economic Effects of an “Ultra-Rich” Wealth Tax

“Reducing inequality” is emerging as a major focal point in the presidential primary. Several anticipated and declared candidates have declared their support for tax policies that they believe will reduce the gap between the rich and the rest in America.

Yet as our previous article on a proposal to raise top marginal tax rates points out, engineering equality through the tax code can be harder than it seems.

Below, we consider presidential candidate and Senator Elizabeth Warren’s (D-MA) proposal to tax the wealth of the ultra-rich who hold fortunes over $50 million.  

What Is the Plan?

Dubbed the “Ultra-Millionaire Tax,” Sen. Warren’s plan taps research from University of California, Berkeley economists Emmanuel Saez and Gabriel Zucman to target the “richest 0.1% of Americans” for an estimated tax harvest of $2.75 trillion over a decade.

This tax is intended to be redistributive and possibly punitive. Sen. Warren’s website notes that “a small group of families has raked in a massive amount of the wealth American workers have produced, while America's middle class has been hollowed out.”

Here is how it would work: Households with a net worth of $50 million or more would pay an annual tax of two percent on every dollar above $50 million and three percent on every dollar above $1 billion.

“Net worth” includes all assets, some of which are easier to value than others. The value of things like stocks, bonds, and real estate are fairly straightforward to measure. But many assets, like collectibles, art, and private businesses, are harder to assess (and perhaps better vehicles through which to scuttle away wealth).

Wealth taxes have been historically plagued by “ultra-millionaire” mobility. Zucman, who is assisting Warren on the plan, is an expert on such tax avoidance issues. The Ultra-Millionaire Tax, therefore, contains “strong anti-evasion measures” like a 40 percent exit tax on any targeted household that attempts to emigrate, minimum audit rates, and increased funding for IRS enforcement.

How a Wealth Tax Compares to a High Income Tax

At first glance, Warren’s wealth tax might seem modest, compared to the aggressive 70 percent income tax bracket championed by Representative Alexandria Ocasio-Cortez (D-NY). A two or three percent tax sounds less severe than 70 percent; perhaps that’s why Warren’s plan is about 28 percentage points more popular than Ocasio-Cortez’s.

But comparing an income tax bracket to a wealth tax is apples-to-oranges, and in reality, Warren’s idea is far more drastic.

As we wrote previously, a 70 percent income tax would only apply to income over a certain (high) limit; Rep. Ocasio-Cortez has said it would tax income above ten million dollars. But almost no one makes over 10 million dollars in traditional income—most of the super-rich gather their wealth through capital gains. So the income tax isn’t an effective means for reducing inequality, and the additional taxes from a 70 percent bracket would amount to less than a four percent increase in government revenue.

On the other hand, Sen. Warren’s wealth tax would target the essence of American fortunes. The households that met the threshold—around 75,000—would be required to value all of their assets, which would then be subject to a two or three percent tax every year. Sen. Warren’s team estimates that all of this would bring $2.75 trillion to the federal treasury over ten years, well over three times the sum that Rep. Ocasio-Cortez’s 70 percent tax rate would generate.

Obstacles to Implementation

Wealth taxes were a hot topic about five years ago, immediately after French economist Thomas Piketty published Capital in the Twenty-First Century (a work that a Mercatus scholar responded to in-depth here), which decried economic inequality and suggested a global wealth tax.

While even Piketty admitted that his proposed solution was “utopian,” a worldwide tax would theoretically prevent wealthy households from merely moving their wealth elsewhere to avoid tax incidence—the same problem that probably inspired Sen. Warren to include a 40 percent exit tax in her plan.

In America, however, wealth taxes pose thorny legal issues.

The Constitution explicitly forbids Congress from levying a “capitation, or other direct, tax... unless in proportion to the census or enumeration herein before directed to be taken.” In other words, direct taxes have to be proportional to state population—something that certainly wouldn’t be the case with Sen. Warren’s wealth tax, which would affect relatively rich states disproportionately. While the Sixteenth Amendment abolished this requirement for income taxes, wealth taxes are never mentioned. Observers have argued the Constitutional question both ways, but any wealth tax would almost certainly trigger an immediate legal challenge.

The law would also prove difficult to enforce.

The valuation of illiquid assets, like paintings or privately held companies, is complex. Sen. Warren’s plan provides room to hire a legion of IRS employees to evaluate assets, but there would be plenty of incentive for the wealthy to value these holdings as low as possible. Since value is ultimately subjective, estate-related questions would be difficult to answer, and the assessments would be incredibly time consuming, thus robbing the economy of more productive uses of skilled labor.

Economic Consequences

Even if the practical and legal issues were surmountable, a wealth tax would almost certainly be anti-growth. Mercatus faculty director Tyler Cowen has pointed out that such a tax would “lower investments in human capital and the creation of new businesses.” While it might be tempting to imagine that large accumulations of personal wealth just sit in a hidden vault, that image is entirely inaccurate.

In fact, the savings of the rich are quite active. They are disproportionately likely to invest their wealth, which provides fuel for long-term projects, risk-taking entrepreneurship, and the development of unexploited potential. A wealth tax might not cause economic indicators to tumble immediately, but the American economy would eventually become less dynamic and competitive as a result.

Cowen has also written that Sen. Warren’s tax would duplicate the effect of the capital gains tax, which, since it is not indexed to inflation, can actually have a negative real impact on wealth. Implementing what would be in effect a second wealth tax would only double down on the anti-growth consequences.

Unlike the capital gains tax, however, a direct wealth tax would have the least effect on those whose wealth grows the fastest, while having the most punishing effect on those who are less successful. This is ironic, given Sen. Warren’s stated objective of reducing wealth inequality, but it is the natural result of the wealth tax structure.

Think about it this way. If a household’s wealth grows at a normal rate—say, five percent—then the three percent annual tax on wealth would amount to a 60 percent tax on net wealth added. But if a wealthy person is extraordinarily successful in this scheme, and grows his or her wealth by 20 percent in a year, then the three percent wealth tax would only subtract 15 percent of this new wealth.

These obstacles help explain why the wealth tax has failed in most other countries. In 1990, 12 member countries of the Organization for Economic Cooperation and Development had wealth taxes. By 2017, that number had fallen to just four.

Recent attempts to install wealth taxes in Italy and Cyprus have been similarly frustrated, as Cowen has noted. The problems that developed nations have encountered with wealth taxes should give US policymakers pause.

While Sen. Warren’s wealth tax would be a new development for the United States, it isn’t a new idea. Bringing this tax to American shores might boost Treasury revenues, but it would certainly come with a number of challenges and negative economic consequences.

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