Politics and Your Wallet – Warren’s Wealth Tax

In case you hadn’t noticed, there’s a race for president that’s been going on in the United States. For the past 14 months. That will last another 9 months.

Sigh.

With that in mind, we’ve been spending time exploring the intersection of politics and personal finance. If we’re going to be figuring out which candidates to vote for then we might as well learn how their proposed policies would affect our wallets.

We’ve already looked into Kamala Harris’s LIFT Act and Cory Booker’s baby bonds proposal. (Both have since ended their campaigns but, as I noted in those articles, they are still members of the United States Senate and will presumably continue to push their respective plans.

Today we’re going to look at something a bit more complicated: Elizabeth Warren’s wealth tax plan.

Priorities Matter

Warren is not the only candidate in the race to support a wealth tax. Bernie Sanders has released his own wealth tax plan and Pete Buttigieg has announced support for a wealth tax generally without releasing a separate plan.

There are a lot of politicians and a lot of policies on the table. Because I can’t cover everything, I want to spend my time investigating the policies that stand the highest likelihood of becoming law if a candidate wins.

Through this lens, prioritization is extremely important. Accomplishing big legislative goals requires a lot of time, effort, and political capital. It is unrealistic to expect that a president will make it too far down their list of legislative priorities. That fact has informed my choice of topic.

Harris said that the LIFT Act was her top priority. Booker said that his Baby Bonds plan was his top legislative priority.

Why Warren?

Simply put, Warren has a wealth tax as a higher priority than Buttigieg or Sanders.

Warren has said that her top legislative priority is her anti-corruption plan and her second is the wealth tax (along with the programs it would fund).

Sanders has said that his top priority is Medicare for All. I have not heard him list a wealth tax as a priority in any of the interviews I’ve heard.

Buttigieg’s top priority is a series of democratic reforms. Neither he nor Sanders have (to my knowledge) listed a wealth tax as a top issue. This means that Warren is much more likely to put the time, effort, and political capital into passing her plan into law.

Why a Wealth Tax?

It is rare for a politician to highlight a tax increase as part of their platform, for obvious reasons. At most, politicians (Trump in 2016 included) often promise to eliminate particularly unpopular deductions like the carried interest loophole.

So why has Warren decided that it is important to create a whole new tax?

First, Warren is proposing a series of programs and wanted a mechanism to pay for them. Democrats running for president tend to be very careful about proposing ways to pay for the programs they want to create or expand. Warren is no different in this regard.

The wealth tax that she has proposed would pay for a wide-range of programs, including:

  • Universal child care for every child age 0 to 5.
  • Universal pre-K for every 3- and 4-year old.
  • Higher wages for all child care workers and preschool teachers.
  • Free tuition and fees for all public technical schools, 2-year colleges and 4-year colleges.
  • $50 billion for historically black colleges and universities.
  • Forgiveness of student loan debt for 95% of those with such debt.
  • $100 billion over 10 years to combat the opioid crisis.
  • Down payments on a Green New Deal and Medicare for All

(Warren later proposed an expanded version of the wealth tax as part of a plan that would cover the full costs of Medicare for All. Because Warren’s Medicare for All plan is further down her list of priorities and a vote for full implementation would not happen until late in her first term, I am analyzing the base wealth tax from the original proposal.)

Rising Inequality

The other reason that Warren is proposing a wealth tax is to combat rising inequality.

Inequality has been on the rise in the United States in recent decades. In the late 1970s, the top 0.1% of Americans had approximately 7% of the country’s wealth while the bottom 90% had 35%. As of 2016, the share going to the top had almost tripled to 20%, while the 90%’s share dropped to 25%.

There are all sorts of different ways that you can slice this and different lenses through which to view it. Some measurements look more drastic than others, but all show that inequality has increased in the last few decades and is continuing on a similar trend.

The most obvious approach to raising taxes on the rich would be to raise the top marginal income tax rate. The problem is that the richest Americans generally make their money from investments rather than labor. This means that more often than not, they pay capital gains taxes rather than income taxes. The capital gains rates are lower and the taxes are charged upon the sale of an asset rather than on the annual gains.

Warren has decided, then, that the best way to combat inequality through the tax code is with a wealth tax.

A Wildly Popular Tax Increase

The goal of reducing inequality is the purpose that gets the most public attention. Many of the people I spoke to when soliciting questions about Warren’s plan did not even know that the plan was for funding specific programs. The popular image of the wealth tax is just a way to raise taxes on wealthy people for the sake of raising taxes on wealthy people.

And, interestingly, people seem to love it.

Warren’s wealth tax plan has majority support from Democrats, Republicans, Independents, men, women, people with a college degree, people without a college degree, and every single age bracket.

The only sub-demographic that does not support this plan is Republican men with college degrees.

The tax, then, would both fund popular programs and aim to achieve a popular goal. So how does that fit in with how we understand taxes generally?

Basics of Tax Theory

This is where we take a brief step back to run through some fundamentals of tax theory. And as a nerd who voluntarily took (and actually enjoyed) tax law, I’m excited to finally put that knowledge to use.

The main goal of taxation is to raise the money that you need to run the government (or specific programs) without doing unnecessary damage to the economy or creating unwanted effects. (More on the heavy lifting being done by “unwanted” here in a moment.)

A good (though often-misused) example of this is the Laffer Curve.

The idea here is deceptively simple.

An income tax of 0% would bring in $0 because the tax rate is, well, 0%. An income tax of 100% would also bring in $0, because nobody would work for money if they didn’t get to keep any of their money.

An income tax of 5% would not bring in much money because the rate is so low, but also would not discourage much work. An income tax of 95% would still leave some incentive to work, but would still eliminate a huge portion of the tax base because most people would choose not to work for money if they only got to keep 5%.

As the tax rate rises from 0%, the amount of revenue rises because you are collecting higher percentages of people’s income. As the tax rate shrinks from 100%, the amount of revenue rises because more people will choose to work for money. These two trends create a curve like the one we see above.

Somewhere along that curve is an ideal point to set the top marginal income tax rate, where you are maximizing revenue through a balance of the rate and the incentive to work. (Economists’ vary on where that point is, but the rough consensus appears to be a top marginal rate around 70%.)

This is the type of thing that economists consider when trying to design a tax system that will raise sufficient funds without unnecessarily harming the economy as a whole.

Taxes as Incentives

Now, back to the rule about wanting to avoid creating “unwanted” effects.

Oftentimes tax laws are designed specifically to create changes in people’s behaviors. The governing body, whether it is Congress or your state or local government, decided that they want to encourage or discourage a specific type of behavior, and so they create an incentive or disincentive in the tax code.

The home mortgage interest deduction exists because Congress wants you to buy a house rather than rent. If you do what the government wants for your housing situation, they will agree to give you a break on your taxes.

States and cities implement extra taxes on cigarettes and alcohol because they want you to smoke and drink less. By making these habits more expensive, they’re hoping that people will decide to quit.

We have tariffs on some foreign products so that the American version is artificially cheaper in the hopes that consumers will buy American more often and support American companies.

There are countless examples where the government uses the tax code to intentionally influence the behavior of its citizens. This is why it is important to distinguish between intentional and unintentional effects of new taxes.

Funding

Okay, so what does that mean for Warren’s wealth tax?

First, it is raising money to fund specific programs.

The plan would implement an annual 2% tax on every dollar of net worth above $50 million and a 3% tax on every dollar of net worth above $1 billion. Net worth is calculated to include all assets, including residences, closely held businesses, assets held in trust, retirement assets, assets held by minor children, and personal property with a value of $50,000 or more.

This ends up being a tax on around 75,000 households that is projected to bring in $2.75 trillion over the first ten years. (More on this projected amount later.)

Incentives

Because this tax only applies to the top 0.1% of households, it would not constitute an incentive or disincentive to the vast majority of Americans. Even if we expand our view to look at everyone that is directly affected and everyone that is approaching a wealth level where they may be affected in the future, we’re still looking at a very tiny slice of the population.

Even amongst the people that will be directly affected, the incentive/disincentive should be minimal.

(I will caveat this with the simple note that we can never really know how people will react. That said, I read a wide range of economists and analyses and the vast majority believe that there will be relatively minimal behavioral change as a result of Warren’s plan. Some of the concerns of those who disagree will be addressed later.)

For people with a net worth between $50 million and $1 billion, the tax will be 2%. This is much less than the investment income that you would earn most years by parking this wealth in any sort of investment portfolio. This also disincentivizes many of the ways that one might hide wealth to avoid the tax, because you want that wealth to be out there earning you more wealth. It will hurt you more to hide that money away and miss out on investment earnings than it will to pay the tax.

In addition, because most investment growth is passive, there is no real incentive to stop growing your wealth. If you pull your money out of your investments you won’t be gaining back time to spend with your family or go on vacation like you would be if you stopped earning wage income.

What About the Billionaires?

The higher rate that applies to billionaires would obviously cut a bit more significantly into growth for those who would have to pay it.

There are 608 billionaires in the United States and about 130 million households. This means that around 0.000005% of households will be subject to the 3% rate. If there are behavioral consequences, they would be very limited in the number of people they impact.

Of course, billionaires have quite a bit of money (go figure) and can impact the economy significantly, so we should still look at all potential consequences.

The most likely outcome is that billionaires paying the 3% rate will have the same incentive structure as the millionaires paying the 2% rate. The rates of return on many investments available to billionaires will be higher than the 3% rate and so they will keep their money invested and continue to grow their wealth.

Some may look to hide wealth, although their ability to do so would depend upon the final language of the law. Warren’s proposal uses a very broad definition of net worth and includes a “significant increase” in the IRS enforcement budget to discourage this type of behavior. It also expands on existing Foreign Account Tax Compliance Act reporting requirements to catch people that attempt to hide wealth overseas. That said, there will always be some level of tax avoidance.

They could renounce their U.S. citizenship in order to avoid paying American taxes, but the proposal includes a 40% exit tax on all net worth above $50 million for anyone that chooses this path.

They could also attempt to spend down their wealth, either through pure consumption or through charitable giving. The former would put money into the economy and support job growth, while the latter would increase support for charitable causes. Either option would not necessarily be a negative outcome, despite decreasing the revenue that the wealth tax would raise.

Reducing Wealth Inequality

In fact, billionaires increasing their spending and charitable giving would further a key goal of Warren’s wealth tax proposal: reducing wealth inequality. Even without that increased spending and giving, however, Warren’s plan addresses inequality in multiple ways.

On one end, increasing taxes on the wealthiest Americans attacks inequality by slowing the rate at which the top 0.1% are continuing to pull farther and farther away from the rest of us.

On the other end, that revenue funds programs that functionally put more money in the pockets of poor and middle-class families.

Universal child care and pre-K would put money in the pockets of young families. Raising the wages of child care workers and preschool teachers would give those workers more money to spend. Forgiving student loan debt would allow people to spend or save the money that they are currently sending to the government for their loan payments every month.

These programs also help create more opportunity for people to climb the ladder and become successful themselves. Universal pre-K has been shown to improve outcomes for children. Providing free tuition and fees for public colleges and technical schools opens up opportunities to lower-income families. An additional $50 billion for historically black colleges and universities provides funding targeted to a traditionally marginalized community.

When viewed as a whole, Warren’s wealth tax proposal would provide both cash and expanded opportunity to poor and middle-class families completely funded by the wealthiest Americans.

Objections

When I wrote about Harris’s LIFT Act and Booker’s baby bonds proposal, I explained the bills, talked about their impacts, and walked away. That doesn’t feel all that appropriate for Warren’s wealth tax plan.

A wealth tax is both more complex in its effects and more controversial in the public square than Harris and Booker’s plans. Many objections have been raised, some more fair than others, to the idea of wealth tax generally and to Warren’s plan specifically. I want to be sure to give sufficient attention to those objections.

In addition to studying the discussions that have taken place among policy experts and economists, I also put out a call to the personal finance community for their concerns.

In the next sections I will walk through each of the concerns and objections that I have come across.

How Much Revenue Will It Raise?

The most common dispute surrounding Warren’s plan is how much revenue it will actually raise.

Warren’s numbers are based on an analysis by economists Emmanuel Saez and Gabriel Zucman that projected revenue of $2.7 trillion over ten years. An analysis by Lily Batchelder and David Kamin estimated a slightly lower $2.6 trillion. A third analysis out of the Wharton School of Business projected $2.3 trillion.

The odd economists out here are Natasha Sarin and Larry Summers, who have projected somewhere between $250 billion and $750 billion over the same ten-year period.

I spent a long time studying these different models and I have pages and pages of notes. There are all sorts of minor disagreements over how this would affect the economy writ large and how best to weight the positive economic impacts of the programs it would fund against the negative impacts of a new tax.

However, the vast majority of the difference between models comes down to one question: How successful will people be at avoiding and evading this tax?

Avoidance/Evasion

Saez and Zucman used an avoidance/evasion number of 15%, meaning that those subject to this tax will pay only 85% of what would be expected through some combination of legal loopholes and illegally hiding assets. However, they say that estimate is conservative. Here’s their explanation:

“Recent research shows that the extent of wealth tax evasion/avoidance depends crucially on loopholes and enforcement. The proposed wealth tax has a comprehensive base with no loopholes and is well enforced through a combination of systematic third party reporting and audits. Therefore, the avoidance/evasion response is likely to be small. To be on the conservative side, we assume that households subject to the wealth tax are able to reduce their reported net worth by 15% through a combination of tax evasion and tax avoidance. This is a large response in light of existing estimates.”

Sarin and Summers, on the other hand, predict avoidance/evasion will be as high as 90%. Their argument is based on a combination of looking at how European wealth taxes have fared and how the United States Congress tends to work. They predict that an eventual wealth tax will be filled with loopholes and exceptions and enforcement will be low.

Saez and Zucman have responded by noting that Warren’s plan specifically addresses the failures of European policies, is designed to avoid loopholes, and calls for increased enforcement.

The takeaway is that if Warren’s plan is passed as written, it should raise around $2.7 trillion over ten years. However, some economists are skeptical that it will pass as written. If Congress manages to water it down and defang it, the revenue raised could be substantially smaller.

What About Europe?

Sarin and Summers are not the only people concerned about the failures of wealth taxes that were implemented in Europe. This was a common concern both among skeptics that I found in my research and skeptics in the personal finance community.

The OECD did extensive research and released a full report analyzing the failures of these European wealth taxes. It included the benefits of a wealth tax, the drawbacks of a wealth tax, and the points of failure of specific taxes in different countries.

The report noted that there was a need for some level of taxation above and beyond a simple income tax.

“Wealth inequality is far greater than income inequality, and there is some evidence suggesting that wealth inequality has increased in recent decades. In addition, wealth accumulation operates in a self-reinforcing way and is likely to increase in the absence of taxation. High earners are able to save more, meaning that they are able to invest more and ultimately accumulate more wealth. Moreover, investment returns tend to increase with wealth, largely because wealthy taxpayers are in a better position to invest in riskier assets and generally have higher levels of financial education, expertise and access to professional investment advice.”

The report notes that while this concern can be addressed by a wealth tax, it also could be addressed by a combination of expanding and increasing capital gains taxes, inheritance taxes, and gift taxes.

Lessons Learned

If a country is interested in pursuing a wealth tax rather than the package of other recommended taxes, the report lays out the lessons learned from failures of the past.

A successful wealth tax would need to have low rates and very limited exceptions. It should be applied only to the wealthiest people in the country. There also should be a method to pay over time for anyone that is facing liquidity issues, as well as an exit tax to prevent people from taking their wealth out of the country.

Warren’s plan addresses all of those concerns.

Only the top 0.1% of the country would be subject to a wealth tax under Warren’s plan. Of those, the vast majority would be at a 2% rate, with a top rate of 3%. Exceptions, exemptions, and loopholes are essentially non-existent. There is a payment plan in place for anyone who faces liquidity issues and would struggle to pay the tax and a 40% exit tax for anyone that wants to renounce their American citizenship and take their wealth elsewhere.

It is still possible, of course, that this plan fails in some way that we cannot predict or do not foresee. However, the concerns that this will fail for the same reasons that European wealth taxes have failed is unfounded.

Liquidity Problems

Liquidity seemed to be a major concern among the personal finance community, with a number of comments like “billionaires don’t have a billion dollars in a bank account” and “you’d have to liquidate every year to keep what you own.”

As an initial matter, the plan includes a payment plan based on liquidity issues. If you ended up with a family business worth $100 million and you don’t have any other money in liquid assets, you won’t have to sell your business just to pay the tax.

The other thing to remember is that this just isn’t a very common problem. There aren’t many people that pass $50 million without any sort of diversification. There really aren’t billionaires that don’t have at least 3% of their wealth in liquid assets of some kind.

I found a wide range of different statistics on this, as there does not appear to be a way to get real definitive numbers on the portfolios of the wealthy. These stats varied greatly in estimating what percentage of wealth the top 0.1% keep in liquid versus illiquid assets. However, none of them indicated that a 2% or 3% wealth tax would pose a major liquidity problem.

Volatility

A frequent concern that personal finance bloggers had (although not so much from economists and experts) was the volatility of wealth. There were a number of questions about what would happen if the stock market dropped after someone paid a wealth tax.

As one person colorfully put it, “Tax Bill Gates $100 billion dollars. Okay, cool. Next year Microsoft stock drops 16% and he’s flat broke.”

When headlines showed that Elon Musk’s net worth had dropped $768 million in one day after Tesla stock fell as a result of the Cybertruck announcement, one person said “We just taxed this guy on a billion dollars and he lost 80% of it in a day. What do we do?”

These concerns overestimate both the volatility of wealth and the impact of a 2%-3% wealth tax.

Markets versus Taxes

Both the Bill Gates and Elon Musk hypotheticals are demonstrative here.

Let’s assume an absolute worst-case scenario for Gates and treat him as if he has never diversified his portfolio and 100% of his wealth is still in Microsoft stock. In that world, Gates pays a 3% wealth tax and then loses 16% of his wealth from the drop in stock price. He still has over 80% of his wealth at the end of the year.

That’s a rough year, obviously. Not fun for Bill. But he’s not being ruined by the wealth tax. He still has almost $100 billion, and the drop in stock price (which would have happened if the tax did not exist) was a much bigger factor (over 500% bigger) in his bad year than the tax.

We see something similar when we look at the Musk example.

That $800 million that Musk lost in one day was only about 4% of his net worth, not 80% as our personal finance friend speculated. $800 million is an unthinkable amount of money for most of us, so it is hard even to contextualize this, but it just isn’t that much to Elon Musk.

This also means that the tax bill Musk would face for a year is less than the amount he ended up costing himself in one day by designing an ugly truck. The wealth tax is minimal compared to the fluctuations in the market. If at some point Musk were to lose 80% of his wealth in one year, it would be because the markets killed him, not the 3% tax.

Anti-Tax Sentiment

The personal finance community also had a lot of comments and concerns in response to the wealth tax that were mainly just broad anti-tax statements.

One person said that we should cut spending instead of implementing a wealth tax. Another said that the government will only waste the money anyway. A third asked what we could do with this money that we can’t do with the money that we already have. None of these are concerns with a wealth tax specifically, but rather ideological statements about the size of government.

Another argument was that we should not “punish wealth.” Under that same logic we would need to eliminate the income tax for punishing work and the capital gains tax for punishing investing. For a more nuanced discussion on the incentive structure of the tax code, feel free to head back up to the Tax Theory section above.

One person argued that a wealth tax would not solve wealth inequality and that instead the solution is growth with low unemployment. The problem with this point is that we’ve had growth and low unemployment for a while now and inequality is still growing.

The main reason, as the OECD report identified, is that return on capital is growing at a faster rate than return on labor. In an environment like this, there is no way for your hard work and labor hours to catch up to the wealthy’s earnings from capital. The numbers just don’t add up.

Growing the IRS

Another argument that some people made is broadly anti-tax once you peel away the outer shell. That is: a wealth tax would require more IRS agents.

This is true, as far as it goes. Even if the wealth tax in and of itself is simple to implement, Warren’s plan calls for increased enforcement. In order to have more enforcement you need to have more people doing the enforcing.

However, these new employees would more than pay for themselves. Study after study has found that we could increase government revenue by hiring more IRS agents. Enforcement is so lax that each agent we add would bring in many times more than her salary in missing revenue. It’s free money!

When confronted with these statistics, the proponents of this argument fell back to the argument that they want government to be smaller. This means that the argument is not about taxes or tax collection or a wealth tax at all, but rather about an ideological goal of shrinking government at any cost.

Slippery Slope

A few people also mentioned the slippery slope argument. These people claimed that once a wealth tax existed on the top 0.1%, it would only be a matter of time before the rest of us had to pay. Politicians would just keep lowering the threshold until eventually everyone was paying taxes on their wealth.

There are a few very limited circumstances where a slippery slope argument can make sense. These are generally where a judge is considering expanding existing case law based on questionable or overly broad reasoning. Occasionally it can be convincing when discussing expanding the scope of executive power.

99.9% of the time, however, a slippery slope argument is nonsense, as it is here. Each change to the tax code gets voted into law separately. If you’re fine with a wealth tax on the top 0.1%, but don’t want one on you, then make sure your elected representatives don’t support a bill to drastically lower the threshold.

Even if we did not have the power of our votes, our calls, our voices, and our dollars, the likelihood that a wealth tax would be applied to a significantly larger group is extremely low. First, most of us just don’t have enough money to make a 2% tax worth it. Second, the popularity hit that someone would take for passing a wealth tax on the middle class would be bonkers. Third, if the purpose of a wealth tax is to combat runaway inequality, then what would be the point of applying it to those with less wealth? Finally, the OECD report specifically highlighted that wealth taxes that applied to larger segments of the population ultimately failed and were repealed.

Callbacks

Next, I want to quickly touch on a couple of arguments that were addressed more fully in the main article above.

First, a number of people argued that all of the wealthy people would renounce their American citizenship and take their money elsewhere. Warren has taken the OECD report’s advice and added an exit tax to prevent this from happening. Even so, all indications are that this would be a much rarer occurrence in the United States than it was in European Union countries where moving from one country to another was much less of a big deal.

Another argument that people raised was that eventually this bill would have a lot of loopholes and people would just hire tax attorneys to avoid paying it anyway. This is addressed in the discussion above regarding how much revenue a wealth tax would bring in. However, for the purposes of this article, I’m going to go ahead and analyze the proposal as written rather than assume that some worse bill will exist in the future.

Effects on the Economy

One objection that people raised in various forms is that a wealth tax would hurt the economy. The most common economist version of this argument was that wealth flight damaged the economies in European countries where wealth taxes were implemented. The more common blogger version was that wealthy people would have less money to invest, which would hurt the economy.

The issue of wealth flight is addressed above, but I do want to give some time to the idea that there will be less money invested. This is obviously a legitimate effect of a wealth tax. It is equally obvious that viewing this factor in isolation would be an extremely facile view of the economic impacts of such a tax. In trying to figure out the nuances of this question I spent months studying different economic models to try to sort through the potential bigger picture economic effects of Warren’s plan.

Economics is more of an art than a science, so there were a lot of varied opinions on what a wealth tax’s impact would be. The majority opinion appeared to be that a wealth tax, in isolation, would have a small negative effect on the overall economy. A 2%-3% tax on the top 0.1% of people would have very little effect on the overall economy, but that effect would likely be negative because of the lost investment.

This was not the only opinion, however. Many in the newer generation of economists found that a wealth tax, even in isolation, would actually have a positive impact on the economy. In short, this comes down to findings from Thomas Picketty and others in the past decade that inequality has reached such extreme levels that it is acting as a drag on the economy. If we decrease inequality, then the economy will benefit. This benefit would offset the lost investment.

We don’t actually need to decide which of these two views we subscribe to in order to determine whether the impact of Warren’s plan would be positive or negative, however, because the wealth tax does not exist in isolation. Instead, the plan includes the programs that would be funded by the revenue that is raised. This means that when looking at the plan’s effects on the economy we need to look both at the impacts of the tax itself and the impacts of the programs that the tax would fund.

Without spending much time on the details of the specific programs, each would create a positive impact on the economy by putting money into the hands of poor and middle class people who would spend it at much higher rates than the wealthy, spurring economic growth. Universal childcare and universal pre-K would put money in the wallets of parents with young children. Raising wages for childcare workers and preschool teachers would give more money to traditionally lower-wage workers. Forgiving student loan debt would provide more spending power to young adults who are looking to start families and buy houses.

By moving money from the wealthy, who are often sitting on a lot of unproductive wealth, to poor and middle-class families who will spend it, the net effect is increased growth for the economy as a whole.

(This is obviously a simplified explanation of a very complex issue, but it faithfully captures the gist and the conclusions I found. If you find this interesting, I highly encourage you to read some of the analyses from both pro-wealth tax economists and anti-wealth tax economists. There are so many different factors to weigh and so many different ways to measure them that you could dedicate an entire career to this one issue.)

Nonprofit Efficiency

One creative objection to a wealth tax that I came across was that it will make nonprofits less efficient.

The idea here is that people would donate much more money to charity than they currently do in order to minimize their tax liability. This would lead to a huge influx of cash into charities that are currently lean and efficient. With all this new money, those charities would not need to be so efficient and would instead start wasting money.

I’ll be honest here: I find it hard to take this argument seriously.

First, it seems like a stretch to argue that “too much money will be donated to charity” is a major negative outcome that we need to work hard to avoid.

Second, there are plenty of charities right now that are lean and efficient. There are also plenty of charities that are inefficient and waste money. There does not appear to be any reason to expect that the efficiency or inefficiency of individual charities is based upon the amount of money that happens to be in the nonprofit sector as a whole.

Third, this argument fails to explain why a massive (and sustained) increase in charitable donations would lead to every current charity becoming bloated rather than an increase in the number of charities vying for donations. There are plenty of problems that need to be solved. If there were suddenly more money to solve them, why wouldn’t more people jump in to fill that gap?

On the whole, this problem seems unlikely to arise, and even if it did, it doesn’t seem to be such an overwhelmingly bad problem.

What About Other Taxes?

A number of people in the personal finance community argued that other tax increases should be tried before resorting to a wealth tax. The most common suggestion was raising the capital gains tax rate to match the income tax rate, but others included closing the carried interest loophole, eliminating corporate deductions for specific industries, and lowering the threshold for gift and estate taxes.

I don’t have a problem with any of those changes, but nobody was able to provide a reasonable answer for why it was necessary to hit those milestones first. The closest anyone got was the suggestion that those changes would be more popular than a wealth tax. That may be true (at least for some of the changes) but as we already learned, Warren’s wealth tax proposal has majority support among Republicans, Democrats, and Independents, as well as almost every possible demographic. Popularity is simply not a hurdle that this plan needs to worry about.

As noted above, the effects of a wealth tax could be replicated by increasing the capital gains tax in coordination with an increase in the gift and estate taxes. That said, I am skeptical of people that suggest that they would prefer a plan that raises their own taxes over a plan that raises taxes on only a small fraction of the richest Americans. Additionally, some of these same people raised concerns about a decrease in investment based on a wealth tax. This same concern would apply to an increase in the capital gains tax.

Instead, this seems like a case of motivated reasoning. I am quite certain that if the proposal on the table was for an increase in the capital gains tax, many of these same people would be against such an increase.

But It Can’t Pass!

Another complaint was that a wealth tax will not become law because it cannot get enough votes in the Senate, so it isn’t worth discussing. This came in two variations. The first was “This won’t become law, so why are the Democrats promoting something that will be used against them in campaign ads.” The second was “This won’t become law, so why are we even talking about it?”

First, short answers. A wealth tax is very popular, as already discussed, and would help Democrats more than hurt them as a messaging tool to reach the average American voter. As to the second question, even if the votes do not exist at this point in time, we should always be exploring new solutions to problems. These ideas enter the civic bloodstream, become either accepted or rejected over time, and lead to laws in the future or expand the conversation and build towards other solutions.

Now, the longer answer. Whether this, or any bill, can pass in the next few years depends on the outcomes of a handful of Senate races. If a Democrat wins the White House, but Mitch McConnell remains the Senate Majority Leader (which is a very likely outcome), then there will be no major legislative accomplishments. Warren will not get her wealth tax. Sanders will not get Medicare for All. Buttigieg will not get democratic reforms. Nobody will get any major legislation passed.

If, on the other hand, Democrats can pick up a majority in the Senate, then the president may* be able to push through legislation to the extent that he or she can get moderate Democrats on board. (*This is based on the idea that the Senate eliminates the filibuster.) This is a place where the wealth tax’s popularity across parties and demographics becomes a real boon. It will be much easier to convince someone like Kyrsten Sinema or Joe Manchin to pass a wealth tax on the top 0.1% than it would be to convince them to pass Medicare for All or certain other progressive goals.

In short, a wealth tax could become law in the near future depending on the outcomes of certain Senate elections. Even if it could not, though, there is still value in talking about it.

(The races to watch here are Maine, Arizona, Colorado, and North Carolina. Depending on how the next few months go, Alabama, Georgia, and Iowa could also be close elections.)

Constitutionality

The final question we’ll cover is whether a wealth tax would be constitutional.

I don’t have a definitive answer to this question. Neither does anyone else who isn’t named John Roberts. If they tell you otherwise, they’re overconfident.

The Constitution says that “no capitation, or other direct, tax shall be laid, unless in proportion to the census.” This means that direct taxes need to be applied evenly across the states.

A wealth tax would apply only to the top 0.1%, regardless of the states in which they live. If a wealth tax is considered a direct tax, then, it would be unconstitutional. The question we must answer, then, is what is a direct tax?

The first place we often look for answers when we have unclear language like this is the intent of the founding fathers. James Madison took extensive notes on the Constitutional Convention. His notes tell us that Rufus King “asked what was the precise meaning of direct taxation? No one answd.” Supreme Court cases are also a bit muddy and ambiguous on this question.

In my research I found well-argued, credible law review articles and legal analyses arguing both sides of the constitutionality question. I would guess (and that is all anyone can do at this point) that the four most conservative justices would find a wealth tax unconstitutional and the four liberal justices would find it constitutional.

The question then becomes whether John Roberts believes a wealth tax is a direct tax or an indirect tax, and he isn’t jumping at the opportunity to let us know what he thinks.

7 thoughts on “Politics and Your Wallet – Warren’s Wealth Tax”

  1. Wow. Just wow. Your articles are so thoughtful, well researched and well explained. Thank you for all your work – you must have spent hours on this! I’ve learned a lot and enjoyed doing so. And I don’t even need to know this stuff – I’m Canadian!!

    Please don’t ever stop writing.

  2. I know it is Warren’s top priority but wouldn’t it be better to focus on candidates who actually have a chance of winning?

    Personally Sanders and Warren are too divisive and as extremist as the extreme right they claim to fight against. Warren’s AB5 has created enough issues in CA that I know the road to hell is paved with good intentions.

    I won’t even go into her ban fracking on day 1 and hating on big tech including villifing Gates with her calculator. Guessing free college for US people who major in subjects which have no real world value is more important than saving lives in developing countries?

    If environmental issues are a concern then eliminating child care credits and consumption tax would make more sense.

    In the spirit of disclosure I am a male with a college degree. But also gay, immigrant and registered independent so don’t fit into the neat vote bank politics you mentioned as opposing wealth tax 🙂

    1. Thanks for your thoughts. I will say the same thing as I said in the article: even if ideas like this didn’t have a chance of becoming law in the near future, they’re still worth discussing. It is important to spend the time to explore and develop different ideas for solving problems. Maybe they become more widely accepted in the future and become law. Maybe they lead to a national conversation that spins off better ideas. Whether you are for or against the idea of a wealth tax, there is value in fleshing it out and understanding its pros and cons in taming the increase in inequality even if you don’t believe that Warren will become president.

      I’m not sure if the rest of your comment is just a list of reasons you don’t like Warren or whether they are intended to support your thesis that she doesn’t have a chance of winning. If the former, I will leave them be as they are unrelated to anything in the article. If the latter, I would note that Sanders is the frontrunner for the Democratic nomination and is leading Trump in head-to-head polls, so there is no reason to believe that in the current political climate leftist views make one unelectable.
      Matt recently posted…Personal Finance and PoliticsMy Profile

      1. First let me start by saying that I do appreciate the civilized tone of discussion; although we might not agree. There are very few places one can still do that.

        My remainder of the comment was a combination of both factors you mentioned. If as a centrist, I disagree rather than agree with most of her policies; I see slim chances of victory. Or I might be biased in my belief that a centrist stands a better chance.

        Point taken wrt polls. Not sure wrt poll accuracy but that is something we will soon find out.
        Financial Freedom Countdown recently posted…My 4 Worst Investments And How You Can Learn From My MistakesMy Profile

  3. I am so impressed with this analysis, and the research that went into it. Thank you!
    One note about billionaires leaving the country and taking their wealth with them… first of all the USA is a uniquely comfortable place and why would people leave their home just to avoid 2-3% tax? What kind of loyal citizens would those people be? And Americans have to pay US tax no matter where they have residence, so avoiding the wealth tax would mean renouncing US citizenship (there is already an exit tax attached to that, so Warren is not innovating anything here), which could be very difficult for anyone with investments or businesses that require them to be in the USA or have citizenship.
    I am always astounded that the wealthy have so many (not significantly wealthy) supporters! The wealthy have a huge influence over elections and messaging through super PACs and have outsized influence due to their outsized wealth.

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