Wealth Tax?

Sen. Elizabeth Warren and her fellow Democrats want to levy a wealth tax on rich households.  Their proposal would impose a 2% tax on wealth over $50 million, and an additional 1% tax on wealth over $1 billion.  The government definitely needs to address the country’s budget deficit.  As of fiscal 2020, the Federal government – and all of us by extension – is in the hole to the tune of $26.9 trillion dollars. 

That’s trillion with a T.

This wealth tax proposal has a couple of problems; it would be difficult to administer, and it wouldn’t do much to fill the debt hole we’ve dug ourselves.

 

Administering a Wealth Tax

 

Calculating a wealth tax would be a matter of creating a household balance sheet, i.e., listing assets and liabilities and doing the math to figure net worth (assets – liabilities = net worth or wealth) and then multiplying that wealth figure by the appropriate tax rate. 

 

Doesn’t sound too bad so far.  

 

Getting a valuation on a house or other real estate via property tax assessments would be pretty straightforward, and the financial markets give us up-to-the-minute valuations of stocks and bonds (and sometimes they’re right!)  But there are lots of other assets that are very hard to value.  Example, how do you value a privately held business?  Wealthy people tend to own such things.  You could hire a valuation firm to determine a value for the company, but that’s pricey.  Are you proposing a yearly valuation?  Who pays?  If you were able to get to a valuation, does the owner have to then liquidate a piece of the business to pay the tax?  Who would buy that piece? Are we including art and collectibles in the wealth mix?  Good luck putting a valuation on that weird painting you bought at auction 20 years ago by that eccentric artist who only paints cigar smoking monkeys wearing vintage dresses. Hmmm, one sentence with 'weird', 'eccentric', 'smoking monkeys in dresses'…seems redundant.

 

Addressing Our Debt Burden 

 

As mentioned, the US Government’s cumulative debt now weighs in at $26.9 trillion.  The chart below shows how we’ve been adding to the debt over the last few years.  We were in pretty decent shape until the 2008 financial crisis, and it’s been a pretty ugly picture since.  We really hit the debt gas pedal hard in 2020 as the government ramped up spending to deal with COVID and the related economic fall-out.

Revenues from the proposed wealth tax wouldn’t take much of a chunk out of our debt pile.  According to figures from Barron’s, approximately $11T of rich household wealth would be subject to the 2% tax and another $3.3T of rich household wealth would be subject to the 1% tax.  Doing the math says the tax would raise $253B in new revenue. 

 

Even if we could magically stop adding to our debt (we can’t) and devised a 10 year installment plan, the new wealth tax would pay-down less than 10% of the yearly amount.  The math - $253B in new tax revenues divided by $2.69 trillion (one-tenth installment) = 9.4%.

 

We can’t tax our way out of our debt mess.  The debt solution must address 3 areas—economic growth, taxes, and spending. 

 

The last time the US was in a comparable debt hole was at the end of World War II.  Then (as now) US Government debt was over 100% of GDP.  As the post-war US economy boomed, we essentially grew our way out of debt.  It’s analogous to the young couple taking on a big debt to buy a house.  Fast forward and few years (and a few raises) and that big debt is smaller in relation to the now bigger paycheck.

 

It’s hard for the Unrepentant Capitalist to say, but given the scale of our deficit problem, taxpayers will probably have to chip in more to pay down the debt.  Having said that, there tends to be an inverse relationship between taxes and economic growth, i.e., raising taxes too much dampens economic growth.

 

While taxes will probably (and unfortunately) have to go up, solving the debt problem has to include government spending cuts including cuts to Mandatory spending.  In 2019, according to the Congressional Budget Office, approximately 61% of Federal government spending was for Mandatory spending programs (ex. Social Security, Medicare, Medicaid), 30% of spending was for discretionary spending (ex. Defense, Education), and 9% of spending was interest on the debt.  Mandatory spending has steadily grown over time, and is now at a scale such that the deficit cannot realistically be paid down without cuts to this category.  

 

It’s important to mention that the debt doesn’t necessarily have to be paid down to zero.  Debt at 50% of GDP feels like a more reasonable figure versus the 125% debt to GDP ratio we’re sitting at currently. 

Another Way Out?

 

Up to this point, this post has discussed honorable ways to remedy the deficit.  There is a school of thought, Modern Monetary Theory (or MMT) that suggests as sole issuer of the US Dollar, the US government shouldn’t worry about deficits because we can just create/print the money needed to cover the budget shortfall.  The Monetarist leaning Unrepentant Capitalist can’t help but see this as inflationary. (Monetarism at 50,000 feet: money supply growth should basically track economic growth; money growth too far ahead of economic growth leads to inflation.) 

 

As politicians usually don’t like raising taxes or cutting government benefits, one can’t help but wonder if MMT starts winning more converts in Washington.  If so, the days of sub-2% inflation are history. Bitcoin anyone?

 

Beware the Tax Man

 

The proposed Warren wealth tax probably doesn’t concern most people given the tax doesn’t apply to those with a net worth under $50 million.  The tax would not apply to me or anyone I know, so what’s the fuss?  

 

It’s worth going back and taking a look at the numbers associated with the original income tax system. Congress enacted the Income Tax in October of 1913 as part of the Revenue Act of 1913.  The original tax rate was 1% on incomes over $3,000/yr, and 6% on incomes over $500,000/yr.  Given the average Joe was making about $600/yr in 1913, I’ll bet a lot of Joe’s said “…this new income tax does not apply to me, so what’s the fuss?...”