There is a good reason we don’t tax wealth directly. Actually, there are many good reasons. But that’s not stopping some states from giving it a try. The best thing to be said about their efforts is that they probably won’t work. But it’s still a bad idea because even attempting to collect this tax will require resources states don’t have.
There are much more effective options for targeting wealthy people for tax revenue that are better for the economy. Some we’re already doing, such as state property taxes, federal capital gains taxes and estate taxes on inheritances. The last two are collected upon an event, when assets are sold or are transferred to another person.
But new bills introduced this week by California and Washington propose taxing their richest residents 1% to 1.5% each year. Four other states including New York and Illinois propose taxing unrealized capital gains, or taxing wealth based on how much it grew in the last year whether or not you sold any assets. How these states will handle assets that lost value is unclear.
Crafting good tax policy starts with a question: How much will it distort economic behavior? Taxes that impose the fewest distortions incur the least waste and harm to the economy. Many economists argue that wealth taxes create the most distortions, followed by income and consumption taxes.
The problem with wealth taxes is that they discourage saving and investment. A 1% or 2% wealth tax may sound small, but it’s actually very large compared with current tax rates. Since it’s levied each year, it’s better compared to our current taxes on realized capital income. If your assets return 4% in a year, a 1% wealth tax is the same as a 25% capital income tax, and that is on top of existing federal capital gains taxes. These plans drastically reduce the return on risky investment, and rewarding risk is an important element of economic growth.
But even if you don’t think such things are important, the wealth tax bills are a bad idea because they’ll be impossible to implement effectively. They may not even be constitutional. But they’re certainly impractical. Income is relatively easy to measure: Your employer sends you a regular paycheck that can be documented and has an objective value.
Overall wealth, and unrealized capital gains in particular, are much harder to measure. On what day do you assess the tax liability? What if asset values fall between when the tax is assessed and the tax bill is due? If the result of such a tax is that people sell their stocks and bonds around the same time each year to pay their tax bills and just generally lower the return on investments, it can depress asset values for everyone, not just the wealthy.
Very rich people also tend to hold a lot of their wealth in assets that aren’t publicly traded, either in private equity, in the businesses they’ve started, fine art or other possessions. California claims it will hire people to make this assessment. But it’s not easy. The arbitrary nature of valuing a private asset is a big reason why many people think private equity returns are unreliable. And because privately held assets are so hard to value and easy to manipulate, it creates an incentive to keep assets private for longer and avoid public markets. That would deprive most other Americans the opportunity to invest in the best public companies — imagine if Amazon.com Inc. never went public — and reduces transparency.
This is why other countries have mostly abandoned wealth taxes. They are very hard to implement on the federal level, let alone by individual states who have far fewer resources to collect and assess data on wealth holdings. A possible model is Switzerland where individual cantons (similar to our states) have their own wealth tax, but the tax is very small and accounts for a trivial share of Switzerland’s tax revenue.
A wealth tax is a bad policy based on the economics and feasibility. Collecting it will require tremendous resources that states don’t have and it won’t produce the revenue they’re counting on. It’s notable that many states now considering it are the very ones that are losing population to tax-friendlier states like Florida and Texas, and are dependent on the few rich people who already contribute a disproportionate share of their tax revenue.
But what may be the worst part of these plans is that they inflame the politics of envy, where success is not seen as adding to growth and prosperity, but something to be eliminated. These states all face future fiscal challenges. Promising that a few extremely rich people can pay for everything is a compelling message but bad economics. States would be better off making their consumption taxes larger and more progressive. For example, states can put larger taxes on luxury goods, like designer clothes, private jet travel or second homes. We can better enforce our existing wealth taxes by eliminating loopholes in capital gains and estate levies.
For now, odds are the bills going before the state legislatures won’t get much traction. The legal challenges alone will be a big hurdle. But wealth taxes will continue to be in the conversation as states and the federal government need more revenue and are reluctant to raise taxes on anyone who earns more than $400,000 a year. Eventually everyone is going to need to pay more, but there are good and bad ways to raise revenue. Wealth taxes are not the solution.
Allison Schrager is a Bloomberg Opinion columnist covering economics. A senior fellow at the Manhattan Institute, she is author of “An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk.”