Growing wealth inequality has fueled calls for a federal wealth tax to be introduced in the United States. This letter provides an introduction to wealth taxes, also known as wealth taxes. It summarizes how a wealthy tax works, examines the revenue potential of such a tax and describes the distribution of the economic burden that would be imposed.
A family’s wealth is the total value of all the assets members own, minus their debts, also known as liabilities. Wealth is a measure of the economic resources a family controls at any given time.
The United States already taxes wealth in several forms. The political debate is therefore less about whether wealth should be taxed and more about how wealth can best be taxed and how much it should be taxed.
Assets can be financial or non-financial. Bank accounts and retirement plans such as 401 (k) plans are common financial assets.
Cars and houses are common non-financial assets. Home mortgages are the largest source of debt for US households.
High wealth families own assets that are held much less often by the wider population. These less common assets include stakes in non-corporate companies, complex financial products such as investments in hedge funds or private equity funds, and valuable works of art.
The table below provides a breakdown of U.S. household wealth as estimated from the Federal Reserve’s financial accounts in 2016.
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What is a wealth tax?
A wealth tax is an annual tax on a family’s wealth. A key feature of wealth taxes is that the tax is imposed on the people who ultimately own assets, not the intermediaries. In particular, this means that a company pays no taxes on its assets. Instead, shareholders pay taxes on the value of the company, including the value of its assets.
Wealth taxes are sometimes referred to as wealth taxes, but a wealth tax is just one way of taxing wealth. Property taxes, capital gains taxes, and corporate taxes are also wealth taxes.
Two important structuring options for a wealth tax are whose wealth is to be taxed and what types of wealth are to be taxed.
Organization for Economic Co-operation and Development member states that levy a wealthy tax now or in the past have generally exempted most families from the tax through a generous tax exemption. Families only pay the tax if their wealth exceeds the exemption.
For example, a wealthy tax with a tax rate of 1% and a tax exemption of $ 1 million would charge a family a tax equal to 1% of their wealth over $ 1 million. Such an exemption would have exempted more than 90% of US tax units in 2016. A family with $ 2 million in net worth would owe $ 10,000 in taxes, which is an effective tax rate of 0.5% of their total net worth.
As with income taxes, wealth taxes can have a flat rate or a progressive tax rate structure.
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Property taxes can also provide preferences for assets such as condominiums or retirement plans. While these preferences can be motivated by reasonable policy concerns, tax preferences are generally not the best approach to addressing them.
As with any other tax, policymakers should strive for a broad base to minimize the tax burden for any desired income level. To avoid unnecessary complexity, wealthy taxes usually offer generous preferences or exemptions for consumer goods such as home furnishings.
How is wealth taxed in the United States today?
The United States does not have an explicit wealth tax, but the federal government, states and local governments tax wealth in different ways under applicable law. Perhaps most notably, state and local governments in the United States are unusually reliant on property taxes from OECD countries.
Property taxes are taxes on the value of a particular asset – real estate. Unlike wealth taxes, property taxes do not subtract the value of the mortgage from the value of the asset when calculating tax liability. The federal government also taxes capital gains, dividends, corporate income, pass-through income, and estates – all taxes on wealth.
There are important economic relationships between a wealth tax and income taxes. Assets have their value primarily because of the stream of income they are expected to generate or could generate in the case of condominiums. Property taxes and income taxes differ, among other things, in terms of the timing of tax payments, their application to uncertain income streams, and their application to complex business structures.
A major weakness of the federal government’s current approach to wealth taxation is that capital gains are only made when an asset is sold. Increases in the value of an asset are ignored for tax purposes until the owner sells the asset.
Thus, asset owners can choose when to pay taxes as they can decide when to sell assets. One reason policy makers find a wealth tax attractive is because it addresses this limitation of the current system.
One factor that can partially explain why the United States does not have a federal property tax is the debate over the constitutionality of a federal property tax. However, the unresolved nature of this debate is no reason to preclude discussion of the merits of the tax, and there are compelling reasons why such a tax should be maintained.
Who would bear the burden of a wealthy tax?
A wealth tax applied to wealthy families in the United States would be very progressive. The economic incidence of the tax – that is, the economic burden on the tax, which is conceptually different from the legal obligation to pay the tax – would lie primarily with the owners of wealth.
Taxing property ownership (as a wealthy tax does) rather than property use (as business taxes indirectly do) allows for a superior tax burden alignment for property owners.
The distribution of wealth even in the United States is highly skewed. The richest 1% of families hold approximately 40% of all wealth and the richest 5% hold 65% of all wealth.
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Families with high wealth relative to their income bear relatively more of the burden of a wealth tax than an income tax. Families with little wealth in relation to their income will contribute relatively less.
A wealthy tax or other means of taxing wealth would therefore generally shift the tax burden not only from families with low wealth to families with high wealth, but also from younger families to older families and from families of skin color to white families.
How Much Revenue Could a Wealth Tax Add?
The revenue potential of a wealth tax in the United States is great. The richest 1% of families have assets of $ 33 trillion and the richest 5% have assets of $ 57 trillion.
Estimates of the income from a wealthy tax are highly uncertain as they depend on both the detailed specification of the tax and assumptions about how families would respond to the tax, for which little guidance is available in the academic literature.
An important part of this estimate is the elasticity of taxable wealth, which summarizes the various behavioral responses to the tax. These answers affect the amount of wealth taxpayers would declare on their tax returns. For example, to reduce their wealthy tax liabilities, wealthy individuals could hide wealth overseas or increase their spending (thereby reducing their wealth).
Probably the biggest challenge in introducing a wealth tax is that it requires an assessment of all taxable assets in order to determine tax liabilities. In many cases it is easy to generate these ratings.
For example, publicly traded securities SPX, -0.72%, have readily available market valuations. Local governments regularly rate real estate for property taxes, albeit not without a hitch and subject to rules that artificially alter the value in some jurisdictions.
However, other assets are harder to value, such as B. Participation in a closely managed company. Owners of a closely run business would have a financial incentive to undervalue them in order to avoid paying taxes. This type of reaction would be reflected in an estimate of the elasticity of taxable assets and thus also in an estimate of income.
Why might policymakers introduce a wealth tax?
Taxes put a strain on income. In developing tax legislation, policy makers should evaluate the change in burden and the resulting changes in revenue.
Policy makers looking for a highly progressive tax tool that generates significant revenues would find a wealthy tax attractive. Such a tax would primarily weigh on the richest families – reduce wealth inequality – and could generate significant revenues.
As noted above, the United States already taxes wealth in several forms. The political debate is therefore less about whether wealth should be taxed and more about how wealth can best be taxed and how much it should be taxed. A wealth tax could be a useful addition to or replacement for other means of taxing wealth, as well as an instrument for increasing the overall taxation of wealth.
This article was originally published by the Washington Center for Equitable Growth, a nonprofit research and grant organization dedicated to promoting evidence-based ideas and strategies for promoting strong, stable, and broad-based economic growth.