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Sen. Elizabeth Warren’s Wealth Tax Legislation Faces Administrative and Economic Challenges

4 min readBy: Erica York

The United States has never had a comprehensive wealth taxA wealth tax is imposed on an individual’s net wealth, or the market value of their total owned assets minus liabilities. A wealth tax can be narrowly or widely defined, and depending on the definition of wealth, the base for a wealth tax can vary. , and while some European countries have them, many more have repealed wealth taxes over the past several decades. That has not deterred Sen. Elizabeth Warren (D-MA) with Reps. Pramila Jayapal (D-WA) and Brendan Boyle (D-PA) from introducing legislation to create a tax on household net wealth above $50 million at a 2 percent rate per year and above $1 billion at a 3 percent rate per year, mirroring the signature policy from Warren’s presidential campaign. Despite its proponents’ optimism, the amount of revenue a wealth taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. could raise is highly uncertain, and it would cause many economic distortions and face significant implementation and administrative issues.

Sen. Warren’s wealth tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. would consist of a household’s financial and nonfinancial assets, like stocks and land, at market prices, minus a household’s debts. In addition, the 3 percent rate on net wealth above $1 billion would rise to 6 percent if legislation enacting a comprehensive health insurance program went into effect.

Compared to income taxes, wealth tax rates seem much lower, but that perception can be deceptive. The best way to interpret wealth tax rates is to translate them into an equivalent income tax rate. Imagine an investor who owns a long-term bond with a 5 percent fixed rate of return each year. A 3 percent annual wealth tax implies that 60 percent of the income flow from the bond would be remitted as tax. The 60 percent tax on the return to wealth would be in addition to other layers of tax that capital income faces under current law, including federal, state, and local corporate income taxes, individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. es on interest income, capital gains, and dividends, and estate and gift taxes.

A wealth tax would place a higher burden on normal returns than on super-normal returns. In other words, someone at the margin of deciding whether to consume now or invest for the future would face a higher wealth tax burden than someone enjoying windfall returns due to monopoly power, patents, or economic rents.

A wealth tax would have a negative impact on the economy. It would reduce national income, discourage saving and encourage consumption, and potentially lead to significant distortions in international capital markets as foreigners increased their investment to offset the reduction in domestic saving. In January 2020, Tax Foundation estimated that Sen. Warren’s wealth tax would reduce national output by 0.37 percent and reduce national income by 1.15 percent in the long run.

In terms of revenue, we estimated Sen. Warren’s wealth tax would raise $2.6 trillion over 10 years on a conventional basis and $2.3 trillion on a dynamic basis, whereas she estimated it would raise $2.75 trillion over 10 years.

Estimates vary over how much revenue a wealth tax could raise. For example, Kyle Pomerleau of the American Enterprise Institute reviewed 13 publicly available revenue estimates of wealth taxes that varied from $366 billion to $5.3 trillion over 10 years. The high level of uncertainty is in part due to questions about how to value privately held assets that do not have a straightforward market price like stocks or bonds, and how such assets are distributed. The legislation leaves it to the Treasury Department to design a way to appraise hard-to-value assets.

The legislation includes $100 billion of additional funding for the Internal Revenue Service. It is not clear, however, that the IRS would be able to collect a wealth tax more efficiently than current taxes, even if resources were increased. The legislation mandates a minimum 30 percent auditA tax audit is when the Internal Revenue Service (IRS) conducts a formal investigation of financial information to verify an individual or corporation has accurately reported and paid their taxes. Selection can be at random, or due to unusual deductions or income reported on a tax return. rate for households subject to the tax and a 40 percent “exit tax” on net worth above $50 million on Americans who renounce citizenship. The inclusion of such stringent measures suggests a comprehensive wealth tax would be difficult to enforce.

Several countries in the Organisation for Economic Co-operation and Development (OECD), including Austria, Denmark, Germany, Finland, Iceland, Luxemburg, Ireland, and Sweden, chose to repeal their wealth tax during the last 30 years. The tax policy literature indicates reasons for repeal include limited revenue collection, administration and compliance cost, tax avoidance, and evasion. The experience of enacting and then repealing wealth taxes shows that they were not effective tools.

The international experience with wealth taxes should serve as a warning to the U.S. A wealth tax would reduce the size of the economy, shrink national income, and significantly distort international capital flows. It would likely raise less revenue than what Sen. Warren estimates and create large administrative challenges for the IRS. Rather than design a new tax structure on wealth on top of existing taxes, it would be more productive to reform our current system of capital taxation and find less distortionary and administratively challenging ways to increase federal revenue.