Last week, Senator and presidential candidate Elizabeth Warren (D-MA) was quoted on Twitter as making a comparison between her proposed 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 the traditional property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. . Addressing a crowd, she said: “You’ve been paying 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. for years. They just call it a property tax. I just want their tax to include the diamonds, the yachts, and the Rembrandts.”
In a way, this analogy works well because residential property taxes are a type of wealth tax. For homeowners, a house is an asset and the value of one’s house, minus the remaining balance on a mortgage, is part of an individual’s net worth. Each year, an individual is required to pay local property taxes, which are a set percent of the value of one’s home. Property taxes have been used in the United States since its founding. They are relatively stable sources of revenue for local governments.
This analogy sets the wealth tax up as something very familiar and is a good sales pitch. However, the analogy isn’t perfect. There are important differences that, in my opinion, make a wealth tax a worse source of revenue than traditional property taxes.
First, traditional property taxes have a comparatively efficient 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. . Traditional property taxes fall on both the building and the land underneath. Land is thought of as a very good tax base because its supply is fixed—individuals and businesses cannot avoid a tax on land by producing less of it. Because of this, economists generally think that land taxes are very efficient taxes. In many jurisdictions, the land is a significant portion of the total value of real estate. As a result, a meaningful portion of real property taxes share this positive characteristic with a land tax.
Warren’s wealth tax would apply to land, but it would also fall on many other types of assets, some of which are much more responsive to taxation. For example, Warren’s wealth tax would fall on the ownership of financial assets such as corporate stock or bonds. A wealth tax would reduce, sometimes significantly, the return to these assets. For example, municipal government bonds, which have interest rates around 2 to 3 percent, would face effective tax rates higher than 100 percent. This would make it much less likely that individuals would hold on to these assets. This could have several negative effects on the broader economy, including a reduction in national saving.
Another virtue of the traditional property tax is that the taxable asset isn’t particularly hard to value. While there can be controversy over the value of property in a given year, localities are pretty good at determining it. One reason is that there is a lot of property to compare to and homes are sold frequently in many places. There are companies that can tell homeowners what their house is worth at any given time.
The wealth tax would fall on many assets that are very hard to price. For example, a closely held business—one that is not traded on the market—does not have a known value, and the value can change significantly from one year to another. As a result, it would be very challenging to apply the wealth tax. Tax authorities would either need to guess or use some sort of formula to impute the value—a process taxpayers would be unlikely to trust.
For homeowners, there is another important distinction to consider. Under current law, the returns to homeownership are mostly exempt from the income tax. Under current law, the first $250,000 ($500,000 for married couples) of capital gains on the sale of your primary residence are exempt from the income tax. In addition, the imputed rental income (the rent you, as a homeowner, pay yourself) is exempt from the income tax. The CBO shows an effective rate close to zero. As a result, the state and local property tax is usually the only tax that falls on real estate for homeowners.
In contrast, a lot of the wealth under Warren’s wealth tax is already taxed under the income tax before it’s hit by the wealth tax. For example, dividends from corporate stock are subject to the 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. . Then the value of the stock would be taxed under the wealth tax. The assets subject to both taxes would face significant effective tax rates—a combined tax burden that homeowners don’t face.
Warren’s comparison between the property tax and her proposed wealth tax makes a good sales pitch. However, there are important differences between the taxes. By no means is the property tax in many jurisdictions perfect, but it is generally better structured than a wealth tax.
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