Elizabeth Warren recently proposed a wealth tax as part of her plan to partially pay for single-payer healthcare. I think this is significantly worse than other methods of raising the same amount of revenue from the same group of people, so this article describes the problems with wealth taxes plus an alternative if we want to raise tax rates on the rich (spoiler: just raise the income tax rate).

Note: Previously, this article used a misreading of the tax rates in Warren's plan. It's been updated to correctly use the 2% over $50 million and 4% more (6% total) over $1 billion numbers. Thanks to Vivek Rao for pointing this out.

This article also used to talk about sales taxes but it was distracting and I'll cover it in a separate post.

Imagine Alice and Bob are both pro sports players, each making $16 million per year over 10 years. Alice saves almost all of her money and has about $100 million in investments (after paying $58 million in income taxes). Bob spends most of his money on partying and ends up with less than a million dollars. Under Warren's wealth tax (2% of wealth over $50 million), Alice owes $1 million more in taxes than Bob does because she didn't spend all of her money.

Imagine Alice from the previous example retires and stops adding to her account (but also doesn't draw it down). After year one, Alice pays $1 million in taxes leaving $99 million. This is equivalent to adding approximately 1% to her income tax rate. In year two she pays $0.99 million. Now it's as if her income tax rate went up by 1.99%. If she continues to not withdraw from her account (except to pay taxes), it looks like this:

After 10 years, Alice has paid $23 million more in taxes than Bob did, with an effective income tax rate of 43% (compared to Bob's 36%). And this keeps increasing the longer Alice doesn't spend her money.

Imagine instead of investing in other businesses, Alice had started her own company which buys $100 million in assets (buildings, equipment, etc.). Her company does well and is worth $2 billion. Alice now needs to come up with around $125 million in the first year to pay her wealth taxes (2% wealth tax over $50 million, another 4% tax over $1 billion, plus around 3% from the income tax on the capital gains), but she invested everything she owns into this company. If her company is only breaking even (as many companies do), then she'll need to sell around 6% of her share of the company in the first and second year, 5% the second, and so on. After 16 years, she becomes a minority owner in her own company to cover the wealth tax.

Note that Alice still hasn't spent any money on herself. It's common to point at the lavish lifestyles of rich people to say that they don't deserve their wealth, but Alice is paying these higher taxes precisely because she hasn't done that and started a business instead. If she had spent all of her money on herself like Bob did, she wouldn't pay this tax at all.

To put it another way, if Alice spends all of her money on booze, she's allowed to keep it (if she can drink it fast enough), but if she spends her money making something of value (like a business), it will be taken away.

As a second aside, property taxes have the same problem (imagine an old person losing their home because they can't pay the property taxes).

Eve and Frank are both normal middle class people who each buy a painting for $100. The artist Eve bought her painting from becomes famous and the painting is suddenly worth $100 million. Eve now owes $1 million in wealth taxes while Frank owes $0. As neither of them have that much money, Eve is forced to sell the painting. On the one hand, she's still rich now, but if she would prefer the painting, the law still forces her to sell it.

The obvious alternative is to raise the income tax rate. If you want to increase revenue, raise income taxes across the board. If you want to increase tax progressivity, increase the top marginal rate or add higher brackets.

Income taxes are nice because you can directly target income inequality, and they're designed so that no one ever loses money because of them (you can end up gaining less money than you would have otherwise, but that's significantly less bad).

The capital gains tax unfairly privileges self-employed investors over employees. As a quick example, if Charlie works for an investment company and is paid $1 million per year in salary, and David is a self-employed investor who makes $1 million in profits (capital gains), Charlie will pay around $330,000 in federal income taxes while David will only pay $200,000 in capital gains tax, despite the fact that they made the same amount of money doing the same job.

A more minor problem is that rich people are more likely to be self-employed investors, which means the income tax rate is less progressive than it's intended to be. I call this a minor problem because taxes in the United States are extremely progressive so this mostly means that some rich people are paying higher taxes than they should because some other richer people are paying too little.

Anyway, the obvious fix here is to treat capital gains as income, either lowering tax rates if we want to make things more fair while being revenue-neutral, or keeping it the same if we want to bring in more revenue. At the same time as this, we should also index capital gains for inflation but the tax rates could be changed at the same time to make this revenue neutral (or revenue-positive).

I'm assuming that a big part of why people support wealth taxes is concerns about generational wealth transfers (it's bad that someone is rich because their ancestor was rich). I think wealth taxes are the wrong way to handle this, since they treat the "new rich" and the "old rich" the same way, plus the concerns above (i.e. taxing an inheritor who spends all of their inheritance less than one who re-invests it). This is strange since only around 30% of billionaires in the US inherited their money. If we want higher estate taxes, we should just raise the estate tax. This targets inherited money without penalizing self-made billionaires who invest instead of spending on themselves.

The estate tax has similar problems to wealth taxes, but I see them as much less bad because you only pay the estate tax once per life and having to sell your parents' company to pay taxes isn't as bad as not being allowed to own your own company long-term. Wealth taxes are also complicated to administer so it's better to only appraise someone's estate once per lifetime vs every year.

My preference is to use sales taxes (as described above) and let inter-generational wealth go away on its own, but if we want to target inter-generational wealth transfers then just tax inter-generational wealth transfers.

It's worth pointing out that estate taxes barely raise any money so this is mostly pointless from a revenue perspective.

Wealth taxes tax people who are smart about their money more than people who waste it. Income taxes are good because they directly tax people with higher incomes more.

The US goverment needs money to operate but we should raise that money in the most efficient and fair way possible. Wealth taxes are not that.