Elizabeth Warren And The Terrible, Horrible, No Good, Very Bad "Wealth Tax" Idea

Recently, Elizabeth Warren unveiled a bold plan to help close the nation’s wealth gap. Although the proposal by Warren is still in its infancy, the basic premise would be to levy an annual tax for the ultra-wealthy, based upon the value of their wealth. Households with more than $50 million of net worth would be liable for a 2% tax on that wealth. And for the super-duper-ultra-wealthy – households with a net worth of more than $1 billion – that tax would be increased to 3%.

It’s estimated that Senator Warren’s proposal would “only” impact about 0.1% of U.S. households. However, that still means the tax could hit nearly 75,000 households, a staggeringly high number of households when you consider the extreme wealth it would take to become subject to the tax in the first place. But while the Warren Wealth Tax could potentially raise nearly $3 trillion in additional tax revenue over the next decade – far more than other progressive proposals, such as the 70% top income tax rate floated by Congressional newcomer Ocasio-Cortez – it is riddled with problems so deep that it is hard to imagine any scenario where it could become a reality.

There Are Serious Questions About The Constitutionality Of A Wealth Tax

Who’s ready for an exciting discussion about the constitutionality of taxes? Neither am I, but having said that, it’s not really possible to talk about Senator Warren’s Wealth Tax proposal without at least mentioning the potential constitutional issues it faces. In short, Article 1, Section 9 of the constitution reads:

“No capitation, or other direct, tax shall be laid, unless in proportion to the census or enumeration herein before directed to be taken.”

In English – or at least more easily understood English – what that’s saying is that no direct tax, like a capitation (head) tax can be assessed unless it is imposed to each state or its residents in proportion to the overall amount of tax set to be levied. So, for instance, if New York has 30% of the population, it and its residents can only pay 30% of the tax.

Now if you’re thinking to yourself, “Hey, wait a minute! What about the income tax? Surely some of the higher-income states like Connecticut pay more than their proportionate amount of income taxes.” you’re absolutely right. They do. And that would be in direct violation of the Constitution… If it weren’t for a little thing called the 16^th amendment, which reads:

“The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.”

Note that the 16^th Amendment’s language expressly authorizes Congress to collect taxes based on income without having to make those taxes proportionate to the states. It makes no reference, however, to any sort of tax based upon an individual’s wealth or property ownership.

“But Jeff, what about the estate tax? Isn’t that a tax based on a person’s wealth? Surely if such a tax were unconstitutional someone would have challenged it by now!”

It’s a fair thought, but there is a key difference. It’s a bit of semantics, but as I am fond of saying, when it comes to taxes, semantics matter. The key difference is that a Wealth Tax would be just that, a tax levied based directly on one’s net worth. The estate tax, on the other hand, is calculated based on the value of one’s estate, but is only assessed an indirect tax on the transfer of wealth. In other words, it’s not the size of one’s wealth that triggers the estate tax, but rather the passing of wealth from one person to another. See… it’s a matter of semantics. But semantics matter.

While I’m not a constitutional scholar, I think Senator Warren’s Wealth Tax would have a very hard time surviving a trip to the Supreme Court; a belief only furthered by the Court’s current Conservative tilt.

A Wealth Tax Would Be Highly Impractical

Another significant problem with Senator Warren’s proposal is that it is highly impractical. In theory, a “Wealth Tax Return” would probably look and feel something like an Estate Tax Return, since the estate tax is also imposed based upon the total value of a (deceased) person’s wealth. So, in essence, those subject to the Wealth Tax would have to file an estate-tax-like return each and every year.

And therein lies the rub.

Consider that each year, Americans spend billions of hours preparing their income tax returns. In fact, according to the IRS, the average taxpayer spends well over 10 hours preparing their return, and some studies estimate that the real number could be closer to twice that amount. Complex returns for high-income, high net-worth taxpayers, on the other hand, can take hundreds of (wo)man hours (or more!) to prepare.

But as burdensome as a complex income tax return is to prepare, it’s a proverbial walk-in-the-park compared to a complex estate return. You see, as complicated as income tax returns can be, they have one thing going for them…the inputs are generally known amounts. For example, if you make $100,000 in wages, that $100,000 gets reported on your return as income.

On the other hand, when it comes to an estate tax return, the inputs are often less “concrete”. Sure, assets like stocks, bonds, ETFs, mutual funds and other publicly-traded investments have an easy-to-determine fair values. Even the value of most real estate can be “ballparked” with relative ease. The uber-wealthy, however, often own assets that are harder to value.

Many ultra-wealthy taxpayers own private businesses, which can be hard to value. Such valuations may require a deep-dive into a company’s financials, as well as a more macro overview of the industry and economy as a whole. In addition to being an expensive proposition, it’s also time-consuming, as such valuations can take weeks, if not months, to complete.

That’s to say nothing of other assets the ultra-wealthy own that people like you and I will only see in the movies or on TV; one of a kind works of art, “priceless” jewelry, expensive cars… the list goes on and on. And now imagine the need to have all these assets valued each and every single year.

It would be a total disaster show.

And how would the IRS even begin to police this!? Which brings us to the next major issue with Senator Warren’s proposal…

Disagreements Would Be Rampant And Enforcement Next-To-Impossible

I value this one-of-kind, “priceless” Monet at $51 million. You think it’s worth $56 million. But hey, what’s a few million dollars between friends, right? Well, in Senator Warren’s plan, your valuation is going to cost the Monet-holder an additional $100,000 in wealth taxes… annually!

With that in mind, and with the stakes so high, the wealthy would do everything in their power to hire teams of lawyers, accountants, and other professionals to “prove” that they are worth as little as possible… at least on paper. Valuations would be shopped around, and firms and appraisers would be incentivized to value assets as low as possible in order to keep the future flow of business coming. All of this, mind you, would be before an army of professionals get to work, artificially depressing the value of assets further using trusts, partnerships and other tools and techniques at their disposal. Frankly, it would be a “dance” that would not look all that dissimilar to the way that the “rich” plan for the estate tax today.

And lest you count on the IRS to enforce the tax fairly. Its resources are already stretched to the breaking point. According to a recent ProPublica report, the IRS conducted nearly 675,000 fewer audits in 2017 than it did at the start of the decade. That’s a drop of roughly 42%! Now add in a new “simplified” tax code that isn’t really simpler at all, further cuts to the IRS’s budget, and a shutdown that left the Service with some 5 million pieces of unopened mail and it’s hard to imagine that rate ticking up again any time in the near future.

A Wealth Tax Would Be Highly Inequitable

Saying a tax on the wealthiest of the wealthy “isn’t fair” may sound absurd to some, and isn’t likely to create much sympathy for those ensnared by its grasp, but the reality is that Senator Warren’s Wealth Tax would be highly inequitable. Consider the following scenario to “prove” the point:

First up, we have Max, a “trust fund baby” who inherited an $80 million portfolio of stocks, bonds, and other investments. He’s never worked a day in his life and spends most of his time thinking about where he should go on his next vacation. Under Senator Warren’s plan, Max would owe $1.5 million in Wealth Tax.

Brenda, on the other hand, is a hard-working entrepreneur living out the “American dream”. After putting herself through business school, Brenda had a brilliant idea and that, coupled with putting in 75-hour work weeks for the better part of two decades, has allowed her to build an enviable company. In fact, today,  Brenda’s business has become the largest employer in her home town, employing more than 200 individuals. Brenda’s business is currently valued at $80 million, so she’d owe the same $1.5 million in Wealth Tax as Max.

Does that seem fair? Does it seem right?

And here’s something else to consider; while Max can simply sell some of his portfolio assets to cover the tax, Brenda’s business is what has created her net worth. So how would she pay her $1.5 million Wealth Tax bill?

… which leads us to yet another problem with Senator Warren’s plan.

There Are No Exempt Assets

If every mega-wealthy individual was a trust fund baby like Max or was a major shareholder of a massive publicly-traded company like Mark Zuckerberg, Bill Gates, or Jeff Bezos, raising the cash needed to cover a Wealth Tax wouldn’t be all that burdensome. All wealth is not equal though, and what about those, like Brenda, whose net worth is “tied up” in the business?

While the Warrant Wealth Tax “plan” isn’t fully fleshed out yet, early indications are that the plan would not exempt any assets. How then, is someone like Brenda supposed to pay her annual Wealth Tax bill?

Should we force business owners to sell some of the businesses that they’ve worked so hard to create? Should they have to take out loans to pay the tax? Or how about those whose wealth is concentrated in real estate or other illiquid assets?

Mind you, these same issues exist today with the estate tax, but the estate tax is a one-time issue, whereas the Wealth Tax would be an annual problem. Furthermore, in recognition of the problems that can arise when illiquid assets must be sold to satisfy a tax bill, Congress has built in special rules into the estate tax regime that don’t exist on the income tax side of things. The IRS, for instance, can grant an extension of time not only to file an estate tax return, but to pay the estate tax liability as well. In total, the IRS can grant extensions for up to 10 years (in no more than one-year increments)!

Without a similar mechanism in place for a Wealth Tax, it’s hard to imagine how some taxpayers would be able to pay their annual bill.

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In recent decades, income and wealth inequality has ballooned out of control. The issue has become particularly problematic in the United States, where today, the gap between “the rich” and “the poor” has grown larger than that of any other major developed nation. That unstable trajectory must change, and soon. Yes, there will always be those with more, and others with less, but the playing field must become more level.

There is no simple solution to the problem. It will require social initiatives, corporate initiatives, changes to regulations and employment conditions, and better access to education, especially for those who have been traditionally disadvantaged. And yes, it will likely require changes to the tax code that require “the rich” to pay more.

A “Wealth Tax”, however, should not be one of those changes.