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Monday, January 9, 2012

The Conservative Case for a 3% Annual Wealth Tax

Wall Street Journal op-ed, The Conservative Case for a Wealth Tax, by Ronald McKinnon (Stanford University, Department of Economics):

A modest levy on the overall wealth of the very rich would allow lower incentive-distorting income tax rates for them and everyone else.

The Occupy Wall Street protests have faded from the news, while the unemployment rate fell to 8.5% in December, the lowest level since February 2009. Still, unemployment and income inequality remain justifiable concerns for tens of millions of Americans and are two of the most pressing issues in the 2012 presidential election.

Reforming the income-tax system is commonly seen as the principal way to reduce inequality. But any attempt to impose higher marginal tax rates on even moderately high income earners—as President Obama wants for families earning more than $200,000 per year—can lead to losses in economic efficiency and even to losses in sorely needed government revenue if high earners work less or seek out more loopholes and tax shelters.

The basic problem is that defining "income" becomes progressively more difficult as income and wealth rise. Straight wage income is relatively easy to define and tax for middle-income earners—through payroll taxes for Social Security or through the personal income tax. But wealthy people live much more off returns from their asset holdings. They receive capital gains, stock options, interest and dividends; and carried interest for owners of hedge funds that, to avoid double taxation, are taxed at lower rates than wage income. They may receive imputed rental income from multiple homes and major consumer durables such as automobiles, art collections or yachts, which the federal income tax misses altogether.

In order to have a fairer tax system, we should implement a new federal wealth tax in addition to the federal income tax. Unlike the current income tax, the wealth tax would not rely on how income is defined. Rather, it would require that households list all their domestic and foreign assets on, say, Dec. 31 in the relevant tax year. With a large exemption of $3 million that effectively excludes more than 95% of the population, a moderate flat tax—say 3%, on wealth so defined—could then be imposed. ...

[A] wealth tax designed to hit only the very well-off would render moot the critics' major complaint that a flatter income tax would not hit the rich hard enough. A wealth tax is a necessary political condition for much needed rationalization of the income tax.

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Comments

Although this tax would be reasonably fair, here are a few of the potential objections which must be addressed:

1. This tax appears to require a constitutional amendment. The alternative is admitting that the constitution does not constrain any federal action which has a reasonable rationale. A constitution which does not meaningfully constrain the government is a dead letter. This is similar to the health insurance mandate argument.

2. The 1986 Tax Reform history shows that when you trade increased scope of taxes for rate reductions, the former is permanent while the latter are largely temporary.

3. This tax would require more intensive and intrusive auditing than the income tax. The possibilities for abuse are frightening, including debtor's prison. The public might withdraw its support when this feature becomes clear.

4. This tax has no parallel in other countries. This puts American subjects at a disadvantage. We will not attract and retain as many highly capable entrepreneurs from other countries. The lost income tax revenues may eventually exceed the take from this tax.

Posted by: AMTbuff | Jan 9, 2012 11:55:32 AM

It's difficult to see how that wouldn't be an unconstitutional direct tax. From time to time one sees proposals suggesting, as a more clearly constitutional substitute, a tax on unrealized gains (like an annual mark to market basis tax), but that could only hit wealth once. ie, say in Y1 my unrealized gain of $X is taxed at 3%; next year the tax could only apply on the excess over $X. Such a tax could function as a wealth tax substitute in year 1, but in subsequent years could only capture incremental unrealized gains.

Posted by: jpe | Jan 9, 2012 11:57:22 AM

The income tax originally hit only the very rich.

If this were passed, in no time flat it would be safer to keep your savings under a mattress reather then in a bank/S&L/credit union where the government could find it.

Posted by: gospace | Jan 9, 2012 3:59:30 PM

Bad as this extract is, the full article is even worse. The theme of "imputed rental income" is expanded on, and offered as one of the two main "loopholes" of the current system. This must be one of the silliest ideas in all of tax writing. Fortunately the concept has essentially zero support among the general public.

Posted by: No-no-no | Jan 9, 2012 4:51:34 PM

If it made sense to tax homeowners on their "imputed rental income," why not extend that tax to tenure rights held by college faculty?

Posted by: Jake | Jan 10, 2012 7:23:45 AM

Imputed rental value of assets is accepted by economists as a component of true income. Whether it makes sense to tax it is another question.

The rental value formulation merely states that if you own an asset (such as your home) that would cost $X per year to rent, you are $X per year better off than another taxpayer who has no such asset. For example, two retired people live in identical houses. One owns his house free and clear and the other is a renter paying $800 per month. The renter's ability to purchase and consume is $800 per month lower.

If you regard ability to consume as the correct measure of economic income, you can't omit imputed rental value. That said, there are ample practical and political reasons why income tax will never be assessed on imputed rental value.

Ironically the best argument in favor of the mortgage deduction depends on an understanding of imputed rental income. The current mortgage interest deduction approximately levels the income measurement between mortgaged homeowners and free-and-clear homeowners. Yet renters are left out in the cold. It's not possible to truly align taxable income with ability to consume without counting imputed rental value.

Posted by: AMTbuff | Jan 10, 2012 9:21:19 AM

The appraiser's lobby would get an Olympic gold medal for such a law. The gross subjectivity and complexity of administering such a tax is mind boggling. This proposal has no legs.

Posted by: captcook | Jan 10, 2012 9:38:24 AM

@AMTbuff:

Among the multiple definitions of income, some very broad and abstract, that have been proposed by economists, there are some that include "imputed income" and "ability to consume". To conclude from this that (all? most?) economists accept a unified measure of "true income" that includes imputed income is quite a stretch.

In any case, the context is the US income tax system. The US doesn't have a wealth tax, and as I understand it such a tax would be unconstitutional (I think you agree, from your first comment above). On the other hand an income tax is expressly authorized. So any theory that treats wealth as equivalent to some implied amount of income *in the context of the US income tax system* is something to be viewed with deep suspicion. If someone owns an asset, the straightforward way to look at it is that the asset is part of their wealth.

The article asserted that not counting imputed income was a "loophole" in the US income tax system. Ludicrous!

Posted by: No-no-no | Jan 11, 2012 9:35:19 AM

I think imputed rental value is already largely built into the price of homes. For example, if people started getting taxed on imputed income, then the price of homes would drop pretty significantly as people returned to renting.

Posted by: Matt | Jan 11, 2012 10:39:15 AM