This week bore witness to political jockeying between the centrist and progressive wings of the Democratic party. The objective: to reach a mutually agreeable framework to fund Joe Biden’s multi trillion-dollar infrastructure, climate, and social spending initiatives.
Ideas included limiting business loss deductions, a surtax on income over $10 million, a corporate minimum tax, tax on stock buybacks, and more.
One proposal is a wealth tax on unrealized capital gains of the wealthiest Americans. Iterations of this proposal have been worked on by Elizabeth Warren (D:MA), Bernie Sanders (I:VT), and Senate Finance Chairman Ron Wyden (D:OR).
Negotiations are fluid; though House Ways and Means Chairman Richard Neal (D:MA) contends the proposal is “dead.” That would be a good thing. Of all the tax proposals recently floated in Washington, a wealth tax is the most suboptimal. It is destructive to all Americans, not to mention, potentially unconstitutional.
Implementation Issues
Taxing unrealized capital gains is a horrific idea. It would not raise anywhere near the projected amount of revenues - the wealthiest Americans would spend millions on lawyers to save billions on taxes. What it would do is hamper the greatest engine of innovation anywhere in the world, the American entrepreneur, thereby thwarting economic growth and stifling job creation. Said The Economist, “Because this tax would apply only to securities traded on public markets, with different rules for stakes in privately held firms, it would deter entrepreneurs from floating their companies on the stock exchange. That would ultimately be bad for investment and the incentive to innovate.”
Another idea would be to apply a wealth tax on private investments. This would be fiendishly hard to implement and cause major dislocations across various private marketplaces, neutering investment, and innovation.
Consider the following: Entrepreneur X owns an interest in a start-up valued at $100. Six months later, the company’s prospects have improved, and the firm successfully raises a round of funding at $1000. Under the proposed wealth tax, Entrepreneur X would be taxed on the $900 increase in value of the start-up even though she has not sold her stake. This creates a litany of problems. How would Entrepreneur X satisfy her tax liability if she did not have ample cash on hand? Furthermore, a need to hoard cash for unrealized tax liabilities would be a grossly suboptimal use of funds. Those monies could otherwise be put to work investing in other entities, generating economic growth, jobs, and perversely, tax revenue.
What if the following year, Entrepreneur X’s firm loses a key contract, and the implied value of the start-up decreases to $500? Entrepreneur X would then be due money back from the government. This is ridiculous. Not to mention, the optics of it would look terrible. An already overburdened and underfunded IRS would be completely overwhelmed.
“Tax The Rich”
Wyden & Co argue their plan(s) will only affect the richest sliver of Americans. That is not true. The individuals who would bear the burden of a wealth tax are responsible for creating a disproportionate number of private sector jobs in America. A wealth tax would surely accomplish one thing: disincentivizing some of the most inventive entrepreneurs from creating solid employment opportunities for working Americans. If a wealth tax is implemented, the richest Americans will certainly be worse off. And so will the 99%. Everyone will suffer.
At TQC we believe people who earn more income should pay more taxes, but a progressive tax code should be applied with level headedness and proportionality.
Third Time’s A Charm
This is not the fist time a wealth tax has been proposed. In 1999, Donald Trump was angling for the presidential nomination of the Reform Party. Among his ideas was a onetime wealth tax of 14.25% on people with a net worth of $10 million or more.
One problem with Trump’s proposal in ’99 is the same problem as Wyden, Warren, and Sander’s proposal today: a federal wealth tax may very well be unconstitutional.
According to Beverly Moran, a law professor and tax expert at Vanderbilt University:
“There are strong arguments that a federal wealth tax is unconstitutional. Wealth taxes violate Article I, Section 2, Clause 3, of the U.S. Constitution, which forbids the federal government from laying ‘direct taxes’ that aren’t apportioned equally among the states. A direct tax is a tax on a thing, like property or income. An indirect tax is a tax on a transaction: for example, a sale or a gift. The income tax is a direct tax and constitutional because of the 16th Amendment, which specifically allows income taxes without apportionment. As for property, you may notice that only states levy real estate taxes. In almost every case, the federal government cannot tax real estate or any other form of wealth absent a transaction.”
(The reason estate, gift, and other generation skipping taxes pass constitutional muster is because they are federal taxes on the transfer of wealth, not on the wealth itself).
Other legal scholars believe a wealth tax is indeed constitutional. The legal granularity buttressing both positions go well beyond the scope of this post. One thing is assured: if a wealth tax is enacted it will be challenged and the Supreme Court will ultimately decide on its constitutionality.
Progressive Tax Code
At TQC, we believe in a progressive tax code. People who earn more should pay more. However, a progressive tax code must be applied thoughtfully. We agree with the position taken by many on the right who argue against excessively high marginal tax rates. A disproportionate number of people who would bear the burden of marginal tax rates over 50% and / or be subjected to “wealth taxes” proposed by politicians on the left, are responsible for creating a disproportionate number of jobs in America. We must be careful not to impose a marginal tax so burdensome that it takes away job creators' economic incentive to offer employment opportunities for working Americans. That is suboptimal for all Americans. It is imperative to keep in mind: most higher earning salaried people in the United States already do pay significantly more in taxes, as they should.
We align ourselves with many on the left who argue that although marginal tax rates are higher on the wealthy, it is unjust that a select few very rich individuals can use loopholes in the tax code to their advantage to cut their tax rate to a level lower than what working- and middle-class Americans pay, in some cases to 0%.
At TQC, we do not begrudge those individuals for utilizing the existing tax code to reduce their tax bill; any rational person would do so. That said, many regressive loopholes in the tax code should be closed or curtailed. Without debate, they disproportionately help the very wealthiest Americans. Very few middle-class and working-poor Americans benefit from these carve outs. We believe that is regressive and unfair.
The IRS
Incredibly, the Internal Revenue Service (IRS) is still processing refunds for 2019 and 2020. If the IRS is going to be tasked with ensuring that any change to the tax code is implemented efficiently and effectively, they must have sufficient resources/staffing (and morale) to do so. Indeed, it is a fantasy to believe the IRS can handle the intricacies of any potential changes to the tax code when they cannot process basic refunds in a timely way. Said a New York based accountant when recently asked about this, “they (IRS) continue to blame every delay on Covid, and the computers keep spitting out incorrect notices and threatening people with asset seizures. If you want to frustrate yourself, you can go to IRS.gov and follow the link to "Where's my refund."
This author filed his (uncomplicated) tax return months ago and has yet to receive his federal refund. This week I logged onto IRS.gov, clicked on “where’s my refund,” filled out the required documentation, and was informed that my “tax return is still being processed” and that “a refund date will be provided when available.”