The Net Wealth Tax - Problems and Possibilities

The Net Wealth tax - An Overview

The one and only subject matter of this blog is the proposal that the United States impose an annual tax on the net wealth of citizens and residents, in lieu of an annual income tax. (I do not propose a tax increase. Tax rates would be calculated to produce the exact same quantum of tax revenue as the income tax does today.) The two-fold purpose of the change would be (a) to shift the tax burden of the annual tax away from middle- and low-income taxpayers, on to the truly rich, i.e., those with significant wealth; and (b) cause the gradual erosion of large accumulations of wealth and the power that goes with it. For that reason,  the annual tax would be supplemented by a truly aggressive estate tax. 

The basic arithmetic of the tax is simple. There is about six times as much wealth in Western society as there is income, according to Thomas Piketty and other sources. Therefore, a six-fold expansion of the tax base, without any revenue increase, results in tax rates going to 1/6th the present level. We are not going to forget about income. Annual W-2 and 1099 income is going to be added into the wealth base as an addition to wealth. But for the vast majority of taxpayers whose income is their primary source of wealth, the degree of tax relief is profound. Instead of paying a top rate of (say) 40%, the rate drops to 6.66%. Thus, the tax burden thus falls away from the middle class and largely on the rich and super-rich. 

The change of the tax base from income to wealth would produce a variety of fascinating effects, some very exciting, some very frightening,  some easily calculable, others beyond the range even of wild imagination. We will be discussing these in future posts. For now, all I want to do is lay out the basic administrative template. 

(1) The tax would be imposed on all US citizens and permanent residents on all the assets they possess, regardless of situs.Thus, it is useless to transfer a large balance at Chase to Gringott's (the Harry Potter bank). The taxpayer is liable just the same. There will be very few taxpayers so taxphobic as to move major assets to a holder so obscure that it can't be identified. There would be major security risks to an institution so far removed from charted waters, and this to avoid a tax that is a maximum of 6% and change. In addition, there would almost certainly be an audit trail.

(2) The tax would be imposed annually, based on the valuation at a given date (say, January 31st). The tax base is the taxpayer's assets less liabilities. plus his W-2 and 1099 income. It is a far easier tax to compute than the present income tax, for the same reason that balance sheets are far easier to produce than income statements. There is no need to calculate gain and/or loss on transactions, no need to distinguish ordinary income from capital gain, no need to compile deductions, etc. A taxpayer does not gain or lose by selling an appreciated or depreciated stock on a given date. Whatever the stock is worth, whether liquidated or not, is the basis for the assessment. Annualization problems are thus close to non-existent.

(3) There will be generous exemptions for home equity and personalty. One of the major benefits of taxing wealth instead of income is that the tax is truly and easily progressive. Because of the inverted pyramid nature of wealth holding in the US, a comparatively small change in the top bracket - say, from 6 t0 6.25% - pays for a huge volume of tax expenditures at the lower, 'needy', levels. 

(4) Valuation of different assets is going to be the subject of many posts to follow. For now, I would simply note that the problem is hardly insuperable. Asset valuation is already required by the Internal Revenue Code in connection with the estate tax. The regulations in force at present apply to almost every conceivable asset a citizen may own, the common standard being 'willing buyer/willing seller'. Banks and financial institutions are prepared to loan on all sorts of unusual holdings, and to appraise the same. Real property is taxed as wealth almost everywhere in the US, and county assessors assess the value routinely. To be sure, much of this practice is based on one -time sales or tax imposition, and would have to be tinkered with to be of use on an annual basis. But these are solvable problems, and in fact very tame, compared with the difficulty of calculating and taxing income.  

(5) The top rate is 6%. The following are hunch numbers, simply to illustrare . We'd impose a (a) 1% tax over the first $100,000 of wealth, 2% over the amount between $100,000 and $500,000, (c) 3% on wealth between $500,000 and $1,000,000, (d) 4% on wealth between $1,000,000 amd $5,000,000, (e) 5% on holdings between $5,000, 000 and $10,000,000, and (e) 6% on holdings above $10,000,000. (FICA and social welfare taxes are not affected. These are not income taxes.)

Note that home equity and personalty are not included in the base. Thus, the tax is assessed on working assets, that themselves produce an income stream.  An astute investor may quite possibly outpace the tax rate, and add to his store of wealth, particularly since income is untaxed (or more accurately, taxed as wealth).

But I don't think the social purposes of the tax should be disguised. The first benefit is that upwardly mobile, high earning tax payers are not burdened with the major tax burden of the nation. For example,  a 'hell-for-leather' salesman who earns $1,000,000 a year in commissions, but comes from a modest background, pays only $24,000 dollars in wealth tax ($1,000 plus $8,000 plus $15,000) as opposed to the six-plus figure he would owe under the present system. On the other hand, a legatee content to live on the largesse of his ancestors, pays the exact same amount, whereas before he would have paid next to nothing.

The second social benefit is probably more important. The effect of the net wealth tax is to create a leveling wind that over several generations would erode even the largest estate and return the distant ancestors of the estate creator to relative equality with his fellow citizens. I don't mean this to be class warfare, or even class hostility. It reflects the opinion that one of the essential elements of American culture is the open frontier, abundant economic opportunity for those who pursue it. In the days of Frederic Jackson Turner, the frontier was literally that. In the Twentieth Century, it took the form of various unexplored business vistas, airlines, oil, and - in the last quarter of the century - electronics. But as the world settles in and wealth grows and calcifies, that vista disappears. Without the sense of abundant opportunity, what becomes of American culture? My great fear is that it becomes stratified, like the European and Asian societies some of our ancestors fled, or the African culture from which others were involuntarily sold.

However, the most profound consequences of a net wealth tax are unintended, i.e., not related to policy. Imposing a tax on all assets requires asset be valued, appraised, and taxed. The effects of the tax on non-productive stores of wealth, such as collectibles, speculative stocks, and so on, are so far reaching they are impossible to assess completely. It is one thing to pay $50,000,000 for a work of art. It is quite another to pay it knowing that there will be a tax  of several hundred thousand dollars to pay every year. Similarly, it is one thing to invest in a high tech stock at a price that has no relation to its earnings - quite another to pay a substantial tax on the theoretical value every year. The change is so far reaching that it may alter the nature of entrepreneurship as well. From some perspectives, these changes are all to the good of society, from other perspectives, devastating. It will be the mission of this blog to explore these in as much depth as possible.

The leveling wind provided by a net wealth tax is hardly the one-and-only solution to these problems. But , without confiscation, without revolution, without undue inconvenience, it does contribute to restoration of the frontier. Prosaically, someone has to pay taxes. Shifting the burden to the rich and the ulra-rich makes economic sense, historical sense, common sense, and frankly accords with ordinary morality. 

Administration of a Net Wealth Tax - Basics

No administration of a direct tax is free from problems. But the administration of  net wealth tax will be far easier than an income tax, for the same reason that it is much easier to construct a balance sheet than an income statement.   Here is one likely template:

(a) The Tax Base of the Net Wealth Tax Consists of the Net Assets of the Taxpayer, Including  W-2 and 1099 Income for the Calendar Year,  Excluding Personal Assets Such As Home Equity and Personalty To a Given limit.  Computation of the tax base of a taxpayer is thus rather simple for the vast majority of lower-, middle-, and even upper middle-, class taxpayers. Most people own only a few major assets - home, maybe some rental property, and a securities portfolio that is held by one or two brokerage firms (Schwab, E*Trade, Merrill, etc.). Identifying the assets and liabilities that make up the balance sheet is thus extremely simple, for most taxpayers, under an hour.

Valuation of the assets is the crux. The discussion of the issues presented by valuation will be the major subject of this blog, and the various issues presented thus way beyond the scope of a post labeled as 'basic'. Suffice it to say at this point that we will deal with the basic nightmare of taxpayers concerning a wealth tax - that a tax imposed on a base that includes a home will make ownership uncomfortable or even unaffordable - by including an exemption for home equity and personal items (car, furniture, etc.) generous enough to exclude all but the most expensive homes and personalty. 

(b) The Tax Is Progressive and Imposed on the Entire Tax Base. The Maximum Rate Is Approximately 6%. As I noted in the 'Overview' post, no tax increase in taxes is contemplated. Whatever the net revenue necessary , whatever the 'X', it remains unchanged. Given that productive wealth is 5-7 times the amount of income (per Thomas Piketty and others), net wealth tax rates will be some equivalent fraction of the current income tax rates.  For simplicity, I'm going to assume a maximum rate of 6%.  Note that this is one tax that is truly progressive. Because of the funnel-shaped pattern of societal wealth, even a minuscule increased of the top rate produces a huge addition to revenue, more than enough to fund reasonable tax expenditures in the lower brackets. 

(c) The Tax Base Includes ALL Assets of United States Citizens and Resident Aliens, No Matter Where Situated And Regardless of the Residency of the Citizen. Fleeing the tax is next to impossible, without renouncing citizenship and transporting assets off-shore - steps so drastic that very few individuals would undertake them. Since the maximum rate is only 6%, motivation is also lacking. 

(A tax at some rate will also be imposed on domestic assets held by foreign nationals residing abroad. The complications of that are beyond the scope of this post.)

(d) Rate Structure.  Obviously detail on rates depends on a socio-econometric study of rates that is way, way beyond anything a blog poster could undertake. But for the sake of doing computational examples, assume the following: 1% for wealth between 0 to $100,000, 2% on the base between $100,000 and $500,000, 3% on the base between $500,000 and $1,000,000, 4% on the base between $1,000,000 and $5,000,000, 5% on the base between $5000,000 and $10,000,000, and 6% on wealth of $10,000,000 and more. 

There is no change in FICA and social insurance tax rates, which are not affected by the change in the tax schemata.

The Annual Net Wealth Tax will be supplemented by an estate tax that is similarly aggressive. The rate structure of that is beyond the scope of this article. I will discuss the social purpose in a subsequent post. 

(e) Examples. The following six examples illustrate how a Net Wealth Tax would be computed. (In all cases home equity and personal items are exempt and disregarded).

    (1) Two young married medical professionals finish residency and begin professional practice.  Neither has any inherited wealth. Both have student loans of approximately $150,000. Each earns $300,000 in the first year of practice. I'm going to assume for purposes of these examples that each is taxed individually, i.e, joint returns are not permitted. (As a practical fact, taxation of marital wealth is a huge, but resolvable, issue.) 

    Each of the young marrieds owes a tax  of $2,000, or a total of $4,000. The tax base is $150,000 ($300,000 income added to the asset base, minus $150,000). Each young professional pays 1% on the first $100,000, or $1,000, and 2% on the balance of $50,000 over $100,000, or another $1,000 - $2,000 each,

Comment: This is the paradigm case for the Net Wealth Tax. The tax burden currently imposed on upwardly mobile individuals is shifted to persons with lower income and greater  wealth. As the couple matures and accumulates wealth, the burden shifts gradually to them.

    (2) A  middle aged attorney professional investor has accumulated net assets of $10,000,000. He has a professional income of $250,000 and - because he invests aggressively and acutely - investment income of $1,000,000. His tax base is thus $11,250,000 (professional income, plus investment income, plus asset base.)

He owes a tax of $429,000 ($1,000 on the 1% bracket, $8,000 on the 2% bracket, $15,000 on the 3% bracket, $80,000 on the 4% bracket, $250,000 on the 5% bracket, $75,000 on the 6% bracket [$1,250,000 - the amount in excess of $10,000,000 - x 6%]).

Comment: This is the  paradigm of a professional investor. Note that the investor's net wealth increases by approximately $500,000. There is quite a bit of motivation for wealthy investors to diversify into investments that offer a return greater than 6%.

    (3) A middle-aged charitable worker has inherited an estate of $100,000,000 net.  She is disinterested in commerce and invests in coupon bonds that produce an annual return of 4%.  Her tax base is thus $104,000,000. 

She owes a tax of $5,994,000 ($354,000 on the bottom five brackets, plus $5,640,000 on the assets in excess of $10,000,000 [$94,000,000 x 6%]).

Comment: Finally, this is the paradigm of the fortunate individual with substantial inherited wealth. I have no quarrel with the motives or life choices of the individual. She may be doing important social work of a type that can only be done by someone who has no need to make a living. But at the end of the day, the brutal reality is that she has been blessed with a life choice not available to people who have to make their own way through life. It is also the case that the simple retention of wealth creates barriers for the energetic and upwardly mobile. Shifting the tax burden from them to her makes social and moral sense, no matter how laudable her motives and ethics.

    (4) A Californian nurse retiree owns a rental property that produces $60,000 in gross rental income annually.  However, the net income is reduced to $0.00 after conventional GAAP accounting, including an allowance for depreciation reserve. Valuation methods for this type of asset are a major issue that is too lengthy for this post. For now, assume the valuation is the same as the Proposition 13 valuation that California sets by law - in this case, $1,000,000.  The property is secured by a mortgage of $500,000. In addition to her rental income, she receives a social security benefit in the amount of $30,000 annually.

    The nurse will owe a tax of $9,900  ($9000 on the first two brackets, plus 3% of the assets over $500,000 [$30,000 x 3%]).

Comment: Ordinary GAAP principles are not lost in this scheme. We WILL compute profit-and-loss on the basis, including depreciation and depletion allowances. But the actual valuation of assets will deviate. It is the practical fact that a great many theoretically wasting assets, particularly real property, are actually appreciating. In the case of real property, valuation will almost certainly be based on the value used for local property tax assessments. 

    (5) An older investor has accumulated assets of $1,000,000,000.  Her hobby is collecting the art of old masters. Her collection is valued at $200,000,000. She is conservative with her investments and achieves a 6% return on her productive assets, or $48,000,000. 

    The investor will owe a tax of $62,634,00 ($354,000 on the bottom five brackets, plus $62,280,00 on the assets in excess of $10,000,000 [$1,038,000,000 x 6%]).

Comment: The networth of this taxpayer decreases by $14,000,000 because of the large holding of non-productive assets. The valuation of art and other collectibles - what we might call 'non-productive stores of value' - poses some interesting problems that will be the subject of considerable discussion in the posts to follow. 

    (6) A youthful technologist has founded a technology company that has gone public. His stock holding in the company is worth $1,000,000,000, even though the company is actually still reporting losses in the short term. 

    The technologist will owe a tax of $59,754,000 ($354,000 on the bottom five brackets, plus $59,400,000 on the balance over $10,000,000 [$990,000,000 x 6%]). 

Comment: This is another paradigm, illustrating some fairly seismic changes in valuation that a Net Wealth Tax would produce socially. Obviously, the young technologist does not have $60,000,000 needed to pay the tax. Equally obviously, there is no willing buyer for even a fraction of his holding. This raises the brutally realistic question as to what the worth of the stock actually is.  

At the present time, however, even though the stock may never pay a dividend and is too highly priced for a cash acquisition, the young investor can turn the stock into hard cash or other assets by selling into the market on a greater fool theory, pledge it as collateral, etc. All that changes - radically - in good ways and bad - if a tax is imposed on the actual asset value of the holding.

This, then, is basic administration of the Net Wealth Tax, and a preview of some of the major issues. 

 

 

Valuation Methods

Thus, the overview of the objectives of the Net Wealth Tax, and the basic administration. But God is in the details, and never more so than with the Net Wealth Tax_. The tax requires that every asset and liability owned or owed by every taxpayer be accounted for and taxed every year. The entire scheme fails at the outset unless simple, practical valuation methods are provided, so as to make both compliance and administration relatively easy. The first thought is that this is impossible, given the infinite varieties of property. But the first thought in this case is dead wrong.  The problem is both more simple and more difficult than it appears to be. I'll explain the paradox. 

It's simple because valuation methods are actually all around us, and in constant use. These days, the Federal Estate tax may apply only to a microscopic number of American taxpayers. But it's been around in its modern form since 1916, nearly a century of history. The IRS has developed techniques and regulations to place a value on nearly every item of property imaginable. The same thing holds true with respect to the administration of State inheritance taxes. At the local level, universal property taxes require assessment of nearly all real property parcels, and often significant personalty as well. Finally, banks and other financial insitutitions have all sorts of techniques to appraise any sort of property that is potentially collateralizable. So it is not as if the imposition of a net wealth tax is going to require the creation of any new financial tools. They already exist.

But it's not so easy because these methods are not consistent. Federal Estate and State inheritance taxes are based on the net worth of the decedent on the date of death. Administration of the tax requires a determination of the value of every item of property that the taxpayer possessed on that date, including real property and personal items that may have been acquired decades earlier. It's complex, burdensome, expensive, and an approach that is out of the question for a tax requiring an annual return. For that reason, local property taxes in many States are based on the historical cost of acquisition, with cost-of-living adjustments. 

It seems to me that any one-size-fits-all schemata simply will not do, that this is one place in which any consistency is all too likely to be foolish consistency. I think practical administration is going to require a hodge-podge of methods, a hybrid, in which the ease of determining a value trumps any notion of finely tuned precision.  With that in mind, let me lay out a catalogue of the various categories of property and my suggestion of the practical valuation methods that might apply to each.

1. W-2, 1099, and Other Income. The most obvious departure from consistency hobgoblins is the suggestion that the net wealth tax start off with the inclusion of all income in the tax period, regardless of source. Obviously, not all income inures to wealth. Human beings must eat, drink, clothe themselves, house themselves, and so on, i.e., expend money as they receive it. Treating the entirety of income, particularly W-2 income, as an addition to wealth is not entirely logical.

Yet that is what I would suggest, in the interest of simplicity, accountability, and full taxpayer participation. There is a miniscule regressive aspect to the complete inclusion of income, without any allowance for basic expenditures for necessaries, but it is dwarfed by the savings of the overall progressiveness of the system. For example, a family of four living on an income of $100,000 - barely middle class by contemporary standards - pays a tax of only $1,000 under the Net Wealth Tax. If we were to allow a 'necessaries allowance' of (say) $10,000 for each family member, the tax is reduced by $400. For taxophobes, of course, any reduction is significant. But the savings is picayune compared with the savings implicit in abandoning the income tax.

(One small nuance is worth additional comment. With respect to renters and rental payments, since we are going to exclude home equity, allowing an asset reduction for rent would be inconsistent.)

A necessaries allowance would affect only the bottom-most brackets in a manner that is close to immaterial. The gain in simplicity and ease of compliance more than outweighs the gain in consistency, in my opinion. However, even if my opinion should turn out to be the minority position, including a uniform necessaries allowance is not going to do that much damage to the system. Even itemization (up to a certain limit) is not fatal. 

Finally, to state the banal obvious, income is included in the asset base at its reported amount.

2. Home Equity and Personalty. We are going to exempt home equity entirely, for both practical and policy reasons. The practical reason is that the Great Scarecrow that the ultrawealthy have used to deflect tax schemes that might lead to sensible taxation of their holdings, is the fear that such a scheme would endanger middle class home ownership. Exempting home equity negates that fear  . . .  and that tactic.

But there are policy reasons as well. The net wealth tax is aimed at productive assets, not personal. During my years of active financial practice, I told my clients that including their home equity in their asset base was akin to including their body for its use to medical science. Excluding home equity and a reasonable amount of personal property only makes sense in terms of what we want the tax to accomplish.  My hunch number for the personalty exclusion is $50,000, which should be more than enough to cover clothes, furniture, personal items (jewelry), electronics, etc.

Does an unlimited exemption invite taxpayers to avoid the tax by converting assets into home equity? Maybe so, but converting productive resources into non-productive ones (to avoid a tax with a maximum rate of 6%, yet) is not a choice that too many taxpayers will make. Rendering yourself house poor is not a sensible thing to do in terms of life choices. 

But what about mega-estates? The Ponderosa and the like? Well . . . . .  it won't exactly break the system to put a ceiling on the exemption for home equity, adjusted annually for cost of living. Also, there has to be an allocation between home equity and productive assets, in the case of working farms. But let us say unlimited exemption for the time being.

Purchase money mortgages are excluded as liabilities, a useful consistency in this case. However, second mortgages and the like, as well as the assets generated, are included on the net wealth balance sheet.

Also, second homes and the like are not exempted. 

3. Liquid Assets - Stocks, Bonds, Bank Accounts, Other Monetary Instruments. This is the easiest stuff, since it is easily marked to market on the chosen valuation date (likely the end of the year, but it could be any other convenient date.) Note that attempts to game the valuation with a hedge or temporary loan (i.e., offsetting the asset with a liability) will fail, since the new liability will be offset by a corresponding asset. (The net wealth tax is based on balance sheets, and not income statements. It is extraordinarily difficult to get used to the idea that profit and loss, i.e., income, doesn't matter at all anymore. Whether a taxpayer holds a stock or the cash realized from its sale makes no difference.)

4. Small Businesses - Proprietorships, Closely-Held Corporations, Professional Practices, etc.  Given the remarkable variety of small businesses, evaluating these is likely to require the most serious administrative work and produce the densest regulation - however, even at its densest, not even close to the jungle of income tax regulations. The value of small businesses goes all across the board. Some are worth no more than the annual income produced, some are worth some multiple of income, some may even have negative value.

My own thought is to frame the approach on the KISS principle(Keep It Simple, Stupid). The balance sheet of the enterprise, accounted for on a GAAP basis as of the given valuation date, should be associated with the taxpayer-owner in proportion to the ownership interest, and that value included in the taxpayer's income base. Thus, all of the net assets on a balance sheet are included in a proprietor's return; fractional interests to partners; and shareholders in proportion to their shareholding. Income from the enterprise is captured either as an increment to a retained earnings account or an income distribution to the owner.

(Let me digress for one moment. Associating corporate wealth with the shareholder implies no tax at the corporate level, since that would be a form of double taxation. Thus, logically, even mega corporations pay no tax at all. Since this will never do as a political matter with the American populist tradition, we will probably be adding a basic franchise tax at some rate. Consistently - and this is another good consistency - the tax would be either a flat rate or based on gross income. Imposing a corporate income tax is going backwards.)

What about small businesses that are worth some multiple of annual earnings? I think precision has to yield to practicality in this case. There is in fact no ready market for the business, neither a willing seller nor willing buyer, no certain valuation. Even though it may be obvious that the value of the enterprise is many times its annual income, there is in prosaic reality no way to put a number on it. So we will accept the balance sheet value plus income, in the interests of common sense. If and when the business actually is sold, the appreciated value can be captured at that time. 

5. Real Property.  It's not hard to value real property.  County assessors do it all over the country, every year. So do lending institutions.  My first thought is that the the same value used by local taxing authorities will simply be taken over by the Net Wealth Tax. However, you can make a case that a business holding a real property asset on its balance sheet should be permitted to include the balance sheet value rather than the assessed value. Again, there is no immediate market for commercial property. Using the GAAP value makes common sense.  The bottom line is that either method is easy for both compliance and administration.

6. Miscellaneous Assets - Collectibles, Intellectual Property, etc.  Collectibles over and above the exemption for personalty are valued at the acquisition cost.  Although some collectibles (e.g., stamps, coins, rare books) do have theoretical catalog values, the operative word is 'theoretical'. A tax system that forced collectors to vend some prized item simply to pay tax would fail politically at the outset. So historical cost is not only a simpler method, but essential. In any case, the Net Wealth Tax is aimed at productive assets, not non-productive stores of wealth.

I could go on and on, discussing ever more obscure types of property. But this is enough for talking points. Note that the system is a hybrid - assets that can be marked to market conveniently ARE valued at FMV on the date of valuation. Others are taken at historical value, because there is really no good method to determine the fair market value in any practical manner. The candle is simply not worth the game.

The related Estate Tax is a different matter. That's the subject of the next post, as well as other ancillary taxes. 

 

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A Comment Suggests A Generic Valuation Method

Everything written on this blog is a speculation, a thought experiment about the means by which a net wealth tax might actually be implemented and administered. When a good or interesting idea comes along, consideration of it will be integrated into the discussion.

In response to my last post on valuation methods, the commenter Frank O. asked about the valuation of a timeshare interest that has become worthless. The short answer would be that the timeshare would be accounted for at its historical value. How in fact could the timeshare be demonstrated to be worthless? If it is still carried on the books of the seller and the tax rolls at its original value? To permit a taxpayer to substitute his own estimate or to obtain and use a privately obtained assessment will not do. It leads to obvious potential to game the system.

But then I recalled that there is actually a thriving secondary market for timeshares, in which units of all kind are routinely bought and sold. If the decline in value of a particular unit is demonstrable in that market, perhaps the taxpayer could be allowed (or required) to use that number.

This leads to consideration of the possibility of a larger, generic valuation rule. Items of property - real or not - that can be sold or hypothecated in an on-going, established day-to-day market perhaps should be marked to that market value on valuation date.  I don't know whether the market for timeshares is so active and liquid that a marked-to-market value is possible for all timeshares is practical. But maybe so.

Perhaps the same rule holds true for other non-monetary intangibles. If collectibles (coins, stamps, works of art, etc.) are bought and sold all the time on established markets on the Internet, perhaps those market values should be used for Net  Wealth Tax purposes. On the other hand, these assets are not terribly material in the larger sense, and the political cost might be too high. 

Assets for which no established market exists, which comprise most real property assets, are valued on the basis of historical cost or local assessment value. (In passing, I expect the enactment of a Net Wealth Tax would cause assessment method of local tax agencies to be conformed around the country.)

 

It's an interesting speculation.

The Estate Tax and Other Ancillary Taxes

Let me round out the entire scheme of Wealth Taxation in this post.  Just a friendly reminder - we are not talking of a tax increase in advancing this proposal. The issue is the sources of revenue, not the amount. There may be all sorts of good reasons for a tax increase. In fact,  given the size of the Federal deficit, there probably are. But that is not the issue here. Whatever the revenue need, X,  it remains the same X.

With that caveat:

1. Estate Tax.  An effective Estate Tax is a necessary pendant to the annual Net Wealth Tax, and the stopping point of the whole system. This is the point where all assets are appraised at present fair market value, and taxed accordingly. There isn't too much to add, since the United States does impose an Estate Tax at present, in a format that doesn't need much tweaking. The schemata will be pretty much the same, except that the progressive rates will be much higher, rising to 70% and beyond for huge estates. (The definition of 'huge' remains to be determined.) It's the same story as Akio Morita in a previous post - in three generations, we want to reduce the fortune to the starting point. I don't see this as class warfare. The present level of exemption and credit, even if reduced to 2015 levels, is more than enough to provide younger generations with a solid starting-off point and even a little investment capital. But it is not enough to entrench them in the ranks of the super-rich.

The object, as always, is to create an open economic horizon for Americans of all classes.

2. Consumption  or Value Added Tax.  A Net Wealth tax fits easily beside a consumption or value added  tax, which could increase the progressivism of the tax system and lower the already mild bite of the annual return.

3. Utility Taxes. The Net Wealth Tax also fits nicely with utility taxes for roads, highways, harbors, and so on. 

4. Social Welfare Taxes. As noted earlier, collection and administration of FICA and Medicare taxes are unchanged. 

Summary. Though this is a short post, this completes the entire tax template. The lynchpin is an annual Net Wealth Tax, supplemented by a more aggressive Estate Tax. Other policy-based taxes fit easily into the scheme.

 

 

 

Revaluing Value - The Most Striking Aspect of a Net Wealth Tax

Let's suppose Elizabeth Warren's proposal for a wealth tax becomes law. It's pretty picayune compared to what we have been discussing in this blog i.e., a wholesale substitution of a net wealth tax for income tax. But let us suppose. I read a blog or Twitter post the other day, somewhat gloating over the fact that Jeff Bezos, the Amazon chairperson, would apparently owe some hundreds of millions of dollars of tax under Warren's scheme. The one small problem is that he hasn't got hundreds of millions of dollars - his Amazon holding is nothing like that value in terms of ordinary productive value. 

 

So he can sell some shares? To raise money to pay the tax? I vividly recall my old corporations law professor at Berkeley, Jesse Choper, who taught the class in a wonderfully theatrical manner, responding to a student's improvident suggestion that oppressed minority shareholders could sell out - "SELL? TO WHOM??? WHO THE HELL WANTS TO BUY THIS PROBLEM?"

 

Just so.  Bezos isn't going to find any willing buyers for a fractional interest, because they're buying a liability, not an asset. This aspect of the tax is going to hit a lot of people if the floor is set at $50,000,000 and it will ripple down through the market. Buyers and sellers both will confront a raw, explosive reality - Bezos' multibillion dollar holding of a non-dividend paying, non-redeemable common stock isn't worth anything like its present market, without a greater fool willing to buy it at that premium. The same holds true for Apple, Amazon, Facebook, a legion of high-tech start ups and others, none of which generate a cash flow or item of value that remotely justifies the present trading value.

 

Right now, it's wonderful to own several tens of millions of dollars of stock in a glamor company. It's a liquid store of wealth that you can sell or hypothecate at the time of your choosing, turning the stock into real property, funds for higher education, nice concrete items of consumption and use. True confession: I'm the beneficiary of this oddity. Back in 1983, as lawyer, I founded Borland International, a software company that Philippe Kahn turned into a real force in high tech. I took a small number of founder's shares at a nominal price. Borland was a spectacular innovative company, and I am very proud of my role in its success. But in terms of returns to shareholders, it never paid a dividend and never redeemed a share. It was never acquired. Nonetheless, in 1992 I sold the holding for a seven figure sum and did indeed reinvest in a home, college funds, and so on. What with splits and recaps, the basis in the initial shares was so low by that time  - 1/40th of a cent a share - that I did not bother to report it on my return. A few years later, management lost its way, and Borland went under. Though I am not planning on returning the funds, the brutal reality is that the shares that I sold never did have any realistic value.

 

Neither do many of the stocks being traded today, at least not remotely close to the share price at which they trade. They're tulip bulbs. So many private and public expectations are based on those values that no one likes to admit how divorced from financial reality they really are. But a Net Wealth Tax brings that brutal fact brutally home. (Of course, what is true of high profile stocks is also true of other non-productive stores of value - art masterworks, stamp and coin collections, other collectibles, and so on. It's one thing to pay $100,000,000 dollars for a Rembrandt when it hangs in your study. It's quite another when you may have to pay up to $6,000,000 every year for the privilege.)

 

It's my own intuition that at the end of the day, taxing wealth has a profound effect on the meaning of fiat money. I think it results in the grounding of the value of money in the basic rate of return on capital. But this is an intuition only. Proving it out one way or another is way, way beyond me. That's why the academic economists to whom I have distributed this have been so burdened. These posts are like rocks thrown in the pond, spreading concentric circles, in the hope that one of them will touch someone who has the ability to do something with this.

 

Would this reduction of money and value be a Good Thing or Bad Thing for our entrepreneurial capitalist society? Again,a question beyond my paygrade. A friend and frequent correspondent, Josh Galanter, puts the affirmative case effectively:  

 

The other concern is that a wealth tax will encourage a shift of wealth from non-productive stores of value to productive investments.  Think of wealthy people who might own something like gold as an inflation hedge.  Because it is a non-productive asset, its expected return is zero over the long term, which means that under a wealth tax, its value will erode by some fixed percentage every year, now making it a poor store of value.  Thus there will be a strong incentive to take that gold, which is sitting there losing value over time (because it is being taxed) and put it into a more productive use.  It might, instead, be invested in a startup.  Sure, the startup might go bankrupt, but it also has a finite probability of bringing a huge return.  Since the value of the money just sitting there is declining, this is actually a strong incentive to put the money to use.  I actually see that as a feature, not a bug.  Would it be such a bad thing if the value of assets not being used productively was decimated?  

 

Well put. But a contrary case can be made. Our society has done extraordinarily well in the last 40 years by holding out the promise of windfall rewards to entrepreneurial success that lie off the beaten path - in some spectacular cases, forge a path where none was known to exist. Many of the successful technological companies of the last few years succeeded by demonstrating the viability of markets that did not exist when the companies were formed, e.g, personal computers, video games, social media, and so on. The absence of a pre-existing market or even a perceived social need distinguishes this type of entrepreneur from other shifts in the social paradigm, for example, the shift to steam and railroads from horse-drawn .Maybe the promise of an extraordinary, 'bonanza' return is necessary to lure entrepreneurs and venture capitalists into places where conventional angels fear to tread.

 

Maybe so, but my own instinct is to side with Josh.  For my two cents, the wild increase in wealth inequality the United States has experienced in the last two generations may well be due to the fact that we have developed a two track monetary system. A lucky minority of people are playing the game with funny money , which they take to the pari-mutuel window at the end of the day, and turn into real goods - houses, college educations, second homes in Bermuda. The rest of us deal in cold, hard cash,  rooted in individual productivity, without anything like the expansive potential of non-productive money.

 

I don't think venture capital is going to disappear if a Net Wealth Tax is enacted. What we will see (I would bet) is a return to the traditional corporate financing template, stocks promising a healthy dividend perhaps combined with put options at different levels as the venture attains various milestones. That is the form of traditional American capitalism. It has considerable vitality. In any case, financial realism to my way of thinking beats financial fantasy. 

 

In any case, taxing wealth comprehensively and annually will result in a tremendous revaluation of stores of value, inevitably resulting in a shift away from non-productive assets. Whether the change is desirable or not, how comprehensive it would be - I will leave that to others better qualified. But my hunch is that the change is one of the most desirable features of the Net Wealth Tax.