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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