Taxing Wealth

A lot of Democratic presidential candidates are in favor of a wealth tax.

This sounds better than it can ever be. Why is that so?

First off, while Congress can definitely pass such a thing, but it would very likely be ruled unconstitutional. In fact, it would probably require passage of a new Amendment to the Constitution.

How can that be? It’s because the Constitution doesn’t permit direct taxes (direct are those directed at an entity). Income was not initially taxable, and it required the 16th Amendment to make an exemption for income so that it could be directly taxed. An exemption for wealth would require an amendment too.

Do note that direct taxes are permissible on real property.† But much wealth, and the part that seems to bug many progressives, is financial property. So the Democrats are scoring political points by proposing to tax something that isn’t yet taxable. Uh oh. Also note that most real estate taxes, and personal property taxes (on stuff like cars) are levied at the state and local level. It probably would be hard to introduce a new and additional federal layer of tax on to those things.‡

Now, you may say that there are inheritance taxes on wealth, and this is true. But those are levied on the transfer of wealth. And taxes on transfers of stuff (called excise taxes) are permitted by the Constitution at the federal level. So any wealth tax done this way would be … occasional for any particular asset, rather than a regular income stream for Congress to spend.

In sum, we have presidential candidates proposing policies that they aren’t capable of enacting. That’s not unusual, just significantly harder if an Amendment is required.

Secondly, there’s an issue with counting and valuing wealth. The value of anything is unknown until it is actually bought and sold. This makes the value of Big Mac’s easy to observe, but the value of, say, fine art much harder to observe. This is why homes are taxed based on “assessed value”, rather than (actual) value. Assessed value is set below an estimate of value to reduce complaints, and is often reset to the sale price when a sale happens (because that’s the time when value is established most firmly).

Now, wealth is composed of a wide variety of assets of value, but where would you draw the cutoff of which ones to value (and tax)? Stocks? Common, or preferred, or both? Equity? Net worth at book value or marked to market? What about options? Warrants? Derivatives? How about bonds? Registered or bearer? If the latter, that means you could tax cash in peoples’ pockets too (can you imagine)? Convertible debt? How about goodwill? How about brand equity (if we didn’t tax brand equity, could Coca-Cola Inc. avoid a lot of wealth taxation that a weaker brand’s owner — like Dr Pepper Snapple Group’s RC cola — could not)?

There’s nothing in this point that’s impossible to work through. But no one should have illusions that a wealth tax will be as simple as an income tax … and no one thinks those are easy.

† The usage of the word “real” here is as in “real estate”, and is not the same as its usage as an adjective indicating corrected for inflation, as in real GDP.

‡ I generally have some international students who don’t understand the American system of government very well, and some American students who could understand it better. In a federal system, like the U.S., the top layer of government is weaker, and the second level is stronger. The word federal is related to the word federation. In the U.S. this means the states often have more latitude to do things differently from one another than they may in other countries. In this case of this post, states can institute wealth taxes if it’s consistent with their state constitution. The federal government in Washington is a different entity, and its governing document doesn’t permit direct taxes on wealth that isn’t real.