A wealth tax is a levy imposed on the net value of held assets, including cash, real estate, investments, and personal possessions. It is typically levied on taxpayers with a wealth above a certain threshold, aiming to target wealth itself for redistribution—as against an income tax, which is levied on inflows of value.
In this way, the distinction between a wealth tax and an income tax can be thought of as one between stock and flow. A wealth tax is a tax on the held assets of a taxpayer, whereas an income tax is a tax on one type of inflow of value to a taxpayer.
The aim of a wealth tax is to redistribute collected wealth from the richest segments of society by capturing a portion of the value of held assets irrespective of whether or not they generate income. They can vary in rates and exemptions and are at the center of numerous economic and political debates.
Opponents of wealth taxes point to their outsized effect on the underlying investments, acting almost as the inverse to compound interest and taxing the same pool of wealth every year. This, at least in theory, would suggest that a wealth tax could conceivably lead to a net decrease in an individual’s wealth from one year to the next. In any situation where the value of the underlying assets increased in value by less than the wealth tax rate, this could be true.
In reality, this would be a more rare occurrence than one might imagine and can be mitigated through wealth thresholds. A threshold of $250 million, for instance, would not capture most startups and small businesses. Such a threshold would also act as an escape hatch for any taxpayer that does see their wealth decrease owing to the wealth tax: fall below the $250 million threshold and you are no longer subject to the tax.
A Simple Model
There have been other attempts at simple wealth tax models, but they have generally understated the significant factor that values tend to go up over time and thus overstated the impact a wealth tax has on actual wealth.
Suppose for the sake of argument there was something akin to an exchange traded fund in 1984 that would allow an individual to purchase 1000 shares of the S&P 500—with a closing price that year of $167.24. This would, naturally, be an investment of $167,240.
A highly simplified 1% wealth tax, assuming the investor held only this investment, would mean that investor owed $1,672.40 in tax. This would mean they’d be left with a wealth of $165,567.60—and, presumably, they’d need to sell ten shares in order to make their tax payment.
Now opponents of a wealth tax would suggest that this tax policy will act as a cancer and, over the intervening years and decades, will whittle away the taxpayers investment. But if we check in at the ten year mark, the data tells a different story. The S&P 500 has a closing value in 1994 of $469.16 and our investor has a value of $464,468.40, having paid $36,103 in taxes to that point. This comes to about a 7.7% tax rate—significantly less than the lowest income or capital gains tax bracket.
This pattern continues—in 2004 the investor would have a wealth of $1,418,300 and owe $14,183 for a total tax paid amount of $156,331.70. It is true that they have now nearly paid the entirety of their initial investment in wealth tax, but they have also increased their wealth by more than a million dollars.
Catching up with our investor at the end of 2023, the picture is even more rosy: their wealth swells to $4.39 million and their total tax bill for the preceding 40 years is $644,945.6.
One way to frame this outcome is that the investor, through a 1% wealth tax, winds up paying nearly four-times their initial investment in taxes. Another is to take a holistic view, and see the investor has paid the equivalent to a 15% one-time wealth tax payment, distributed over forty years.
Caveats and Assumptions
This hypothetical and extremely simplified model demonstrates that, contrary to some arguments against wealth taxes, a modest rate does not necessarily spell financial doom for an investor’s wealth over time. Instead, it shows that even with the tax, wealth can grow significantly in light of the general trend of rising asset values over long periods.
We are constrained in our analysis by the data we have at hand. It is always possible that given a different chosen investment, or the same investment over a different time period, the outcome would be different.
In short, a wealth tax, properly designed and with carefully calibrated thresholds, can balance the need for revenue generation and wealth redistribution without unduly burdening taxpayers.
Read the full article here
