We have been hearing quite a bit lately about the need to tax the wealth of this nation's wealthiest citizens. The cry of the supporters of these taxes is simple: Make the wealthy pay their fair share of taxes. I want to use this space to dispel the big myth, consider some logistical issues and question why we need to raise taxes on the wealthy in the first place.
Supporters for a wealth tax talk a lot about making the rich pay their "fair share." What is their "fair share?" Do they already pay it? According to the Tax Foundation, a nonprofit, nonpartisan research organization founded in 1937, the top 1% of income earners paid approximately 38% of the income tax burden. Data from the National Taxpayers Union Foundation showed nearly identical results. To put some perspective on this, in 1980, with the top marginal rate at 70% (compared to 37% today), the top 1% of income earners paid approximately 19% of the total tax burden. Is the 38% figure today a "fair share?" According to the Tax Foundation, the top 1% of income earners make 20-22% of the total income, while they pay 38% of the total income tax burden. The data shows that the top earners clearly pay their fair share by any reasonable measure.
How will wealth be determined? I will begin this with the basic accounting equation:
Assets = Liabilities + Equity
In this equation, assets are what you have and the liabilities + equity are how those assets are paid for. True net worth is the equity portion of the equation, not the asset portion. Written differently,
Equity = Assets - Liabilities
The supporters of wealth taxes would tax the assets regardless of how they are financed. The assets are not someone's true net worth.
On what date will net worth be determined? Chances are the valuation date will likely be December 31. What will likely happen in the days and weeks leading up to the valuation date? The people who will be subject to the tax will be incentivized to minimize their net worth so they can minimize their tax. For entrepreneurs who founded their companies and became wealthy on the IPO of the shares, their shares in the stock are their ownership interest in their companies. It is understandable that they do not want to sell their shares. Not only would selling shares result in lesser control of the company they founded, but it would also result in large capital gains which also means capital gains taxes. What the wealth tax will do is incentivize fishy attempts to manipulate stock prices in order to hold down taxes. When the wealthy are ultimately forced to sell shares to pay the wealth tax, who will buy the shares? The shares can be sold in the open market, and the share price will decline, perhaps dramatically, as a result. That is one option. Another is that the wealth taxpayer can sell shares directly to his company. But the company will likely have to borrow millions of dollars just to fund this, which will weaken the company financially.
How do you determine the value of non-liquid, privately held assets? If a person owns a privately held company, you can do a discounted cash flow analysis to determine its value. Simple, right? No. In order to run a simple DCF, you need to determine a discount rate and a growth rate. Both of these numbers are highly subjective. The tax man has an incentive to pick numbers that will yield a high number while the business owner will pick numbers that minimize the value. How do you determine cash flow? Is it operating cash flow, is it free cash flow? Just determining value could yield dozens of numbers encompassing a wide range of values. Now how do you determine the value of something like an art collection or a house? These assets do not produce any cash flow and an appraiser's valuation is merely a guess. In other words, the value of these types of assets is a purely made-up number.
Finally, why do we need a wealth tax at all? The data already shows that the wealthy are paying more than their fair share. The bigger question here is why should anyone, regardless of net worth, pay even another nickel to the federal government? We are $40 trillion in debt, and we did not get that way because Congress was a responsible steward of our taxpayer dollars. In a year in which widespread fraud has been exposed in federal and state governments, asking for more tax dollars is insulting and repulsive. How many of these wealth tax proposals have spending reforms built in to ensure that taxpayers get the most bang for their buck? None. Meanwhile, the state of California passed a law this year, nicknamed the "Stop Nick Shirley Act," which makes it a crime to expose the fraudsters! Make it make sense to me! Where are the Inspector Generals in all of this? They are supposed to act as internal auditors for the federal government, yet they clearly did not do their job. And the federal government thinks they can just come and demand more money from us? I want to see efforts to clean up their own house before the federal government comes demanding more money from us.
Ultimately, if the wealth tax is passed it will come for all of us. A history of the income tax serves a guide here. The modern day income tax was started in 1913 with the 16th Amendment. It started out as a 1% tax on incomes above $3,000 up to 7% on incomes over $500,000. Very few Americans were subject to this tax and the rates were seemingly small. By 1943, with the US at war in World War II, automatic withholding was introduced and the number of Americans that were subject to the income tax greatly increased as did the tax rates. Today we are still paying in large numbers and high rates. If a wealth tax passes, I am afraid that the same path will follow, with all of us paying the tax (not just the rich), and that the tax rates will be much higher. I am not saying this path is likely if a wealth tax passes. I am saying it is inevitable.
Economies grow through wealth creation. A wealth tax is wealth destruction. The government is a horrible allocator of resources. There is a perverse incentive to increase funding to agencies that are failing or performing their mission miserably. In the private sector, underperforming assets are defunded and eliminated. Assets that are allocated horribly are why private companies go out of business and why governments end up $40 trillion in debt. Why should we trust the government to put the wealthy people's money to a better use than the ones who actually created the wealth in the first place? Once the wealth is gone, it is gone. Someone else will have to come along and create new wealth, and with a possible wealth tax, will be disincentivized. There will be companies and technologies that do not get funded because of the wealth destruction involved with the wealth tax.
It looks so easy. There is a big pocket of money (technically, it is not money, the wealthy have a large portfolio of appreciating assets that were purchased with money). And we can do so much with it, they say.. The supporters say we will just ask for a small amount that the wealthy can afford and nothing else will change. The problem is that everything will change. It is the phenomenon of the action producing an equal and opposite reaction. When you take appreciating assets out of the economy and put it to agencies that do not add value, you will destroy everyone's wealth and the economy right along with it.
This has become my line in the sand. Any politician that supports a wealth tax will not get my vote. Period. The cons clearly outweigh the pros to me. I have often lived by the saying to be careful what I pray for because I might actually get it. Tread carefully.
