Wealth taxes, an idea whose time has come?

From the October 2019 print edition

Toronto-based Michael Hlinka provides business commentary to CBC Radio One and a column syndicated across the CBC network.

There was a quote attributed to the French political philosopher Baron de Montesquieu that I’ve been thinking about quite a bit lately and it goes something like this: “Happy the nations whose annals of history are boring to read.”

In spite of the economic boom that is going on in the US right now, there seems to be—at least if you watch the mainstream news—a great deal of unhappiness, some of which centres around economic inequality.
Elizabeth Warren, currently one of the leading contenders for the Democratic nomination for president, was first out of the blocks with a wealth tax proposal. Her trial balloon suggested that there should be an annual two per cent tax on anyone whose net worth exceeded $50 million, and then a three per cent charge on anyone whose net worth exceeded $1 billion. And there is a certain populist appeal to this idea. If someone would be worth, say $60 million dollars, it’s hard to see how their life would be impacted horribly if after the tax, they were left with $58.8 million. And once net worth for any reason fell below $50 million, then that tax would no longer apply.

Wealth inequality
The idea of a wealth tax comes out of the growing wealth inequality that we’re seeing in North America. Look at it simplistically and you’ll see that the top one per cent of the American population has more wealth than the bottom 90 per cent. The reason why I’m qualifying this with “simplistically” is because it ignores wealth and income that comes from pension income. A simple model demonstrates the point: there is an entrepreneur whose business has been valued at $2 million and this would be her net worth.

Meanwhile, there is a government bureaucrat who will receive a $100,000 pension, fully indexed for inflation, over the next 25 years. But he has no tangible assets right now. His current net worth would be considered zero, even though the present value of those pension payments would be $2 million. You tell me who’s better off: the entrepreneur with a risky $2 million or the bureaucrat with a 100 per cent guaranteed pension?

But even with that qualification, it is impossible to argue that the concentration of wealth is increasing and mostly because of factors out of their control. It’s largely a function of the scalability that is possible in a global economy, something that wasn’t true for most of the 20th Century.

Back to the wealth tax. There have been some estimates that it could rise by as much as $2.75 trillion over the next 10 years. That might be true, assuming that everyone in those high tax brackets went passively along with it. However, there are a few major problems with a wealth tax:

  • How will a privately held company be valued?
  • How will wealth splitting impact the revenue raised?
  • How much avoidance would occur?

I’ll deal with each in turn.

It would be easy to assess a wealth tax for someone like Jeff Bezos, the founder of Amazon. We could calculate the number of shares he held on average throughout the year, multiply (I would imagine) by the average share price, then take three per cent of that. There is an open and visible liquid market for those shares. However, there are many privately held companies worth tens of millions of dollars, and the valuation of those entities is far more complicated. Financial theoreticians agree that there should be liquidity discounts for these types of companies. How much would that be? And who would be responsible for the valuations?

Wealth splitting
Then there’s the issue of wealth splitting. I read one commentary that suggested that families worth $200 million with husband, wife and two children would be motivated to “split”, giving each individual $50 million to avoid the tax. I think that everyone would agree that tax policy should not encourage family break-up, but this is what a wealth tax would do. That’s another important strike against it.
However, by far the most serious issue is how much avoidance would occur. If you had what you believed was the next great idea … Amazon or Google, would you remain in the US? I wouldn’t and I suspect that this would be true of those visionaries whose products and services fundamentally transform the world.

Elizabeth Warren is a politician. And in a democracy, there is no requirement for politicians to demonstrate knowledge of economic matters—or anything else for that matter. It is the public, and that means us, who are responsible for critically evaluating the ideas that are put before us and determining what will work and what won’t. So while economic inequality is something that should concern us all, a wealth tax isn’t the best way to address it.