The case for incentivizing wealth creation

Back in 2019, a survey by GoBankingRates reported that close to three-quarter of their respondence reported that they had less than $100,000 of savings put away for their retirement; and while I wish I could report more current findings, it’s unlikely that conditions have changed all that markedly since the release of that survey. The implication is clear: Too many of our nation’s households have had, and presumably are having, difficulty in building their wealth.

This concern becomes particularly pressing for households experiencing interrupted or diminished earnings. During those periods, those without sufficient wealth face the prospect of bankruptcy or even homelessness. Thus, broadly encouraging wealth accumulation to mitigate these risks would seem to be a worthwhile and appropriate social objective. I’m for that; and with this orientation, I’m concerned that our current tax structure discourages that outcome. That is, income taxes, which account for about 52 percent of federal revenues, serve to impede building wealth, particularly for those who don’t start with wealth in the first place.

For this discussion, the distinction between income and wealth is important. Consider two households: The first has an income of $100K with no savings. The second has the same $100K income but it also has savings, comprised of a portfolio of assets that appreciated by, say, $200K during the year. Assume that none of that appreciation was realized — i.e., none of the appreciated gain was monetized by the sale of any assets. Under these assumptions, the two households have dramatically different abilities to pay, but both would have the same taxable income and thus bear the same tax liability.

My guess is that most readers would consider this outcome to be, if not unfair, at least somewhat off-putting; but it’s the byproduct of a tax system that precludes consideration of specifically taxing wealth, independently from income. I’d suggest that this structure deserves reconsideration.

As I’m sure most readers recall, during the 2020 Democratic primary, Elizabeth Warren had been pushing for a wealth tax of 2 percent of wealth in excess of $50 million (i.e., 2 cents out of each dollar of wealth over $50 million) and 3 percent of wealth over $1 billion (i.e., 3 cents for each dollar over a billion). Obviously, that proposal withered on the vine. Albeit with some practicalities still yet to be sorted out, I thought it was a good idea. My primary reservation was that I felt the proposal wasn’t framed appropriately; and as a result, it didn’t garner the support that it deserved.

Warren should have asked for larger percentages, and she should have pushed for a more palatable program by paring the wealth tax with a broad reduction in income tax rates. A plan that explicitly offered lower taxes for, say, households earning less than the median income, while at the same time higher taxes for the wealthy, would likely have received a better reception than the one she proposed, which focused solely on higher taxes for the rich.

Depending on the year, roughly half of reporting households end up with a zero federal income tax liability — sometimes more, sometimes less. For these households, earned income necessarily falls below their allowable deductions or exemptions, causing their taxable income to default to zero. Zero taxable income; zero tax liability. Some of the people who pay no taxes are scraping by, and I don’t begrudge them the fact that they don’t pay any income taxes. I don’t have the same forbearance, however, for those who are able to take advantage of generous tax provisions — provisions that had generally been the consequence of special interest lobbying efforts — that allow them to claim any number of exemptions or deductions that lower their taxable income, all the while they’re sitting on mountains of assets. That’s a situation that doesn’t sit right with me, and it would be ameliorated considerably with the introduction of a wealth tax.

During the primary season when Warren was promoting her wealth tax, besides linking her proposal with a call for lower income tax rates, I feel like she neglected to highlight a significant consideration that would have made her program more acceptable. Here’s what she missed: Largely because of the magic of compounding, wealth begets wealth. While annual returns on assets vary year-to-year, it’s not unreasonable to expect this rate of appreciation to be something greater than 5 percent over the long term. Thus, even if as much as a 5 percent wealth tax were applied, household wealth would still be expected to rise in the general case in most years. (Admittedly, I’m referencing nominal wealth, as opposed to real — i.e., inflation-adjusted — wealth, but that’s another story.)

Perhaps more importantly (and on this point Warren had been clear), in the face of declining asset values, a wealth tax applicable only to households holding wealth in excess of some threshold value — say the $50 million as Senator Warren had proposed — provides for an automatic termination of exposure to this tax. That is, once the household’s wealth falls below the critical threshold, the wealth tax would no longer be impactful. I’m not going to cry allegator tears for anyone who suffers the hardship of having to adjust to anything like the miserly level of wealth cut to $50 million, particularly if we link the imposition of the wealth tax to lower income tax rates, thereby enhancing the capacity to build wealth for a substantially larger set of households that operate at income levels, where the wealth tax would have no bearing.

Enhancing the capacity to build wealth by households with limited savings is an objective worth pursuing. Lowering income tax rates for a large segment of US taxpayers while instituting a wealth tax on households having mega millions and billions of dollars of savings would be steps in that direction.