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Taxing Great Wealth Is Just Common Sense. Or Is It?

It’s doubtful that taxing art collections, yachts or big inheritances will attract a significant political constituency. It’s all about the “endowment effect,” the value we place on the things we possess.

Yachts docked in Miami
Yachts docked at Miami’s Watson Island on Feb. 17 for this year’s Miami Boat Show. A coalition of left-leaning lawmakers in at least seven states plans to introduce some version of a wealth tax in this year’s legislative sessions. (Pedro Portal/Miami Herald/TNS)
We tax a lot of things in this country. We tax ordinary income, capital gains from stock sales, property values, retail transactions and a whole host of other activities. Ours is far from the most progressive system in the developed world, but we do apply a higher rate to higher incomes, grant sales tax exemptions for essential goods, offer an earned-income credit for the working poor and provide circuit-breaker discounts on property taxes to the elderly and disabled.

Still, it’s hard to deny that our tax code, at every level of government, has helped to make rich people richer. According to some estimates, the richest 130,000 American families have as much wealth as the poorest 117 million put together. The richest 0.1 percent of the population pay a little more than 3 percent of their money to the federal government, on average. The bottom 99 percent pay about 7 percent.

It might seem to beg the question of why we don’t just tax wealth itself. As you may remember, this became a national issue after Sen. Elizabeth Warren advocated it in her 2020 presidential campaign. Warren proposed a 2 percent federal tax on net worth of $50 million or more and additional 6 percent on fortunes above a billion dollars. She claimed this would bring the federal treasury $3.75 trillion over 10 years.

That idea, like Warren’s campaign, didn’t go very far. But it is back now. A coalition of left-leaning lawmakers in at least seven states has made plans to introduce some version of it in this year’s legislative sessions. The most conspicuous effort is in California, where state Sen. Alex Lee is promoting a bill to impose a 1 percent wealth tax on assets exceeding $50 million and 1.5 percent on holdings of more than $1 billion. “This is all in the spirit of making those who are not paying their fair share pay what they owe,” Lee has said. Some of the plans are tougher, at least on billionaires. In Illinois, state Rep. Will Guzzardi wants to impose an additional tax of 4.95 percent on anyone with a net worth of $1 billion or more.

Warren took a lot of heat for her argument that the wealth tax should include, as she put it, ”all household assets held anywhere in the world.” This conjured up fears of revenue agents barging into living rooms to put a price on art collections, or making wild guesses about the market value of yachts. The current state proposals tilt in a slightly different direction. They focus more on unrealized capital gains — invested personal wealth that the owner hasn’t yet collected on. Local property taxes go up when the value of a property rises, even if the owner has no intention of selling it, so why, wealth tax proponents argue, shouldn’t the same logic apply to unrealized capital gains?

That sort of makes sense. But will it attract a significant political constituency? It seems unlikely, at least in the near term.

TO UNDERSTAND THAT PREDICTION, it might help to look at the phenomenon that behavioral economists call the “endowment effect.” This, to put it simply, refers to our tendency to place more value on the things we possess than on anything of equal worth that we have not yet acquired. If we own a car and have become attached to it, we mourn its loss even if we can acquire a new one of equal value. The longer we have something, the more attached to it and the more possessive we become.

The endowment effect was primarily meant to apply to tangible objects, but it’s relevant in the financial sphere as well. The money we earn in a monthly paycheck isn’t endowed yet — we don’t enjoy having part of it deducted, but the money we lose isn’t something we actually have in our hands. But assets that we hold for a significant length of time begin to feel like they are part of us; having to give some of them up is more painful than a paycheck deduction. A wealth tax strikes at the heart of this human emotion, even when it applies to levels of wealth far above what we have. We feel the effects of wealth taxation vicariously when it strikes at multimillionaires or billionaires, even if we know we will never join that club. (Interestingly, most of the European democracies don’t have the same toxic reaction to taxing wealth that we have. A couple of countries have repealed wealth taxes in recent years, but they remain a fairly common element in the European fiscal universe.)

We can see this principle at work with a brief digression to the issue of inheritance taxes. They are highly unpopular with average Americans at virtually all income levels, even when they are limited to extremely large estates. The federal inheritance tax was mostly eliminated years ago, to widespread popular approval. There is a federal estate tax, but it essentially applies to the executors of estates, not the beneficiaries. It also exempts estates under about $12 million. This is a provision that the average American taxpayer seems willing to tolerate. Only six states impose any sort of inheritance tax. Eleven others have an estate tax. Only one — Maryland — has both.

Given the public attitude toward inheritance taxes, it shouldn’t be too surprising that wealth taxes are, for the most part, viewed with even more disdain. Since property taxes go up when the market value of one’s home increases, even if the homeowner hasn’t realized a tangible dime from the appreciation, taxing unrealized capital gains from our financial holdings might seem about the same. But in the minds of most ordinary taxpayers, it is different. The money that we hold in banks or investment accounts feels like an endowment; the paper profits from the appreciation of our property, not so much. We don’t like paying higher property taxes, but in most cases (notwithstanding California in the 1970s) we don’t rebel against them.

MANY YEARS AGO, I argued that in the world we inhabit the best tax is one that people are willing to pay. I don’t find this a particularly noble sentiment, but it’s a practical one. Governments need money to do their necessary work, and they can get more of it done if the citizens aren’t in revolt against the taxation that is levied upon them. It’s widely known that sales taxes attract the least amount of protest, even though they are regressive levies that burden the less-affluent taxpayer the most. Charging a few extra percentage points on our retail purchases or our restaurant meals doesn’t run into endowment-effect problems.

In a few states, this has led to what may be considered confiscatory sales taxes, even when some essential purchased items are exempted. Alabama’s combined state and local rate averages 9.24 percent. Tennessee’s is even worse — 9.75 percent. But they get away with it relatively painlessly. Ask the citizens of those states what they might think of a wealth tax, and I’m guessing that you would generate a far different reaction.

So despite the renewed desire in some places to impose a wealth tax at the state level, I don’t think it’s a very plausible idea for generating additional revenue, however logical it might be. What could we do instead? Well, I’m not offering a perfect solution, but a partial answer might be a higher tax on capital gains — not the unrealized gains that are part of our portfolio, but the new ones that accrue in a given year as securities are sold.

Actually, some states are beginning to work on this. The federal government currently charges high earners 20 percent on current capital gains — far less than the 37 percent it levies against them on wages and ordinary income. In New York, a bill in the Legislature would add 7.5 percent to the tax rate on new capital gains for families with incomes above $550,000. That would double for those with incomes above $1.1 million. A Maryland lawmaker has proposed adding a more modest 1 percent surcharge to the income tax rate on capital gains.

I don’t know that these capital gains tax increases will go anywhere. Quite likely they won’t any time soon. But in purely practical terms, they may be preferable to going after existing wealth, even among the richest citizens. Rationally or not, we seem more amenable to tolerating taxes when they don’t threaten the money we consider to be part of our endowment.


Alan Ehrenhalt is a contributing editor for Governing. He served for 19 years as executive editor of Governing Magazine. He can be reached at
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