Is the tax man coming for you?

Check coming due.
Check coming due.
Image: Reuters/Eduardo Munoz
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The pitchforks are out. A recent Politico/Morning Consult poll finds 61% of Americans think there should be a tax on rich people’s wealth. Other polls show many Americans support very high taxes, north of 70%, on the highest incomes. While the poll questions may only apply to a tiny population— 0.002% of Americans, the very wealthy—higher taxes on income and a tax on wealth may be in the future of many Americans.

Between unfunded entitlements, like Social Security, and growing support for Medicare for All—at least among the liberal wing of the Democratic party—the US may find itself facing bigger bills than ever. Paying them while keeping debt in check will require taxing more people than just the top 0.002%. If the goal is to also make the tax system more progressive, odds are the so-called mass affluent (pdf)—Americans with between $250,000 and $1 million in income-producing assets—will be facing higher taxes too. If you’re making plans for your future savings and employment, it’s time to consider if we’ve reached a tipping point and if higher tax rates are in your future.

What a government can tax

Generally, a government can tax income (including income from investments), wealth (assets, property, and inherited money), or spending. Northern Europe is often considered the most progressive because they have high taxes on income. But in many ways they are less progressive than the US because they don’t tax wealth very much and tend to have large taxes on consumption which are often regressive. The figure below shows where tax revenue comes from in a range of OECD countries.

America also is notable for its low taxes on consumption. Since reducing inequality is becoming a policy goal of many rich countries, odds are future taxes will fall on income and wealth.

Sky-high income taxes

Representative Alexandra Ocasio-Cortez, the newly elected Democrat from New York, made headlines with her suggestions for taxing income over $10 million at a 70% rate. In the UK, the Labour party is considering a 50% tax rate on the top 5% of income. The high rates struck some observers as unjust, but the US, the UK, and many countries in Europe have a long history with high tax rates. The chart below hows how the highest American incomes were taxed over the years.

In the 1950s and ’60s rates were as high as 90%. Some economists argue that because high rates and strong, balanced growth occurred at the same time, we can tax almost all income earned above a certain threshold, raise revenue, and face few adverse consequences. But high tax rates create incentives to dodge taxes. In the 1950s and ’60s hardly anyone ended up paying 90% because high earners are very good at finding accountants who’ll classify their employment income as capital income (the income paid on investments which is taxed at a lower rate). Average tax rates (an estimate of the rate people actually pay on their total income) in the US were about the same in the 1950s and 1960s as are they are today. Tax avoidance is one big reason why most countries don’t bother with marginal tax rates far above 50%.

A more likely outcome is a higher (but not 70% high) taxes on lower earners. The latest Social Security reform proposal, introduced by Democrats, in Congress now expands the payroll tax to income between $132,000 and $400,000. Right now, it applies only to income up to $132,000. The plan would also raise marginal tax rates to almost 50%, up from their current level of between 24% and 35%, on income between $132,000 and $400,000. There is a good chance the legislation won’t pass the Republican-controlled Senate, but Social Security is predicted to fall short of its obligations in 15 years and something has to happen in the next decade. Increasing the income cap on Social Security taxes features in most reform plans.

Odds of sky-high tax rates in the US: less than 20%. Rates of 70% or higher on super high incomes probably won’t happen because it’s not an effective way to raise revenue. But anyone with incomes in the top 20% can expect higher taxes to pay for Social Security. 

Tax all wealth

Senator Elizabeth Warren of Massachusetts has revived a long-simmering concept to tax wealth. Her wealth tax plan, advocated by renowned economists Gabriel Zucman and Emmanuel Saez, proposes taxing assets above $50 million, at 2% each year, and wealth above $1 billion at 3%. But the Warren tax idea makes some heroic assumptions, such as including no exemptions, which is unlikely given the political process. Wealth taxes are also notoriously hard to implement. The wealth of many multi-millionaires comes from privately owned companies that are difficult to value, let alone sell to pay the tax. If someone owns a $100 million company, what’s to stop them from dividing it up among their children to get under the $50 million limit? Valuing the assets of Americans each year would require a major expansion of the IRS. There are also serious legal concerns about whether a straight wealth tax is even possible.

Talk of wealth taxes makes good politics, but they are nearly impossible in practice. Even progressive countries like Germany and Denmark abandoned them in favor of taxes that are easier to collect.

Odds of a broad wealth tax in the US: Less than 5%:  It’s just too hard to implement and too easy to evade. 

Estate taxes

The US already taxes wealth in two ways, through estate taxes on inheritances and property taxes. Estate taxes, as opposed to straight wealth taxes, have broader support among economists because they are easier to implement and less likely to impact investment decisions. Valuing estates is still difficult and requires many resources from the IRS, but because the tax is only levied once, the effort is manageable and a big source of revenue. Senator Bernie Sanders is proposing increasing the estate tax rate to 77%, up from 40%, and lowering the amount exempted from the tax to $3.5 million from $5.4 million.

The 40% rate is already among the highest in the world. But most families don’t end up paying any of it because the $5 million exemption is fairly high, so only 0.2% of estates are subject to the tax. Lowering the exemption (and leaving the rate alone) appears to be a reasonable idea, but it’s still unlikely because it’s bad politics. The existence of any estate tax is very unpopular, and talk of lowering the threshold tends to bring out powerful lobbies like farmers. Also, Republicans won’t support it: In 2017 they increased the threshold from $5.6 million to $11.8 million (until the higher exemption expires in 2025) as part of a package of tax cuts.

Instead of lowering the threshold, Wojciech Kopczuk, a Columbia University economist, advocates better enforcement of existing rates while closing loopholes. For example, if you bought $1000 worth of Apple stock in 1984 it would be worth about $376,000 today. If you sold it you’d face a capital gain tax on $375,000. But if you die and leave the stock to your heirs, they would only pay a capital gain on the price difference between when you died and when they sell it. Kopczuk advocates getting rid of this feature, called “step-up in basis,” instead. As the government needs more revenue, it may target these sorts of loopholes that benefit the super wealthy.

Odds of an increase in the estate tax: Greater than 60%. The permanent exemption level or tax rate may not change, but expect loopholes like the step-up in basis to disappear. 

Property taxes

Property taxes are another effective method for taxing wealth. In the US, tax revenues from property (usually levied at the local level), as a share of total revenue, have been pretty stable for the last 40 years. But as states and municipalities grapple with under-funded pension benefits, odds are they will need new revenue from somewhere. Since property taxes are a major source of revenue for state and local governments, there’s a chance they will rise in the coming years.

Of course, property taxes are unpopular, too. One likely outcome is higher taxes on the most valuable real estate. The Labour party in the UK has proposed a “mansion tax,” which would charge an annual tax on residences worth more than £2 million ($2.6 million). Labour isn’t in power, so it can’t enact the tax, but according to the Financial Times, many high net-worth Brits think a mansion tax is inevitable. The recent furor over billionaire Ken Griffin’s new $238 million Manhattan apartment suggests there may be an appetite for a tax on expensive homes in America, too.

Odds of an increase in property taxes: Greater than 90%, depending on where you live and how much your property is worth. 

If you are moderately affluent and live in a wealthy country with growing inequality, your tax bill will likely increase. The political rhetoric is mainly focused on the top 0.002%, but even if the government takes all their wealth, it won’t cover current and future entitlements or do much to lessen inequality. The tax man is probably coming for you, too.