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The wealth accumulated by the richest Americans keeps hitting new record highs, leading many commentators and politicians to argue it’s time for the U.S. to start charging a wealth tax. This sort of tax would be based on a person’s net worth and would only apply to the very richest citizens. The U.S. does not currently have a wealth tax, so we spoke to economic experts about how a proposed wealth tax might look.

What Is a Wealth Tax?

A wealth tax is usually based on a person’s total net worth. For example, if you had $1 million in assets and $500,000 in debt, your net worth would be $500,000.

If your net worth placed you among the very richest citizens of the U.S., a wealth tax would charge a percentage of your total net worth each year. A flat 1% wealth tax, for example, would cost you 1% of your total net worth. You’d owe more as you get richer and less as your net worth fell.

Different from many other kinds of taxes—income tax or capital gains tax, for instance—people with sufficient net worth would owe wealth taxes even if they didn’t take any actions, like earning income or selling assets.

“The problem the wealth tax is trying to solve is that we have in the U.S. a tax based on the realization principle,” said Jeff Hoopes, associate professor at the University of North Carolina and the research director of the UNC Tax Center. “This means in general, you have to sell something before you pay income taxes on the gains from ownership.”

You only owe capital gains taxes on stocks after you sell them, for example, meaning someone can delay the tax by holding stocks and not selling them. What’s more, in the U.S., they’re given an incentive of lower tax rates when someone holds onto an asset for at least a year through the long-term capital gains rate.

How Does a Wealth Tax Work?

A wealth tax would be similar to property taxes, where you owe the tax each year based on the market value of your home. The difference is the wealth tax would apply to all property: real estate, cash, investments, business ownership and other assets, less any debts you owe.

“The wealth tax is static in nature,” explained Dr. Tenpao Lee, full professor of economics at Niagara University. “Other taxes are dynamic based on transactions in the forms of earned incomes, capital gains, inheritances and ownerships of real estates.”

The government would charge a wealth tax regardless of whether transactions took place. France, Portugal and Spain are three countries that currently charge a wealth tax. They are usually progressive systems, meaning the more wealth a person has, the higher the tax rate. In France, the wealth tax starts 0.5% for someone worth €1.3m and goes up to 1.5% a year at €10m.

When someone owes a wealth tax depends on how the government sets it up. That means it could be once a year or once in a lifetime. For instance, some European countries charged one-time wealth taxes to help finance their participation in the First and Second World Wars.

A wealth tax doesn’t have to be indiscriminate when it comes to asset types. A government could decide to exempt some asset types to foster certain behaviors. For instance, it might decide business assets didn’t count to encourage entrepreneurship. Ultimately, a wealth tax’s structure depends on how a country designs the law.

Elizabeth Warren’s Wealth Tax

While the U.S. does not currently have a wealth tax, it is something that has been proposed by Elizabeth Warren and Bernie Sanders. Their latest proposal is called The Ultra-Millionaire Tax Act.

“A wealth tax, such as Elizabeth Warren’s proposal, would take the net wealth of very rich individuals above a certain threshold at increasing amounts—the more you have, the higher the rate. It is intended to apply to only the very, very wealthy,” said Hoopes.

In its current form, the Elizabeth Warren wealth tax would charge 2% a year on trusts and households worth between $50 million to $1 billion and 3% a year for those with wealth over $1 billion. Given these high limits, it would only apply to a small share of the country, fewer than 1 in 1,000 families according to an estimate from Emmanuel Saez and Gabriel Zucman, economists at the University of Berkeley.

Advantages of a Wealth Tax

A wealth tax could raise significant amounts of revenue. Even though Warren’s wealth tax would only apply to a small number of households, it could bring in substantial revenue, about $3 trillion over the next decade according to the estimate from Saez and Zucman. This is money that could be used to finance other government programs like childcare or infrastructure.

A wealth tax seems fairer to some. A billionaire entrepreneur who owns their own company, like Bezos or Zuckerberg, is currently able to delay taxes on their business wealth. “If you never sell the stock, you will remit no capital gains taxes. If you pay no dividends, you will remit no individual income taxes at all as a result of owning that stock. To some, there is something unsettling about people who have tens of billions of dollars of wealth who pay little in taxes,” said Hoopes. They would not have the same ability to avoid a wealth tax.

Wealth taxes could incentivize more productive uses of wealth. Since a wealth tax chips away at a person’s holdings each year, Lee thinks it could motivate them to spend or invest rather than hoarding. “In the long term, the wealth tax would encourage people to be more productive as otherwise your wealth would diminish gradually for you and your heirs,” he said.

Disadvantages of a Wealth Tax

A wealth tax could be challenging to administer. A wealth tax is based on calculating a person’s net worth each year based on everything they own, which is easier said than done. While some assets, like cash and publicly traded stock have a clear fair market value, others, like privately held businesses or artwork, do not. It would take considerable resources for the IRS and taxpayers to determine these valuations.

The very wealthy may try to avoid wealth taxes. If the government creates a wealth tax, the wealthy may have an incentive to purchase more complicated assets. “My guess is the wealthy would invest much more heavily in harder-to-value assets, and difficulty in valuation would actually become an attractive aspect of the asset (like, to some extent, intangible assets held by multinational corporations are today),” Hoopes said. If this happens, the tax could end up less effective than proponents expect.

They could encourage wealthy taxpayers to leave the country. Because a wealth tax is a considerable expense each year, it could encourage the very wealthy to move themselves and their assets to other countries, leaving less of a tax base for the United States.

The Bottom Line on Wealth Taxes

Whether the Warren wealth tax or another like it becomes a reality in the United States depends on action by Congress. Representatives are currently debating wealth tax proposals, and whether any will pass is hard to say.

In theory, however, a wealth tax seems like a good idea for progressives like Warren and Sanders who want more tax revenue to support government programs, but in practice, it may be harder than it seems. Any law would also have to be upheld by the Supreme Court, which may find this tax unconstitutional.

For the average American, however, this tax is more of a hypothetical. Unless you are worth tens of millions of dollars, you most likely do not need to worry about paying a wealth tax, regardless of whether such a measure passes in the U.S.

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