Most Taxation on the Very Wealthy Is Essentially Voluntary. That Must Change.

As a result of the Democratic primary, we’re having a robust debate about taxing wealth. The debate invokes tricky technical and legal issues, but it’s an overdue one: There are good reasons the United States needs to start taxing wealth.

You may think we already tax wealth, but that’s mostly not the case. As my colleagues at the Center on Budget and Policy Priorities, Chuck Marr, Samantha Jacoby and Kathleen Bryant, point out in an important new paper, for the very wealthy, taxes are essentially voluntary.

How can that be, when the rest of us have taxes withheld from our paychecks every few weeks, and then often pay more when we file our income taxes every April? Because wealth accumulation isn’t taxed unless you decide to sell the asset, and even then, it’s taxed at a favorable rate, compared with regular income.

The new paper provides the following true-life example from the vaults of Warren Buffett (who, to his credit, has long supported higher taxes on the wealthy): “The value of Buffett’s main asset, Berkshire Hathaway stock, rose over 17 percent in 2010, from approximately $34.8 billion to $42 billion. These figures imply income of roughly $7.2 billion. Yet in his tax returns for 2010 … Buffet’s adjusted gross income was $62.8 million, or less than 1 percent of that amount.”

In other words, asset appreciation, by far the main source of income for the billionaire class, isn’t taxed at all unless it is “realized” through a sale. Because of this, at least outside of bear markets, billionaires’ tax bills will almost always be a mere few percent of their gains in wealth. My colleagues point out that Amazon founder and Chief Executive Jeff Bezos’ “tax bill on a decade of stock sales likely was about $1.5 billion, or less than 1.5 percent of his [$100 billion] increase in wealth due to the appreciation of his Amazon stock.” (Bezos owns The Washington Post).

That extreme concentration of wealth is slowing growth, corrupting politics and blocking opportunity for the many on the wrong side of the inequality divide. According to Federal Reserve data, 32 percent of total net worth is held by the top 1 percent (average net worth $27 million per household), compared with 2 percent held by the bottom half (average net worth $32,000). Because the wealthy have low propensities to spend their extra income relative to the middle class, such concentration hurts growth. Through diminished parental investment, substandard and segregated housing, and education channels, wealth inequality reduces social mobility.

And because most high-end wealth goes untaxed, it is a big missing revenue source. The Treasury is collecting far less revenue than it should be, given where we are in this long economic expansion. The reason is that the 2017 tax cuts severely damaged the link between economic growth and tax revenue. A high-end wealth tax is one way to help repair that damage and fund some of our priorities as opposed to loading everything on the deficit.

So, fairness, opportunity and our fiscal gap all point toward the need for some version of a wealth tax. But what about the critics who say that such taxes didn’t work in Europe, and they won’t work here?

As economist Gabriel Zucman and Emmanuel Saez recently argued, the reason European wealth taxes failed is that they were poorly designed; thus, we can learn from their mistakes. Because these taxes were based on residence, not citizenship, it was easy to relocate to avoid them. Plus, banks didn’t share information, facilitating evasion. Finally, European wealth taxes hit the moderately wealthy, not just the superwealthy, which undermined their support.

In the U.S. case, however, we tax based on citizenship, so unless you’re willing to stop being an American (thereby incurring a hefty exit tax under the proposed wealth taxes), you don’t escape. Under the Obama-era Foreign Account Tax Compliance Act, both foreign banks and U.S. taxpayers holding financial assets abroad must report these assets to the Internal Revenue Service. No question, FATCA needs increased attention and staffing, but it has the potential to plug an important hole. Finally, while most tax experts usually advocate for a broad base with few exemptions, one attribute of taxing extreme wealth is that it has solid public support, and not just from Democrats. Of course, billionaires hate it, but its advocates view that as confirmation of its utility.

In other words, we can and should tax wealth. But as the European case reveals, design is crucial. There are two broad options: Build on what we have, or try something new.

My colleagues’ new paper goes through a lot of holes in the tax code through which significant wealth escapes taxation. Among the most egregious loopholes is one that allows wealthy people to pass along an asset to an heir who is not required to pay any tax on that asset’s appreciated value. That is, the wealthy person herself never paid tax on the asset’s increased value, and unless she sells it, the heir doesn’t incur a liability either. Even when the wealthy do sell assets, they’re taxed at a favorable rate, 23.8 percent vs. the top income tax rate of 37 percent. That’s another loophole that should be closed.

The estate tax also needs a lot more bite. The 2017 tax cuts raised its exemption levels to ridiculous heights: Between $11 million and $22 million of wealthy estates go untaxed (and those numbers are indexed to inflation). My colleagues point out that “fewer than 1 in 1,000 estates are expected to owe any estate tax.”

Presidential candidates Sens. Elizabeth Warren (D-Mass.) and Bernie Sanders (I-Vt.) go much further, proposing new forms of taxation on the wealth of the wealthiest Americans, and based on the rationales above, their plans also deserve a hearing. Many objections have been raised, some of which have merit. By some estimates, Warren’s recent additions to her tax plans lead to tax rates on wealth that top 100 percent. My heart doesn’t bleed for billionaires, but that’s hard to defend.

Another new idea that’s recently surfaced is to levy an annual tax on the value of appreciated assets of the very wealthy, regardless of whether the asset has been sold or held. It’s a smart idea worth pursuing, as it would end the voluntary nature of the system.

Some of these may have sturdier legislative legs than others, of course. But, I’ll just celebrate that we’re finally talking about injecting a huge, long-overdue dose of fairness into the tax code.

Bernstein, chief economist to former Vice President Joe Biden, is a senior fellow at the Center on Budget and Policy Priorities.