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Wealth Taxes Will Not Save Democracy from Inequality

But they could corrupt democracy further.
March 6, 2019
Wealth Taxes Will Not Save Democracy from Inequality
Elizabeth Warren. (Photo by Scott Eisen/Getty Images)

The Democratic Party’s lurch leftward has yielded tax plans designed less for raising revenue than for combating the corrosive force progressives believe wealth inequality exerts on democracy. Bernie Sanders has put forward a plan to reduce the threshold and raise the rates of the estate tax, while Democratic freshman House member Alexandra Ocasio-Cortez has called for a 70 percent marginal tax rate on income over $10 million per year.

Another progressive plan, from Senator Elizabeth Warren, is even more aggressive — and riskier. Warren has proposed to tax the net worth of the approximately 75,000 American households with fortunes greater than $50 million. Under Warren’s plan, “mega-millionaires” worth less than $1 billion would pay a 2 percent rate every year on everything they own — businesses, boats, stock, houses, land, art collections — while those with 10-figure Forbes-list fortunes would face a 3 percent levy.  

Policy wonks tend to evaluate tax proposals on the basis of their likely impact on budgets, economic growth, and the dispersion of income and wealth.  However, few of the many criticisms of Warren’s plan so far address its deeper and primary purpose: to prevent democracy from sliding into plutocracy.

“The root justification [for higher taxes on the wealthy] is not about collecting revenue,” write Gabriel Zucman and Emmanuel Saez, the Berkeley economists who performed the fiscal analysis of Warren’s proposal. “It is about regulating inequality and the market economy” and “safeguarding democracy against oligarchy.” This argument was offered in defense of the Ocasio-Cortez proposal, but it  applies in spades to Warren’s plan, which would reduce the growth of large fortunes far more effectively than a bump in the top marginal income tax rate.

There should be no doubt that American democracy is in trouble, and that big money has something to do with it.  However, we shouldn’t expect a wealth tax to work to thwart oligarchy. On the contrary, a wealth tax could harm the integrity of our democracy by subsidizing the growth of nefarious global networks of dark money already eating away at the foundations of the republic.

To understand how a wealth tax could be self-defeating as a means of protecting democracy, we need to dig into the political theory behind the left’s worries about the corrosive effects of concentrated wealth on democratic institutions.    

This theory, which I call the “progressive master narrative,” says that once economic inequality passes a critical threshold, the wealthy as a class will use their concentrated resources to consolidate political power and rig the economic and political system to their advantage, leaving ordinary citizens disenfranchised, impoverished, and exploited.

If you buy this story, it’s easy to see why you’d want to limit the size of large fortunes to ensure that our political system is able to protects the basic democratic rights and material interests of ordinary citizens. However, the progressive master narrative just is a theory of the limits of political feasibility in democracies with high wealth inequality. If you take the progressive master narrative seriously, you ought to suspect that a wealth tax on the mega-rich, if not impossible to impose, will be difficult to sustain long enough to put a serious dent in the problem it is meant to solve.

The notion that the wealthy as a bloc are so powerful that democracy itself is at risk implies, at the very least, that an annual tax on the net worth of the super-rich own will face powerful, relentless political opposition and launch a wasteful avoidance/enforcement arms race that could unwittingly exacerbate the corrupt culture of dirty money that birthed Donald Trump and is undermining our democracy as we speak.

The record of wealth taxes in other countries shows there’s every reason to take this worry seriously.  In 1990, there were wealth taxes in 12 OECD countries, but that number has since dropped to four. So why did most of the wealthy liberal democracies that had wealth taxes (including social democracies like Sweden and Denmark) ditch them over the past three decades?

A 2018 OECD report suggests that the cost and hassle involved in collecting wealth taxes often comes to outweigh the disappointing level of revenue they actually produce. And this dries up the political will to maintain them in the teeth of organized resistance – even in small, ethnically homogenous countries far more egalitarian in spirit than the United States is ever likely to be.  

Wealth taxes are difficult and expensive to administer. If such a tax exempts certain classes of assets, holdings will be channeled into sheltered categories, shrinking the tax base and creating harmful market distortions. So it’s important to tax everything. The estate tax requires this kind of comprehensive valuation of net assets already, but it can take years of arbitration and litigation to settle the amount owed to the IRS. It would be far more complicated to assess the value of every ancestral manse, minor Basquiat, and closely held private partnership of 75,000 households every year. It ought to go without saying that these households have lawyers and accountants on retainer.

One study by economists at the IRS found that about half the estimated net worth of Forbes-listers goes “poof” in their posthumous estate tax filings. But this appears to be due neither to outright evasion nor wild inaccuracy in Forbes’ estimates. “This research,” the authors write, “highlights the inherent difficulties of valuing assets which are not highly liquid.”

More importantly, wealth taxes are hard to enforce. They create enormous incentives for the rich to avoid them, both legally and illegally, through family foundations, complex multilevel joint ownership structures, the manipulation of deductible debt, tax havens, and other instruments at or beyond the limits of the law.

Because wealth taxes act as immense subsidies to the tax avoidance industry, they tend to become increasingly leaky buckets that reliably deliver less revenue than their advocates advertise. The difficulty of constantly identifying and patching new leaks in the bucket is a principal reason many of the best administered states in the world let their wealth taxes go.  

Moreover, tax enforcement in the United States is already too lax for the current system, which is much less complicated and administratively demanding than it would be with the addition of a wealth tax. The IRS is underfunded and understaffed, and the GOP under Trump has made it worse.   

 Defenders of Warren’s plan will reply that it’s certainly true that tax enforcement is currently too weak, but that’s the result of prior policy choices that are easily reversed. Warren’s plan accordingly includes a badly needed boost to the IRS’s budget and enforcement capabilities, a minimum audit rate, an exit tax equivalent to the estate tax, and new financial transparency measures. Moreover, the United States is an unrivaled superpower with a vast intelligence apparatus spread across the globe. Gabriel Zucman’s fascinating book, The Hidden Wealth of Nations,” lays out a range of worthwhile options for cracking down on the offshore tax shelters the crooked rich use to conceal their assets abroad. There’s much that can be done to limit the avoidance and evasion of a new wealth tax.   

But it’s not at all clear that what can be done will be done – or that it won’t be too swiftly undone. If you think we need a wealth tax because concentrated wealth has too much power in our democracy, you should be seriously concerned about this. Indeed, you should see the need to implement new enforcement measures and build the necessary state capacity before presenting the bureaucracy with such a colossal administrative challenge. Warren’s proposed tax would amount to the largest subsidy to growth and innovation in wealth-concealment in the history of the world. A new IRS Delta Force is unlikely to stand a realistic chance of winning a proliferating, bucket-patching arms race against some of the planet’s wealthiest and wiliest operators unless the tactically necessary regulations and administrative build-up have been well-established years in advance of the tax.

None of this is to say we should take it easy on the corrupt and corrupting rich. But we must pick our fights wisely. As I argued recently in the Times, it’s important to distinguish between beggar-thy-neighbor “extractive” wealth accumulation and socially beneficial, positive-sum “productive” wealth accumulation. We shouldn’t expect their effects on democracy to be the same, and policies that close off routes to ill-gotten fortunes will be sensitive to the difference.

Byzantine, administratively complex tax systems with lackluster enforcement are one such route to institution-weakening wealth, as I’ve argued elsewhere. Donald Trump’s fortune derives in large measure from tax evasion and our democracy and global national interests have been grievously compromised by the president’s corrupt entanglement with dirty money from illiberal regimes. That’s why beefed-up tax enforcement and a crackdown on shadowy international networks of banks, tax havens, and opaque shell companies are urgently needed, and ought to take priority in any serious agenda for protecting the integrity of American democracy against the depredations of corrupting wealth.

When he was FBI director, Robert Mueller warned of the grave threat posed by rival powers peddling influence through the nominally “private” banks, corporations, and investors that ply the global shadow economy. He was right, and we’re paying a steep price for our laxity.   

The globalization of finance and corporate ownership, and the increasing mobility of capital necessarily involved, can produce huge gains in wealth and promote peace by tying interests together across borders. But it has also entangled investors, banks, and corporations in liberal democracies with oligarchs and foreign bagmen acting in the corrupt, illiberal interests of authoritarian despots. Indeed, the president of the United States may well be a compromised agent of authoritarian kleptocrats. We should see the risk of incentivizing America’s mega-rich to even hide more of their assets in the global shadow economy in the light of this truly terrifying fact.  

You don’t need to agree with Elizabeth Warren about taxes to see her, as I do, as the greatest enemy of corruption, graft, and capitalist self-dealing in the U.S. Senate, and its most compelling advocate of clean government and democratic reform. But a wealth tax intended to shore up democracy risks doing the reverse by turbo-charging the shadow economy and aligning the interests of the non-crooked American super-rich with the interests of the despots, gangsters, and native grifters who have already shaken the foundation of our democracy from the backchannels of global dark money.  

Will Wilkinson

Will Wilkinson is vice president for research at the Niskanen Center and a contributing opinion writer for the New York Times.