States are increasingly looking to the wealthy to plug budget gaps, make up for lost revenue, and address concerns about income equality.
The efforts, which predate the COVID-19 crises but are spurred on by it, are proceeding on two fronts — relatively simple millionaire’s taxes and a revival of more complicated wealth taxes that were once commonplace in America and Europe.
In New York, lawmakers introduced several proposals this year to increase individual income tax rates for millionaires and establish new brackets. The proposals could advance if Gov. Andrew Cuomo (D) calls for a special session before the end of the year. Meanwhile, New Jersey Gov. Phil Murphy (D) on September 29 signed S. 2021, which expanded the existing 10.75 percent gross income tax rate on income over $5 million to include income earned over $1 million. The tax increase is expected to generate $390 million in fiscal 2021.
Following New Jersey's expanded millionaire’s tax and several proposals to increase taxes on the rich, Cuomo said in a September 15 radio interview that he would not raise taxes on millionaires. He said it would put New York “at a competitive disadvantage because other people can go to other states and taxes are very high in the state to begin with.”
California and Massachusetts have also considered proposals for levying or expanding taxes on millionaires.
Only California, New York, New Jersey, and the District of Columbia have a tax bracket for millionaire single filers, while Connecticut has a bracket for millionaires filing jointly, according to the Tax Foundation.
State-level wealth tax proposals have been floated in California and New York to fill budget deficits and help address inequality. Some experts argue that a wealth tax — a tax on the value of held assets — would better tax the ultra-rich, since their wealth may not always be realized as income that could be captured by a higher income tax.
California's A.B. 2088 would have created a wealth tax that could generate up to $7.5 billion annually from the rich. That bill, introduced August 13 at the end of the 2020 session, sought to establish a 0.4 percent yearly tax on the worldwide net worth over $30 million (or $15 million for married taxpayers filing separately) of California residents.
According to an August 10 analysis by David Gamage, Emmanuel Saez, and Darien Shanske, California has 17 percent of all U.S. millionaires and 25 percent of all U.S. billionaires. The authors suggested that a wealth tax would more fairly tax the state’s richest residents.
“The COVID crisis further exacerbates inequality: The working class struggles with job and income loss while the rich can generally keep working from home,” according to the analysis. “‘California billionaires’ wealth has already fully bounced back and even surpassed pre-COVID levels.”
New York's S. 8277B, introduced May 1, would create a mark-to-market tax on capital gains for individuals with a net worth of $1 billion or greater. The bill would tax the accrued gains of an asset every year instead of collecting the tax only in the year the asset is sold.
The revenue from the mark-to-market tax would “provide financial assistance to those excluded from Title II of the [Coronavirus Aid, Relief, and Economic Security] Act and from State Unemployment Insurance” as well as help alleviate a projected $15 billion budget deficit, according to the bill’s justification.
That has never been done before in the United States, and “it's incredibly hard to do because it requires that unrealized gains be taxed as income flows, but they are stocks, not flows,” Jared Walczak of the Tax Foundation told Tax Notes.
“It's one thing to do that for shares in publicly traded companies where we have a valuation on any given day. But most of this wealth is bound up in companies,” Walczak said.
But despite the difficulties facing those proposals, sources say that wealth taxes could bring in a significant amount of revenue, especially amid the pandemic.
A New Frontier for Wealth Taxes
A wealth tax is levied as a percentage of all individual net wealth, not just newly gained income. The United States has never before implemented a wealth tax that broadly covers all individual wealth, only taxes that are levied based on specific assets such as properties.
States’ consideration of wealth taxes represents a new development for an old form of taxation that has had limited use throughout much of the nation's history.
According to the Economic History Association, general property taxes, imposed at fixed rates per “enumerated item,” existed in the American colonies. But by the early 19th century, many states had adopted an ad valorem general property tax that was applied to "all wealth — real and personal, tangible and intangible" — and administered and collected by local tax assessors. However, general property taxes failed to account for wealth accrued through financial instruments like stocks and bonds.
The association said the general property tax declined over the 20th century as a percentage of overall revenue for both state and local governments, and reformers early in that century proposed the elimination of taxes on intangible property and limits to the types of tangible property. The income tax gradually replaced general property taxes in most states over the course of the century, according to the Tax Foundation.
While other countries have imposed wealth taxes, most were repealed because they are hard to enforce. According to a 2018 report from the Ifo Institute for Economic Research, wealth taxes were administered in several European nations in the past but were abolished for various reasons such as high administrative costs and constitutionality issues.
An April 15 Berkeley Economic Review article also said wealth taxes in European countries were easy to evade because those nations lacked strong mechanisms to ensure compliance.
However, three European countries still have a wealth tax. Norway's wealth tax imposes a flat rate of 0.7 percent at the state level and 1.5 percent at the municipality level on income over 1.5 million Norwegian kroner. Switzerland's wealth tax is administered at the canton level with varying rates, according to the Swiss Federal Tax Administration. Spain's wealth tax is a progressive tax that varies on a state level similar to the Swiss wealth tax; rates vary between states and regions.
Experts argue that the United States might be better able to implement a national wealth tax than European countries.
A November 2020 National Bureau of Economic Research working paper by Florian Scheuer, professor of economics at the University of Zurich, and Joel Slemrod, professor of business economics and public policy at the University of Michigan, noted that wealth tax supporters suggest a U.S. wealth tax would be based on citizenship, accompanied by enhanced tax enforcement, and implemented after the adoption several years ago of the Foreign Account Tax Compliance Act.
Sens. Bernie Sanders, I-Vt., and Elizabeth Warren, D-Mass., each a former presidential candidate, proposed progressive national wealth taxes in 2019.
The Sanders tax plan would have applied a tax of 1 percent on wealth over $32 million and established progressive tax brackets extending to a maximum rate of 8 percent of all wealth over $10 billion. The Warren tax plan would have imposed a tax at a minimum rate of 2 percent for all wealth over $50 million and applied an additional 4 percent surtax (6 percent overall) on all wealth over $1 billion.
The additional enforcement mechanisms at the national level could also extend to the state level to help states enforce their own wealth taxes. The IRS discloses tax information to the states through the Government Liaison Data Exchange Program. Shanske said this would be useful in enforcing a wealth tax at the state level.
According to Shanske, “a state can reach wealth that it can reasonably show was accumulated in the state.” Seeking tax judgments across state borders is also possible as “a state can get a tax judgment enforced in another state,” he added.
Taxes on the Wealthy Growing in Popularity
Wealth taxes pose a potential solution to the problems of both wealth inequality and state budget shortfalls, and the idea is beginning to draw support from some members of the so-called 1 percent.
According to the Center on Budget and Policy Priorities, “Wealth inequality is already high and, much like high-wage jobs, several sources of wealth have been spared the worst of the pandemic’s economic damage.” The center notes that stocks have recovered from the beginning of the pandemic and home values have risen, disproportionately benefiting individuals who already have wealth.
Meanwhile, the pandemic has resulted in large losses of low-wage jobs, which have hurt minority communities, according to the center.
Shanske said states like California that are trying to tax progressively to support government services have difficulty because some high-earning taxpayers’ wealth never shows up as income.
“They have a stock of unrealized capital gains that they can borrow against, for instance, and they never actually pay tax on those gains on that big stock of wealth,” Shanske said.
A 2019 paper by Lily Batchelder and David Kamin, professors of taxation and law, respectively, at the New York University School of Law, argue that a wealth tax can raise substantial revenue from the wealthy almost exclusively.
The paper also argues that a wealth tax may have a broader tax base than alternative forms of taxation such as raising current rates, implementing a financial transaction tax, or implementing an accrual tax.
Shanske said another reason these taxes have become a more pressing policy question is the increase in income inequality. “It is sort of less and less fair for the most wealthy to pay less, as a total income tax rate, than people in the middle class,” he said.
A wealth tax would be more effective in taxing ultra-wealthy individuals since their wealth does not always present as income, according to the paper by Gamage, Saez, and Shanske. A wealth tax that applies annually to all wealth, not just income, would reduce the concentration of wealth among high-net-worth individuals in the long run, the authors argue.
The paper says the wealth of California billionaires has increased by $218 billion, from $706 billion in March 2019 to $924 billion in July 2020.
Wealthy individuals are also beginning to speak about the need for raising taxes on themselves.
The Millionaires for Humanity pledge, signed by numerous millionaires, implores governments around the world to raise taxes on the wealthy. Morris Pearl, chair of the group Patriotic Millionaires, told Fortune that wealthy individuals need to be taxed more. “Decades of tax policies favoring the rich have resulted in the highest levels in wealth inequality since the Census Bureau started tracking that figure in the 1960s,” Pearl said.
Unintended Consequences
Despite the growing interest by some states in wealth taxes and evidence that they could be effectively used to address key shortcomings in states’ existing tax regimes, experts note there are still reasons for caution.
Although these new taxes are intended to generate much-needed revenue for the state, they may have the larger consequence of causing ultra-high-net-worth individuals to move out of the state, Ani Hovanessian of Venable LLP told Tax Notes.
The taxes could “have the reverse effect of discouraging the very people that you want to keep in your state from staying,” Hovanessian said. Those are the people who are paying high property and income taxes and frequenting and investing in businesses.
Hovanessian said that because of the pandemic, several of her clients who had not previously considered moving have been able to test out living in non-income-tax states like Florida and Texas and have found that they enjoy it there and could get their work done through telecommuting, virtual meetings, and phone calls.
According to Walczak, some states could seek to backstop migration. The California wealth tax bill included language that would continue to tax former residents for up to 10 years.
“The idea is not to sort of reach out and keep taxing and discouraging people from leaving; it's rather we're trying to get an accurate and fair picture of where the wealth was accumulated,” Shanske said.
But there is no constitutional basis on which California can do that, Walczak said.
“The individuals who would be subject to the tax certainly have the resources to litigate the issue if California attempts to tax wealth that is in no way related to the state anymore,” Walczak said.
Wealth taxes are likely to be in the conversation among legislatures as a means of raising much-needed state and local tax revenue, since solutions are desperately needed to remedy pandemic-related revenue shortfalls.
“As a policy matter, I think every state should have a small wealth tax. As a practical matter, I would think it is only even being considered in states with a relatively high amount of wealth, wealth inequality, and relatively progressive politics,” said Shanske.
However, Shanske said not too many states have the combination of progressive politics, inequality, and wealth to practically implement a wealth tax for now. And wealth taxes at the local level are unlikely because of policy implications concerning mobility and possible constitutional issues at the state level. But he said he hopes “a wealth tax is in the mix” at the state level and that “local governments can levy progressive income taxes even in our more mobile world.”