Wealth Taxes and America Divided 

Wealth Taxes

Walter Hellerstein is the Distinguished Research Professor Emeritus and the Francis Shackelford Professor of Taxation Law Emeritus at the University of Georgia Law School and is a visiting professor at the Vienna University of Economics and Business and chair of the Tax Notes State advisory board.

For reasons that I am confident will be identified in my fellow board members’ contributions to our first 2023 installment of Board Briefs, the issues raised by state wealth taxes are complex, controversial, and politically charged. Indeed, readers of these pages have already been alerted to these issues,¹ and they have received considerable attention in other journals as well.² For the record, I plead guilty to contributing to some of this commentary over the years.³

With expectations appropriately lowered for any original contribution that I may make to this dialogue, I would like to focus simply on one aspect of the challenges raised by state wealth tax legislation that sometimes gets lost in the heat of the “conversation”⁴ — namely, the practical issues associated with the implementation of any such legislation.

Lack of conformity to a federal tax obligation. Whatever may be the merits of a state wealth tax, one of the most challenging practical concerns associated with its implementation (whether triggered by interstate migration or some other taxable event) is the lack of conformity to a federal tax obligation. To be sure, states have long adopted and enforced state levies having no analogue to federal exactions (for example, retail sales and property taxes) or deviations from the federal model (for example, taxation of federally tax-exempt municipal bonds issued by other states). Nevertheless, the evaporation of most state estate taxes in the absence of an existing federal model on which to base the exaction⁵ is a lesson that the cost of imposing a tax may well exceed its benefit from a practical and political perspective.

Certainty of legal challenges to the adoption of any wealth tax. Perhaps the one thing that is certain besides death and taxes is the certainty of legal challenges to any state wealth tax legislation that is adopted, particularly if it is associated with cross-border issues relating to a change in residence, a condition that is satisfied by most of the existing proposals for state wealth taxation.⁶ While this may be good news to those of us who bill by hour (as well as those employed to defend such legislation), it is a reminder that the enactment of a state wealth tax is likely to be only the beginning of the story, not the end of it.

The appropriateness of undertaking a cost-benefit analysis to the proposed state wealth tax legislation. My final thought spawned by the preceding reflections is simply that those charged with the responsibility and ultimate determination of whether to adopt a state wealth tax should carefully undertake a cost-benefit analysis of the consequences of their decision. I am not suggesting that this is an easy task considering all the economic, political, and legal concerns that are implicated by the determination. Nevertheless, to end this discussion with yet another cliché, it is absolutely critical to take account of all these concerns in determining whether a state wealth tax is “worth the candle.”

I am hopeful that the ensuing Board Briefs will address some of these issues.

Wealth Taxes Are Not a Solution

Eric J. Coffill is senior counsel with Eversheds Sutherland (US) LLP in Sacramento, California.

Proposals for a wealth tax are currently vogue among the states. A January report from the Tax Foundation states that eight states that collectively house about 60 percent of the nation’s wealth — California, Connecticut, Hawaii, Illinois, Maryland, Minnesota, New York, and Washington — have wealth tax legislation pending.⁷ Space limitations here preclude writing about a fundamental question of whether a wealth tax proposal will run afoul of the relevant state and federal constitutional provisions. I focus here on several policy considerations.

To begin with, what is “wealth”? Webster’s defines it as an “abundance of valuable material possessions or resources.” As with beauty, “abundance” might be found only in the eye of the beholder, but that is not a useful, objective metric when drafting state tax legislation. Hence, someone must make a judgment call. We have seen a number of wealth tax proposals in California in recent years, and the current version is A.B. 259. For tax years beginning on or after January 1, 2024, and before January 1, 2026, it would impose an annual tax at a rate of 1.5 percent on a resident of worldwide net worth in excess of $1 billion, or in excess of $500 million in the case of a married taxpayer filing separately. The bill would, for tax years beginning on or after January 1, 2026, impose an annual tax at a rate of 1 percent of a resident’s worldwide net worth in excess of $50 million, or in excess of $25 million in the case of a married taxpayer filing separately. The bill would also impose, for tax years beginning on or after January 1, 2026, an additional tax at a rate of 0.5 percent on a resident’s worldwide net worth in excess of $1 billion, or in excess of $500 million in the case of a married taxpayer filing separately.

Common sense suggests that most individuals, if asked, would agree that a person with assets in excess of $50 million — the lowest of the bill’s thresholds — is indeed wealthy. A pending wealth tax in Washington state under S.B. 5486 on “taxable worldwide wealth” of a Washington state resident sets the bar at $250 million — that is, it would exempt from the tax up to $250 million of a taxpayer’s “financial intangible assets.” Still lower, a pending wealth tax in Hawaii under S.B. 915 would impose the tax on the “state net worth” of each individual taxpayer who holds $20 million or more in assets in Hawaii. There is no magic behind these numbers that seek to draw a line in the sand for “abundance.”

How to reach that metric is also an interesting question. What assets are included and how are they valued? The Washington bill states it is “a narrowly tailored property tax on extreme wealth derived from the ownership of stocks, bonds, and other financial intangible property.” The Hawaii bill has a long list of includable assets, such as real property and art and collectibles. The California bill has a breathtakingly broad definition of assets includable in “worldwide net worth.” Regarding valuation, it is one thing to include publicly traded assets — for example, NYSE-traded stocks, in the “wealth” base. It is an entirely different matter to include art and other collectibles, trademarks, goodwill, and interests in nonpublic, closely held, passthrough entities and corporations. Irrespective of the policy behind any wealth tax, it hardly seems productive or helpful for compliance and audit purposes to statutorily define a tax base in such a way so as to include assets that have highly fluid values, that are typically far more subjective than objective, and that require annual appraisals.

Accordingly, all should agree a wealth tax in any form is going to be challenging to implement. Litigation is guaranteed challenging its constitutionality. What does the due process clause say about taking the “wealth” of a state resident when that asset (taxable or intangible) is not located in that state? Is my art collection (perhaps on loan to a gallery) located in Texas or Florida or New York subject to a California wealth tax in the same way as if it was located in California? What about the provisions in the California bill through which a California resident who becomes a nonresident may still be subject to the wealth tax (on an apportioned basis) for a number of years while a nonresident? State income taxation is based upon either residency or nonresident source income — nothing else. The complexity of compliance will likely result in low voluntary compliance. Audits, even for those who timely filed, essentially will be guaranteed because of the complexity of the valuation issues for assets in the tax base — a full employment act for appraisers. Appraisal issues are present for income tax purposes for gifts, charitable donations, date-of-death estate taxes, etc., but wealth tax bills will take this problem to an entirely different level. Think perhaps of every wealth tax filing having the equivalent of multiple, guaranteed, 482-type transfer pricing issues in which all parties arrive with dueling appraisals.

Are wealth taxes driven by policy? Yes, certainly to some degree. S.B. 5486 in Washington states in part: “Washington’s status as an economic and social leader is threatened by growing wealth inequality and a tax structure that perpetuates it . . .” and “Washington’s wealthiest residents can and should share more equitably in the responsibility of funding these key community programs alongside their neighbors.” Or is this simply revenue raising disguised as social policy? If it is the former, then we have operational state income tax structures in place in which new progressive rates could be imposed on high earners with no new complexity added to the tax base. If the problem perceived by some is with too narrow a definition of income — that is, “wealthy” people with little taxable income — then the logical solution would be revisit the definition of state taxable income. There is no need to replace something until you know it cannot be fixed. This, of course, makes the assumption there is a need to fix anything in the first place.

Finally, will people leave a state to avoid a wealth tax? I have no doubt the answer is yes, although I will not attempt to quantify the change. I can only confirm, empirically from my practice, the departure of many high-wealth individuals from California over the last several years (and not all of them to “no tax” states) because of its increasingly rigorous California income tax regime — broad definition of residency, no capital gains rate, no small business stock provision, high top marginal rates, and so forth. Imposition of a wealth tax will escalate the departures.

The Marriage of Uniformity and Sovereignty

Helen Hecht is general counsel to the Multistate Tax Commission.

You may be surprised to find me contributing on this topic. State wealth taxes raise questions more suited for academics and philosophers than tax administrators. If only they agreed on the answers.

The biggest question is whether an annually imposed wealth tax will produce the revenue intended given the complexity and high administrative costs, the mobility of capital and state competition, and the threat of abusive tax planning. But just how much all these factors would undermine a state’s tax is disputed.⁸ As for whether wealth taxes are good or bad — let’s just say the experts strongly disagree. All this means we’re unlikely to see such taxes move forward.

Once upon a time, of course, we had a fairly high-functioning national wealth tax of a kind. Called the estate tax, it was levied by all 50 states, Washington, D.C., and the federal government.⁹ Being imposed just once, at the passing of the estate, it was more administrable. And given that inherited assets get an automatic step-up in basis for income tax purposes (a rule to which states generally conform), it made sense.¹⁰ Even the primary means of reducing the tax — charitable donations — was viewed by many as a positive rather than a negative.¹¹

Still, estate taxes, imposed only once, might be even more prone to the effects of mobile capital and state competition. What kept the estate tax system from succumbing to this pressure was uniformity. Not only did that keep interstate competition from eating up tax revenues, cooperation between taxing authorities greatly enhanced enforcement.¹²

Despite of, or perhaps because of, its relative high-functioning, the estate tax had its opponents. They often argued that taxing family-owned businesses and farms was questionable economic philosophy. So, of course, it’s impossible for me not to quote the most preeminent of economic philosophers, Adam Smith, on that subject.

In The Wealth of Nations, Smith observes that: “To improve land with profit, like all other commercial projects, requires an exact attention to small savings and small gains, of which a man born to a great fortune, even though naturally frugal, is very seldom capable.” This 250-year-old observation, that heirs often mismanage inherited assets to the detriment of themselves and the economy, is apparently also borne out by the data.¹³

In any case, it was not some shared view of economic philosophy that gave the estate tax its unusual uniformity. As the Urban Institute noted in its summary, the reason the tax was imposed by every state was:

It’s like the holy grail of uniformity. (Someone tell Congress.)

Of course, like much of the debate over wealth taxes, this is all academic. In 2001 the opponents of the estate tax persuaded Congress to turn the credit for state taxes into a deduction. Not only did this effectively repeal some state impositions, since their statutes were tied to the federal credit, it also made state taxes additive. Only a minority of states reenacted or retained the tax. I guess we’re just lucky Congress didn’t also cap the deduction.

All this prompts me to note something that has long troubled me. The debate over uniformity typically follows a standard formula¹⁵: (1) Taxpayers assert that lack of uniformity increases compliance costs and the risk of multiple taxation. (2) They argue the solution is federal limits on state taxing authority.¹⁶ States oppose this solution as a threat to their sovereignty.

But this sets up the false dichotomy of uniformity versus sovereignty and obscures a critical facet of our federal-state tax systems. So I would reformulate the debate this way: (1) Lack of uniformity makes state tax systems much less effective. (2) The solution is for states and the federal government to agree on essentials (which can be as simple as a federal credit for state tax paid). But then, who could possibly disagree with that?

Wealth and Political Instability

George S. Isaacson is a senior partner at Brann & Isaacson in Maine and represents multichannel marketers and electronic merchants throughout the United States in connection with state sales and use and income tax matters.

Wealth tax proposals, such as the one under consideration in California, are generally met with caustic criticism by tax professionals due to the (1) difficulty of valuing assets, (2) administrative costs associated with implementation, (3) flight of wealthy individuals and families from wealth tax jurisdictions, and (4) susceptibility of such taxes to avoidance strategies. These are all valid objections.

So why do wealth tax proposals keep coming? The answer is not only because they present a potential source of substantial additional tax revenue. The more compelling reason is that untaxed wealth is unfair. It leaves a disproportionate share of the tax burden on those who “earn” their income, and it offers a free pass to those who accumulate wealth by passive investment and then greatly benefit from the tax-free appreciation of their assets.

My concern goes beyond the issue of fairness. Many aspects of our complicated federal and state tax regimes have features that can be characterized as unfair. It comes with the territory. My greater concern is that extreme wealth disparity carries the risk of political instability.

In the last 40 years, the concentration of wealth in the top 1 percent of the population has more than doubled. The top 1 percent now own more wealth than the bottom 92 percent combined. Such wealth inequality is a dangerous development in a democracy. Moreover, for the top tier of richest Americans, federal and state income taxes do not even reach the primary source of their wealth. While unrealized gains in the value of stocks, bonds, real estate, artwork, and intellectual property may largely constitute the annual growth in their net worth, those assets do not generate yearly taxable income.

A system that enables the richest members of society to avoid taxation breeds popular resentment. Such grievances are heightened by sensationalized media reports on the enormous wealth accumulated by a relatively small number of individuals who often lead extravagant and ostentatious lifestyles but pay comparatively little in the way of taxes. What form such widespread resentment may ultimately take is unpredictable, but our political leaders would be wise to adopt tax policies that will lessen the risk of political and social turbulence due to gross income inequality.

The California proposal is problematic for all the reasons that other contributors to this series are sure to detail. Moreover, one state, or even several states, embarking on such a radical initiative will likely cause the very targets of their tax strategy to flee to safer tax jurisdictions. A more modest concept is President Biden’s “billionaire minimum income tax,” which the White House announced as part of its 2023 budget. The plan would subject unrealized capital gains to the federal income tax, and states could piggyback on those changes.

The Biden plan — which applies only to households with a net worth of $100 million or more — would levy a minimum tax of 20 percent on all income plus unrealized capital gains. After calculating the effective tax rate for the minimum tax, if it falls below the 20 percent threshold, those households would owe additional taxes on unrealized capital gains to bring their tax obligation up to the minimum level. The extra tax paid would be treated as a “prepayment” of future capital gains tax liabilities. Assets would be valued at their market value. If that is unavailable, the Treasury Department would establish default rules, such as original cost plus an annual adjustment, to determine market value for tax purposes. The prepayments would be spread over five years with no requirement to prepay for taxpayers who primarily have illiquid assets. However, if a taxpayer is exempt because of having primarily illiquid assets, a deferral charge would be applied upon the sale of an asset that would effectively increase the tax rate on capital gains to compensate for the benefit of delaying tax payment.

Most of the valuation issues are similar to those already confronted by the estate tax. Moreover, given the relatively small number of very rich households to which this new tax base would apply, there would be ample justification to deploy the necessary staff and resources to conduct audits ensuring the accuracy of tax returns.

The most common complaint regarding federal and state taxes is not their complexity, but their unfairness. The English economist, John Maynard Keynes, once wrote: “The avoidance of taxes is the only intellectual pursuit that carries any reward.” Perhaps it should be just a little less rewarding for the very wealthy.

In Defense of Billionaires

Janette M. Lohman is a partner in the St. Louis office of Thompson Coburn LLP.

The big news in SALT these days centers around a group of well-meaning state legislators from eight blue states who in January made a spectacular, well-publicized introduction of a wide variety of tax proposals that seek to extract (more) millions of dollars away from the extremely rich to offset the ever-increasing cost of social programs to benefit the indigent.¹⁷ Although there are many traditional (and acceptable) ways in which these proposed statutes seek to tax their richest citizens (for example, increased income tax rates or brackets, more taxes on capital gains, enhanced estate taxes, and so forth), the most severe of the lot seems to be California’s proposed A.B. 259, which creates new taxes on accumulated wealth in excess of certain thresholds. The most breathtaking part of that proposal would extract a 1.5 percent levy on a California resident’s worldwide net wealth in excess of a billion dollars. In the California legislators’ minds, this represents their vision of a billionaire’s “fair share” of what these families owe to California to enjoy exactly the same privilege of living in California as do California’s poorest residents.

Wealth taxes imposed on only the superrich are politically correct, primarily because there are just not that many billionaires. To put things in perspective, California’s total population as of July 2022 was over 39 million people,¹⁸ of which over 26 million people were registered to vote.¹⁹ In contrast, according to Forbes, there were only 186 billionaires in California at the end of last year.²⁰ Obviously, billionaires are an easy target for tax increases.

But how much is a billionaire’s fair share? Well, if you add up the top 10 California billionaires’ estimated net worths, that amounts to a collective $303.3 billion.²¹ Accordingly, the average billionaire in this highest of high categories would owe an estimated additional annual wealth tax of approximately $440 million under A.B. 259, assuming they had no material deductions and they were in the “married filing jointly” category.²² But how can it be fair, legal, or even constitutional to charge one married couple an additional annual tax of almost $440,000,000, just because they and their families have committed the crime of being rich? But wait, there’s more. Assuming the California billionaires can figure out exactly how much they are worth when they file their reports, these folks have to swear to the accuracy of their net worth under penalties of perjury — lying about it could even constitute a violation of California’s False Claims Act!²³

So, OK, when faced with this new tax and its ominous enforcement provisions, maybe some of those very few billionaires might twig that continuing to reside in their palatial Palm Springs estates just is not worth it. Perhaps, they’d rather reside in one of those gorgeous villas in Palm Beach, Florida, or some other nice, accommodating red state with no state income taxes, let alone wealth taxes. Not so fast. Stepping on California soil is like stepping into quicksand, because (for tax purposes), once you’ve ever been there, you can never leave — trying to pull free only makes matters worse. Buried deep in the provisions of A.B. 259 are “exit” taxes that are designed to trap those scant few billionaires who try to flee California with their net wealth intact. That is, even if a billionaire successfully manages to pull up stakes from California and declare residency in some red state where their family (and wealth) are more welcome, A.B. 259 would enable California to continue to subject them to at least a portion of the wealth tax for up to four more years!²⁴

Given that these billionaires still have to pay the same rates of income taxes, property taxes, sales taxes, and other taxes that all other Californians have to pay, exactly what else are they receiving in exchange for this onerous new tax, particularly after they have abandoned California?

Although at least one noted author has outlined many of the potential commerce clause and other federal or state constitutional provisions that the California exit tax likely violates,²⁵ I would like to add one more. The Supreme Court held that in order to pass muster under the commerce clause of the Constitution, the tax must be “fairly related to the services provided by the State.”²⁶ To my knowledge, the Supreme Court has never invalidated a tax based on this “fourth prong” of the commerce clause. But if ever there were an occasion to revisit the issue, I would hope the California billionaires have a shot. The most famous case in which this “fourth prong” was analyzed was in Commonwealth Edison Company v. Montana.²⁷ That Court held that the fourth prong:

Unfortunately, the Court refused to let Commonwealth Edison offer evidence to quantify the actual measurement of the amount of their severance tax versus the benefits they received from Montana, indicating that imposing any such computational test was an issue that should be addressed by the legislature. In the case of our billionaires, though, how can our Constitution tolerate such a breathtakingly large $440 million disparity in tax burden between the poorest of poor and the richest of rich, in exchange for exactly the same benefit of living in California? To the extent that this doesn’t present a prima facie case for a much more detailed fourth prong analysis, what about the exit taxes? Can California really impose hundreds of millions of dollars of tax on a scant few nonresidents who no longer receive any benefits incident to residing in California?

I suppose there are not many folks (other than billionaires) who have much sympathy for billionaires, but I certainly do. In my next life, I aspire to be Oprah! But I must confess my hidden motive. I don’t want California to give certain billionaires any idea of returning the Rams to Missouri! We Missourians recently celebrated the Super Bowl victory of our beloved Chiefs, and we enjoyed our victory at the opening home game of our brand-new soccer team, the St. Louis City SCs, just last night! But for our comparatively few mega-rich families, we wouldn’t have those fabulous teams. At least Missourians are not about to scare away our precious few, truly affluent families by threatening to impose on them a ridiculously large, and likely unconstitutional, wealth tax.

Wealth Taxes: Thoughts From ‘Billionaires’ Row’

Glenn C. McCoy Jr. is a principal with Ryan LLC in New York.

The United States tax system is not the most progressive tax system in the world. Still, it’s hard to deny that the Internal Revenue Code has helped to make rich people richer. According to the Federal Reserve, income and wealth inequality in the United States is on the rise. According to some estimates, the richest 130,000 American families have as much wealth as the poorest 117 million families put together.²⁹ Historically, a large share of the nation’s wealth has been concentrated in the hands of a few. This fact has been true for decades. So how do we correct this inequality? The question became a national issue in the 2020 presidential campaigns, died on the vine, but is back now.

California, Connecticut, Hawaii, Illinois, Maryland, New York, and Washington all introduced wealth tax legislation in 2023.³⁰ A pending proposal in New York would yield a nearly 30 percent tax on wealthy New York City residents’ capital gains income, about 50 percent higher than the 20 percent federal tax on long-term capital gains.³¹ S. 1570, introduced on January 12, proposed a mark-to-market tax on New York residents with net assets worth $1 billion or more at the end of each tax year beginning in 2023.³²

The New York wealth tax, as proposed, would be a tax on all assets.³³ As is true with the other six state proposals, it includes personal belongings (i.e., clothes, furs, jewelry, autos), business assets (i.e., stocks/ownership interests in businesses), investments (i.e., money that wealthy people put into other companies), and foundations created by the wealthy (i.e., to support certain social or benevolent causes), among others.³⁴

The lessons from other countries’ experiences with wealth taxes should inform policymakers in the U.S. and the states as they consider such proposals. Thirteen OECD countries have imposed wealth taxes since 1965, but as of 2023, only three remain — Norway, Spain, and Switzerland.³⁵ Why?

OECD data reveals that the countries that collected revenues from net wealth taxes resulted in just 1.5 percent of total revenues on average in 2020. Another OECD report about wealth taxes argued that wealth taxes can harm risk-taking and entrepreneurship.³⁶ There is also the prospect that the wealthy will just leave, decamping to another state. The economic consequences from outmigration and lower economic activity are significant. This is a lesson learned by many countries that have abandoned the wealth taxes they once levied. And it is a lesson that New York should pay close attention to.

An article in The New York Times provided statistics about the exodus of millionaires from New York that heated up during the pandemic.³⁷ This is in spite of the fact that so many billionaires have moved to New York City that an entire neighborhood of “supertalls”³⁸ has been dubbed “Billionaires’ Row” by the real estate community.

Maybe the wealth tax proposed by New York (and the other six states) should be reconsidered. Other than enacting a wealth tax, state lawmakers could tax capital gains at the same rate as labor income, tax investment gains annually, reinstate estate taxes and inheritance taxes, or double the top income tax rate.³⁹ There is no right answer. However, careful thought must be given in creating a law that does not contribute to a capital drain or “flight” by taxpayers, that is easily administered and understood, and that will increase tax revenue to the state government, allowing it to redistribute funds where needed to equalize the inequalities.

States, Robin Hood Wannabes?

Amy F. Nogid is counsel in Alston & Bird LLP’s New York office.⁴⁰

Wealth inequality is a problem. Recently, eight states with Democratic state legislative control and Democratic governors — California, Connecticut, Hawaii, Illinois, Maryland, Minnesota, New York, and Washington — have banded together like the Merry Men of Robin Hood by proposing on the same day tax legislation targeting wealthy individuals. These efforts are in addition to “millionaire tax” measures already enacted by California, Connecticut, and New York along with a handful of other jurisdictions, including Maine, New Jersey, and the District of Columbia. While taking from the rich and giving to the poor may be noble and desirable from both tax and social policy perspectives, the efforts should be closely evaluated to avoid undesirable and unintended consequences. For example, the federal alternative minimum tax — originally enacted in 1969 because 155 taxpayers with incomes over $200,000 did not pay any federal income tax in 1966 — eventually impacted 5.1 million taxpayers in 2017.

The theory behind a coordinated effort by the eight states is to minimize wealthy taxpayers from voting with their feet (that is, moving to low-tax states). The same motivation was behind earlier state efforts to tax carried interest; those proposals provided that enactment was contingent on other states enacting similar measures. As we learned from the pandemic, however, remote working is a very viable alternative for many workers, particularly for those who are wealthy and employed in white-collar jobs. California’s proposal has anticipated a potential exodus and provides for an exit tax of questionable constitutional validity.⁴¹

The eight states have, however, not taken a uniform approach and include tactics such as imposing wealth taxes or mark-to-market taxes, increasing estate taxes, and increasing the tax imposed on capital gains. Some states have proposed a multipronged approach.

Focusing on net wealth taxes (that is, taxes imposed on the fair market value of total assets minus the total FMV of liabilities), the OECD concluded after studying such taxes that “from both an efficiency and equity perspective there are limited arguments for having a net wealth tax in addition to broad-based personal capital income taxes and well-designed inheritance and gift taxes.”⁴² It is worthy of note that while 12 OECD countries imposed net wealth taxes in 1996, that number was reduced to five by 2020.⁴³ Reasons given for the retreat include low revenue collection, high administration and compliance costs, and the occurrence of tax avoidance and tax evasion. Tax policy goals usually include simplicity and ease of administration, and it is highly questionable whether net wealth taxes meet that tax policy goal. As those involved in asset valuation issues can confirm, the ease of determining FMV depends on the asset type and often ends up becoming a battle of dueling valuation experts.

Perhaps there are better avenues for states to consider to level the playing field — at least a bit. Increasing tax rates on the ultrawealthy is an easy alternative (for states that have not already done so), although it could trigger moves to lower-tax jurisdictions, with dire consequences to the states since the wealthiest individuals pay an outsize portion of states’ income taxes.

Similarly, increasing state estate taxes or inheritance taxes may be an easy fix, but only a small number of states impose such taxes, and increases to those taxes may also encourage the wealthy to move. From the states’ perspective, the most viable solution is for Congress to increase the federal income tax rates on the wealthiest. (Remember the good ol’ times when federal income tax rates on the wealthiest were 94 percent (1944-1945))? Given the current Congress, that prospect is remote at best and leaves states trying to remedy wealth inequality (and raise revenue) in the lurch. Imposition of wealth taxes at the state level is unlikely to be successful since migration of just a few uber-wealthy individuals out of the state can end up costing the state more in tax revenue than the imposition of a wealth tax can bring in, and the goal of reducing wealth inequality would be unreached. Perhaps states’ attempts to step into the role of Robin Hood should best be left to Congress.

Wealth Taxes In, Taxpayers Out

Timothy P. Noonan is a partner in the Buffalo and New York City offices of Hodgson Russ LLP.

In early 2021 the Twitter world conferred a prestigious award on New York’s then-governor, Andrew Cuomo: “State of Florida Realtor of the Year.”⁴⁴ This honor, presumably given in jest, wasn’t just because of restrictive COVID policies or what some viewed as a declining quality of life in New York but arguably was driven by the increasing tax burden faced by New Yorkers, one that only got worse in early 2021 as New York raised the top tax rate for New York City residents to something close to 15 percent.⁴⁵ Indeed, as reported by the Tax Foundation earlier this year, many Americans moved in 2022, and most chose low-tax states over high-tax states.⁴⁶ Overall population in states like California, New York, and Illinois fell, while the number in states like Florida, Texas, and Montana grew. More than ever, with remote work becoming the new normal, people are moving, and taxes do seem to be a significant driver.

So in examining whether the wave of new wealth tax proposals we’re seeing in so-called blue states could reinforce the divide in this country, the answer seems clear. The drastic and unique nature of some of these proposals is likely to drive many taxpayers away. For example, the California bill would look to impose a 1 percent-a-year tax on the net worth of taxpayers worth more than $50 million and a 1.5 percent tax on those worth more than $1 billion, along with a provision that follows former residents out of the state and continues to levy the tax on them for years after the move.⁴⁷ The Illinois plan would treat billionaires’ unrealized capital gains as income, taxing them at the same 4.95 percent income tax rate that is imposed on taxable income. And similar proposals are out there in Maryland, Hawaii, Minnesota, Connecticut, and Washington, with each state proposing similar bills, leading The Wall Street Journal to dub these states as the “State Wealth Tax Alliance.”⁴⁸

But frankly, the question isn’t just whether the passage of these new laws will reinforce the divide in the country between high-tax and low-tax states. Indeed, take it from a tax practitioner who is steeped in multistate residency issues every day: The mere scent of these wealth tax proposals is enough to drive taxpayers away. The California proposal is especially troubling to many current — and probably soon-to-be former — residents, some of whom have contacted our office already to talk about getting out now, before these proposals become law. To be clear, there’s no judgment from this tax practitioner as to the wisdom of such proposals; that determination is above my paygrade, or at least beyond the scope of the topic here. But I do see how merely proposing changes like these can impact taxpayer decisions about where to live and work. So states interested in going this direction should keep in mind that as proposals like this continue to float around the state atmosphere, we could see an even greater population shift in 2023, potentially creating a lot more competition for that “State of Florida Realtor of the Year” award!

Can a State Wealth Tax Be Administered?

Richard D. Pomp is the Alva P. Loiselle Professor of Law at the University of Connecticut School of Law and the Board of Trustees Distinguished Professor.

Taxation is the art of the possible. And I strongly suspect that a state wealth tax could not be administered. Perhaps the same would be true of a federal wealth tax, but the odds are more in its favor than at the state level.

My skepticism has nothing to do with my view of the merits. But I have read and taught the Panama Papers, the Pandora Papers, and the Paradise Papers. I have been a longtime fan of the work of the Consortium of Investigative Journalists. I have heard stories from my former students abroad about the work of the London enablers, those British-based law and accounting firms, financial advisers, and investment bankers who have protected the Russian oligarchs from sanctions and the seizure of their assets. They have their counterparts stateside. My friends who practice internationally have regaled me with the ease of using offshore devices to shield assets from discovery. I also know better than to bet against capital and wealth.

At least three problems will haunt a state wealth tax. First is the discovery of assets. The ultra-billionaires can buy enablers who have been at this game for a long time. They have networks throughout the world and countries that are only too happy to trade on privacy and secrecy laws.

Ownership can be blurred through multiple trusts, LLCs, LLPs, cross-ownership, and dancing around attribution rules and hiding behind opaque structures. Nominees, dummies, shells, and straws all make discoveries beyond the ability of a state tax administration, even that of California.

Once found, the valuation issue shows how important the realization requirement is to run the income tax. Try valuing an interest in a hedge fund or private equity transaction when there has been no sale, not to mention art, collectibles, yachts, islands, castles, or intangible property, including patents and copyrights.

To be sure, publicly traded stock offers no valuation issue. And unlike some, I do not think that a wealth tax would result in the wholesale dumping of such stock and replacing that stock with harder-to-value assets. I have seen too many times that the lure of a stepped basis at death, especially among my age group, discourages the sale of highly appreciated stock. But that does not prevent restructuring that makes that stock hard to discover or that blurs that stock with other hard-to-value assets.

On the other hand, to the extent assets are valued for purposes of obtaining insurance or loans, perhaps there will be some meaningful benchmarks, and maybe the really tough situations will not represent the lion’s share of the wealth of the ultra-billionaires. But a snapshot of the status quo has little predictive value, as holdings can shift and restructure to avoid a wealth tax. The question, as always, will be whether the game will be worth playing.

Even honest appraisers would be hard pressed to value many of the assets held by the mega-billionaires; one can only imagine the games that would be played by the dishonest ones. Integrity will come at a high cost.

Will the targets of a state wealth tax move to avoid the tax, at least until, (or if ever), such a tax becomes widespread enough that there would be few attractive states in which to hide? We know the residency games that now take place when the stakes are relatively less than they would be with a meaningful wealth tax. At some point, high capital gains taxes, higher marginal rates, serious estate taxes, and a new wealth tax might be a tipping point. And the existing income tax challenges to residency issues provide no comfort for a Pollyannaish view.

Maybe I am too cynical — and I did not want to convince readers otherwise by writing a primer on tax avoidance — but I cannot imagine a state coping with a new set of challenges of discovery and valuation. A state should not get out ahead of a wealth tax, as it is likely to only tarnish the approach for all states and maybe undercut support for a federal wealth tax. States can wait and piggyback onto a federal wealth tax, should that day ever arrive.

A Tale of Two Countries

Mark J. Richards⁴⁹ is a partner in the Indianapolis office of Ice Miller LLP.⁵⁰

On January 19 legislators from eight states (California,⁵¹ Connecticut,⁵² Hawaii,⁵³ Illinois,⁵⁴ Maryland,⁵⁵ Minnesota,⁵⁶ New York,⁵⁷ and Washington⁵⁸), in a show of solidarity, announced state legislative bills for imposing various forms of wealth taxes. The proposals ranged from taxes on wealth (net worth), to increased capital gains taxes, taxes on unrealized capital gains, and increased estate taxes. The targets are the perceived ultrarich and in some cases the upper middle class. The rhetoric, of course, has no limits. And the legal issues with such taxes, like the constitutional issues in Washington state with the imposition of wealth taxes, appear disregarded.

Meanwhile, back at the ranch, a plethora of other states (Kentucky,⁵⁹ Indiana,⁶⁰ Iowa,⁶¹ Ohio,⁶² Oklahoma,⁶³ Missouri,⁶⁴ Wisconsin,⁶⁵ and others), many finding themselves awash with substantial surpluses coming off the pandemic, are looking at issuing tax refunds, cutting tax rates, and/or repealing state income taxes, some of which have already taken place. These states are focused not only on “giving back” to their taxpayers but also on making their states more attractive in the extremely competitive world of attracting, expanding, and retaining businesses, talent, and now, remote workers.

The dichotomy in approach, let alone likely effect, is almost surreal. Where to begin?

A detailed economic analysis of the imposition of wealth taxes is well beyond the scope of this article. In a nutshell, wealth taxes could have a stifling effect on the economy, to the detriment of many beyond those subjected to these taxes. The tax compliance and imposition challenges in subjectively valuing tangible and intangible assets would be immense. Annually taxing unrealized gains in assets that fluctuate in value up and down would create complexity, uncertainty, and compliance costs. And taxing unrealized paper gains and “worth” would create significant cash flow problems. It isn’t hyperbole to say that wealth taxes could lead to taxpayers needing to sell assets, if not businesses, just to pay these taxes.

Then there is the impact on those states of the more affluent (and mobile) residents leaving the state to avoid these taxes. The pandemic created a new economic model for worker mobility and virtual business operations, making a change in residency and the ease of moving or downsizing a company footprint more feasible and already tested to a great extent. In other words, the confluence of the new remote worker economy and the imposition of wealth taxes could make this the worst time to impose state wealth taxes. Wealth taxes could not only have anti-economic development effects, they could also actually cause a reduction in state revenues (or at least revenue projections) due to taxpayer flight. That seems particularly true when your alternatives for residency and business operations include states that are lowering tax rates or eliminating income taxes entirely. Census and IRS data show there is already migration out of many high-tax states, such as California, New York, and Illinois, and into low-tax states in recent years.⁶⁶ Wealth taxes would seem likely to exacerbate these trends.

In response to this concern, some states, notably California, raise the specter of an exit tax, which seems to be more akin to a hostage tax, or, as Don Henley of the Eagles sang in, ironically, “Hotel California,” “you can check out any time you like, but you can never leave.” An exit tax raises constitutional issues — among other considerations — that similarly seem to get brushed aside.

To be fair, the “give back to the taxpayers” states are not free from questioning. A serious concern is that a state’s surplus is a result of a (hopefully) non-reoccurring pandemic and resulting federal stimulus packages, a one-time shot in the arm, while some tax cuts/repeals are of a more permanent nature. Short-sighted thinking may lead to later regrets. With a surplus from the pandemic, Indiana issued refunds not once but twice in 2022,⁶⁷ along with reducing income tax rates.⁶⁸ Indiana did, however, condition future income tax rate reductions on achieving certain levels of revenue, but the pandemic illustrates the risk of unpredictable future events.

These two opposite extremes on state tax policy may merely reflect our political environment. While it is unclear where all of this will lead, what does seem clear is that the adoption of taxes like those that have been proposed would lead to job security for state tax lawyers.

California vs. Wealthy Taxpayers

Kathleen K. Wright is the director of the state and local tax program in the School of Taxation at Golden Gate University, San Francisco. She frequently presents seminars on SALT issues for the California CPA Education Foundation.

California has for some time been a place with very high living expenses and taxes only offset by the year-round beautiful weather and picturesque scenery. But even these positive attributes won’t be enough to offset the increased burden of additional taxes on the wealthy coupled with the indirect tax increase related to the closing of perceived tax loopholes. This article looks at the wealth tax included in A.B. 259. More to come in a later article that focuses on measures being considered to close perceived tax loopholes for the wealthy.

It should be noted that Tax Notes State recently reported that California Gov. Gavin Newsom (D) opposes the wealth tax.⁶⁹ This development imposes a significant obstacle to getting the bill enacted into law. In addition (and possibly due to Gov. Newsom’s objection), the bill has not moved out of the State Assembly.

The Wealth Tax

A.B. 259 was introduced in the State Legislature on January 19 and would enact a “wealth tax” on certain California residents.⁷⁰ If enacted, for tax years beginning on or after January 1, 2024, and before January 1, 2026, A.B. 259 imposes an annual tax at a rate of 1.5 percent on a resident’s worldwide net worth in excess of $1 billion (or in excess of $500 million in the case of married filing separately (MFS)). For tax years beginning on or after January 1, 2026, the wealth tax would be extended to residents with a worldwide net worth in excess of $50 million (or in excess of $25 million for MFS). The rate for these taxpayers would be 1 percent, but for residents with a worldwide net worth in excess of $1 billion ($500 million for MFS), the rate remains at 1.5 percent.

The bill discusses valuation of property for this purpose at some length but starts with the adoption of provisions governing the valuation of property for purposes of the federal estate tax. The wealth tax is based on the value of worldwide property as of December 31 of each year. Worldwide net worth does not include any real property directly held by the taxpayer and tangible personal property directly held by the taxpayer and located outside California. If real property or out-of-state tangible personal property is held by a corporation, partnership, limited liability company, trust, or similar entity, it will be included in the computation of worldwide property.

The bill does provide a credit against the wealth tax for an amount equal to the amount of net-worth wealth tax paid to another jurisdiction relating to assets subject to this tax. ⁷¹

The wealth tax is imposed on California residents, part-year residents, and temporary residents. For the part-year and temporary residents, the tax is multiplied times the percentage of days in the year that the taxpayer was in the state.

Every taxpayer must multiply their wealth subject to this tax by a fraction, the numerator of which is the years of residence in California over the last four years and the denominator which is four. If a taxpayer moves out of the state, then the numerator declines by one year until the lookback period of four years does not include a year of residency. In other words, once you move out of California, this tax continues to apply until you are gone for at least four years, phased out as the numerator of the fraction declines.

Although the wealth tax imposed on residents appears to be constitutional, the “exit” tax is a constitutional disaster. Here are just some of the issues which come to mind.

The California Constitution

There does not appear to be any constitutional limitation on the state’s right to tax worldwide wealth. The state already taxes California residents on worldwide income, and the states have significant discretion in establishing their own tax policies. A state’s taxing jurisdiction may be exercised over all of a resident’s income based upon the state’s in personam jurisdiction over that person. ⁷²

The constitutional limit on taxation of personal property.⁷³ The authors of A.B. 259 have covered this base by linking the passage of A.B. 259 to the passage of ACA 3. The California Constitution limits taxation of most personal property to no more than 0.4 percent of the value of such property and limits the tax rate on personal property to no more than the tax rate on real property in the same jurisdiction. ACA 3 would repeal this limit as it might relate to the wealth tax. If approved by the legislature, ACA 3 would still require approval by a majority of voters in the next election.

The constitutional limit on taxation of real property.⁷⁴ Proposition 13 limits the amount by which the real estate property tax can increase from one year to the next. This limitation is probably not a problem because the wealth tax excludes real property owned directly by the taxpayer from the definition of worldwide net worth.

The U.S. Constitution

The wealth tax (with its exit tax feature) would be unconstitutional under not only the right to travel and due process clause but also under the commerce clause, equal protection clause, and privileges and immunity clause. This article discusses the most obvious (and blatant) violations under the right to travel, due process clause, and commerce clause.

The right to travel. You do not have to be a constitutional law scholar to know that you can travel from state to state without incurring import/export fees, taxes, or other similar assessments. This is because of the right that we have to engage in interstate travel without the undue burden of tariffs and taxes.

The word “travel” is not found in the text of the Constitution. Yet the “constitutional right to travel from one State to another” is firmly embedded in cases that have been decided by the U.S. Supreme Court.⁷⁵ The Supreme Court has defined the right to travel by looking at three different criteria. The right to travel protects the right of a citizen of one state to enter and to leave another state, the right to be treated as a welcome visitor rather than an unfriendly alien when temporarily present in the second state, and, for those travelers who elect to become permanent residents, the right to be treated like other citizens of that state.⁷⁶ An exit tax directly impairs that fundamental right — that is, the right to go from one place to another. Therefore, California will have to show that the exit tax is narrowly tailored to achieve its purpose of closing the wealth tax gap. The state will probably be unable to meet this test, as there are many tools available to the state to close the wealth gap without burdening the right to travel.

The due process clause. The due process clause requires that there be a link between the state and the person being taxed as well as between the state and the activity being taxed. The former is expressed in terms of the minimum contacts test that is familiar in the context of determining the personal jurisdiction that may be exercised by a court sitting in one state and issuing process to a person in another state.⁷⁷ Applying principles from this area of the law, due process requires that a person whom a state proposes to tax have “purposefully availed” himself of benefits within the taxing state.

Once a person has moved outside the state, they no longer have the minimum contacts to be taxed by that state. If we can assume that the taxpayer actually moved and established a new state of residence, then there is probably not going to be anything left in California to tax. Unless stock and other intangible personal property acquire a business situs in California, the fiction of mobilia sequuntur personam (movables follow the law of the person) controls, which states that the taxable situs of stocks, bonds, and other intangible personal property is the domicile of the owner.⁷⁸ Therefore, the taxpayer’s investments do not have any connection to California and do not meet the “minimum connection” requirement imposed by California.

The commerce clause. The commerce clause applies to interstate commerce or interstate business transactions. The computation of worldwide net worth includes corporate stock and ownership of flow-through entities. Therefore, if a wealthy taxpayer moves out of California and moves their business with them, then interstate commerce is implicated.

In Complete Auto Transit Inc. v. Brady,⁷⁹ the U.S. Supreme Court set forth the four requirements that must be met for a state tax to be constitutional under the commerce clause. A tax on interstate commerce will be upheld if it is applied to an activity with substantial nexus with the taxing state, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the state. The wealth tax violates substantial nexus and fair apportionment.

For a state to tax an activity, the activity must have substantial nexus with the taxing state. It is fair to assume that many wealthy taxpayers will own an interest in a partnership, LLC, or S corporation. The ownership interest is an intangible and, when sold, the gain/loss on sale is sourced to the state of residence unless the intangible has acquired a business situs in California.⁸⁰

Under the “exit tax,” the wealthy taxpayer, now a nonresident, could sell their ownership interest in a partnership to a buyer who is also a nonresident, and the gain on sale would go into the computation of worldwide net worth when neither party nor the transaction has any connection to California. This violates the substantial nexus requirement under the commerce clause analysis.

The exit tax is also not fairly apportioned. In other words, a state may not tax interstate commerce on more than its fair share. This test attempts to ensure that the tax policy of a state does not result in multiple tax of the same income. The test looks at the result if all states enacted an identical tax to the exit tax. If a wealthy taxpayer moved more than once in a four-year period, they could end up paying trailing exit taxes to multiple states. Therefore, the trailing exit tax violates the “internal consistency” requirement of the commerce clause.

Conclusion

As unpopular as it would be, California could enact a wealth tax (without the trailing exit tax) and be within the bounds of state and federal constitutional limitations — but not the trailing exit tax, which violates multiple constitutional principles.