So you want to tax the rich – here's which candidate's plan makes the most sense

Several Democratic lawmakers and presidential candidates are proposing taxes on the richest Americans^[1] as a way to reduce income and wealth inequality.

But while they agree that the wealthiest need to contribute more to the government’s coffers, they disagree over the best way to get the job done.

New York Rep. Alexandria Ocasio-Cortez wants to tax millionaires’ wages^[2] at a higher rate. Massachusetts Sen. Elizabeth Warren argues for a new tax on wealth^[3]. Vermont Sen. Bernie Sanders suggests expanding the gift and estate tax^[4].

What’s the difference and which is the best way to reduce income and wealth inequality? As an expert on tax policy^[5], I decided to take a closer look.

Income and wealth inequality

Americans enjoyed substantial economic growth^[6] and broadly shared prosperity from the end of World War II into the 1970s.

But in the 1980s, President Ronald Reagan dramatically slashed taxes on the wealthy^[7] twice, cutting the top rate on wages from 70 percent to 28 percent.

Studies have shown that the drop in tax rates, combined with other “trickle down” policies such as deregulation, led to steadily rising income and wealth inequality^[8].

The top 1 percent controlled 39 percent^[9] of all wealth in 2016, up from less than 30 percent in 1989. At the same time, the bottom 90 percent held less than a quarter of our nation’s wealth, compared with more than a third in 1989.

Each of the Democrats’ proposals aims to change that.

Ocasio-Cortez’s income proposal

Currently, the federal government taxes all income above US$500,000^[11] at 37 percent with an additional 3.8 percent investment tax^[12] on incomes over $250,000.

Ocasio-Cortez wants to create^[13] a new “60 to 70 percent” tax bracket for labor incomes over $10 million. She estimates that her plan would catch about 4,000 people^[14] and raise $720 billion over 10 years.

There are two problems with a tax that goes after income instead of wealth.

First, people who earn very high incomes usually control^[15] when they receive their income and how much they receive. The reason is straightforward: They own the companies that pay them^[16]. This control allows the rich to nimbly take advantage of whatever brings a lower tax^[17].

When rates on ordinary income go up, the wealthy can defer that income until the rates go back down. Or, they can turn salary into a capital gain and watch the value of their stock rise instead of harvesting profits. Or, they can take advantage of retirement savings. Even death is a tax avoidance device for the wealthy^[18].

Second, the income tax targets two types of income: ordinary income from labor and capital gains from property. Mostly, the rich earn their money from capital gains^[19] and capital gains get a much lower tax rate^[20] than wages.

That is why the richest Americans are effectively paying lower tax rates than the middle class^[21].

Warren’s wealth tax

That brings us to the wealth tax.

Sen. Warren proposes applying a 2 percent tax^[23] on assets worth $50 million to $1 billion and 3 percent on everything above that. She claims that her wealth tax would affect 75,000 households and raise about $2.75 trillion^[24] over a decade.

Unlike an income tax, a wealth tax reaches the root^[25] of both wealth and income inequality.

There’s only one snag: There are strong^[26] arguments^[27] that a federal wealth tax is unconstitutional^[28]. Wealth taxes violate Article I, Section 2, Clause 3, of the U.S. Constitution, which forbids the federal government from laying “direct taxes” that aren’t apportioned equally among the states^[29].

A direct tax is a tax on a thing^[30], like property or income. An indirect tax is a tax on a transaction, like when a sale or a gift.

The income tax is a direct tax and constitutional because of the 16th Amendment^[31], which specifically allows income taxes without apportionment. As for property, you may notice that only states levy real estate taxes^[32]. In almost every case, the federal government cannot tax real estate or any other form of wealth absent a transaction.

Warren cites a small group^[33] of law professors who back her claim that a wealth tax passes constitutional muster. But the argument against constitutionality is strong enough that a lawsuit before the Supreme Court is sure to follow any attempt to enact a wealth tax^[34].

Barring a victory before a conservative Supreme Court or an arduous amendment to the Constitution^[35], the federal government is shut out of taxing wealth.

Sanders targets wealth transfers

Sen. Sanders also wants to go after wealth; but unlike Sen. Warren, he wants to focus on when wealth changes hands by reforming the gift and estate tax.

Sanders wants to lower the threshold for when the estate tax applies from $11 million – which touches just 1,000 estates a year^[37] – to $3.5 million, where the threshold stood in 2009. He would also levy a new 77 percent rate on estates over $1 billion. Sanders estimates that his plan would raise $315 billion^[38] over 10 years.

Although this amounts to significantly less than his colleagues’ proposals, it is far superior because it both addresses the root of the problem – wealth disparities – and can be implemented immediately.

A rising tide

I agree with Sen. Warren, Sen. Sanders and Rep. Ocasio-Cortez that the United States should return to economic policies that seek to lift all boats^[39].

Although American wealth and productivity has surged in the last 40 years, most Americans have not fared nearly as well^[40] as the richest among us^[41].

Our tax system is at least partly responsible for these gaps. Changing it can be part of the solution.

References

1. ^{^} are proposing taxes on the richest Americans (www.cnbc.com)
2. ^{^} wants to tax millionaires’ wages (www.vox.com)
3. ^{^} argues for a new tax on wealth (www.vox.com)
4. ^{^} suggests expanding the gift and estate tax (www.cnbc.com)
5. ^{^} expert on tax policy (papers.ssrn.com)
6. ^{^} enjoyed substantial economic growth (www.cbpp.org)
7. ^{^} President Ronald Reagan dramatically slashed taxes on the wealthy (www.brookings.edu)
8. ^{^} led to steadily rising income and wealth inequality (www.thebalance.com)
9. ^{^} controlled 39 percent (www.cbpp.org)
10. ^{^} Reuters/Kevin Lamarque (pictures.reuters.com)
11. ^{^} taxes all income above US$500,000 (www.nerdwallet.com)
12. ^{^} an additional 3.8 percent investment tax (www.thebalance.com)
13. ^{^} wants to create (www.cnn.com)
14. ^{^} estimates that her plan would catch about 4,000 people (www.washingtonpost.com)
15. ^{^} people who earn very high incomes usually control (www.moneytips.com)
16. ^{^} They own the companies that pay them (smallbiztrends.com)
17. ^{^} nimbly take advantage of whatever brings a lower tax (www.fool.com)
18. ^{^} tax avoidance device for the wealthy (www.cnbc.com)
19. ^{^} earn their money from capital gains (www.forbes.com)
20. ^{^} much lower tax rate (www.bankrate.com)
21. ^{^} are effectively paying lower tax rates than the middle class (money.cnn.com)
22. ^{^} Reuters/Karen Pulfer Focht (pictures.reuters.com)
23. ^{^} proposes applying a 2 percent tax (www.nytimes.com)
24. ^{^} raise about $2.75 trillion (www.washingtonpost.com)
25. ^{^} reaches the root (theweek.com)
26. ^{^} strong (taxfoundation.org)
27. ^{^} arguments (nymag.com)
28. ^{^} unconstitutional (theconversation.com)
29. ^{^} apportioned equally among the states (constitutingamerica.org)
30. ^{^} is a tax on a thing (www.salon.com)
31. ^{^} because of the 16th Amendment (www.law.cornell.edu)
32. ^{^} only states levy real estate taxes (www.financialsamurai.com)
33. ^{^} cites a small group (www.bloomberg.com)
34. ^{^} is sure to follow any attempt to enact a wealth tax (www.boston.com)
35. ^{^} an arduous amendment to the Constitution (www.archives.gov)
36. ^{^} Reuters/Lucy Nicholson (pictures.reuters.com)
37. ^{^} touches just 1,000 estates a year (www.taxpolicycenter.org)
38. ^{^} would raise $315 billion (www.washingtonpost.com)
39. ^{^} seek to lift all boats (www.economist.com)
40. ^{^} have not fared nearly as well (www.latimes.com)
41. ^{^} among us (inequality.org)