Can we build a fairer, simpler tax system? One that lowers the tax burden for most Americans and balances the budget? With the Net Worth Tax Proposal (NWTP), these ambitions could become a reality.
This bold proposal calls for a total overhaul of how the federal government obtains revenue to provide for the common defense and general welfare of the United States. It eliminates all forms of the income tax and replaces those forms with a tax on the net worth of individuals and taxable organizations.
It also includes a relatively small national sales tax. The goals are simple: build a fair federal tax system that increases the wealth of the bottom 80% of households, and implement a system that has a realistic chance of balancing the budget.
This Net Worth Tax Proposal (NWTP) is significantly different from other recent proposals for a net worth tax. Compare, for example, the wealth tax proposed by Senator Elizabeth Warren during the 2020 Democratic primaries. Her Ultra-Millionaire Tax included a 2% tax on every dollar of household net worth above $50 million and a 6% tax on every dollar of net worth above $1 billion. (Net worth is the difference between the value of one’s assets and one’s liabilities, i.e., debts.) Warren’s Ultra-Millionaire Tax would apply to the top 0.1% of households and would generate $3.75 trillion over a ten-year period. The Warren tax would not change the nation’s current tax system; it would simply be an additional and relatively small tax on ultra-millionaires.
The Ultra-Millionaire Tax generated significant controversy during Warren’s campaign but faded from prominence when she failed to win the Democratic nomination. Nevertheless, the prospect of a net worth tax is still worth considering.
The Net Worth Tax Proposal (NWTP) includes a 3% annual tax on the net worth of individuals in excess of a $200,000 exclusion. The tax would apply to both citizens and resident aliens. It also includes a 5% annual tax on the net worth (i.e., shareholder equity) of corporations and other taxable organizations, and a 3% national sales tax on goods and services. Additionally, it would apply a 5% surcharge to the net worth of the wealthiest 1% of households (i.e., net worth greater than about $10.5 million), and a 4% surcharge on households in the next 4% (i.e., net worth between $2.5 million and $10.5 million).
Who Would Pay the Tax?
Individuals owning assets worth $200,000 or more would complete an annual and relatively simple assets/liabilities statement in order to determine their net worth, a statement similar to what is typically required by lending institutions prior to obtaining a loan to buy a house, car, boat or other similar asset. A 3% tax would be paid on the amount of net worth in excess of the $200,000 exclusion. Individuals with a net worth valued at less than $200,000 (the large majority of the country) would have to certify this fact at tax time using a simple post-card-size tax return form.
How About Corporations and Other “Taxable Organizations”?
Under the NWTP a shareholder equity tax of 5% would apply to U.S. domestic and multinational public corporations that carry on a trade or business for profit. Corporations would calculate shareholder equity (i.e., net worth) based on the assets and liabilities associated with both domestic and foreign subsidiaries regardless of where income is produced. The corporation shareholder equity tax would also apply to foreign corporations, including so-called “inverted companies,” that do business in the U.S. The tax would be determined based on the degree to which the corporation’s assets are both “effectively connected” to and a material factor in the generation of income associated with the U.S. trade or business.
Under the NWTP non-public companies, both incorporated and unincorporated, would be subject to the net worth tax. These companies include sole proprietorships, limited partnerships, other types of partnerships, subchapter S corporations, limited liability companies, and other types of private businesses. Each owner’s net equity would be included in the calculation of the individual’s net worth tax.
Tax-exempt corporations and organizations, including charitable trusts, private foundations, political organizations, university endowments, and philanthropic organizations, would also be subject to a net worth tax under the NWTP.
What About the National Sales Tax?
The NWTP includes a small 3% national sales tax for two reasons. First, to keep the net worth taxes on individuals and corporations as low as possible, an additional source of revenue is needed. Second, to ensure fairness in the tax plan, everyone should contribute. A national sales tax solves this problem. It ensures that anyone who buys anything is a taxpaying citizen; regardless of income, net worth, and spending everyone would pay exactly the same sales tax rate.
The national sales tax would be a tax on the consumption or sales “process,” not the specific item. Therefore, an item could be taxed multiple times. For example, the purchase of a new car would incur a sales tax. However, sale of the same car later as a used car would also incur a sales tax.
The Rich Would Still Get Richer
Under this proposal, the annual tax on net worth could be as high as 8% for individuals in the top 1% due to the surcharge. However, even at 8%, high-net-worth individuals would easily be able to increase their wealth. Consider the following: over the last 45 years Warren Buffett’s Berkshire Hathaway fund has had an annualized gain of about 20%. Paying an 8% annual tax on net worth still leaves room for high net worth investors to gain an investment return on their wealth which is significantly higher than what they might have to pay in taxes on that wealth; any income from wages would be in addition to this and would not be subject to an income tax.
Tax Wealth Not Income
The federal tax system should be wealth-based, not income-based. As Alan Greenspan, former Chairman of the Federal Reserve, put it: “Ultimately, we are interested in the question of relative standards of living and economic well-being. Thus, we need also to examine trends in the distribution of wealth, which, more fundamentally than earnings or income, represents a measure of the ability of a household to consume.”
For this reason, the NWTP would replace virtually all methods of federal taxation, including individual income tax, corporate income tax, estate and inheritance tax, gift tax, capital gains tax, tax on interest and dividends, payroll tax, alternative minimum tax, self-employment tax, business unemployment tax, and the tax on withdrawals from tax-deferred accounts [e.g., IRAs, Keogh, 529, and 401(k) plans], among others.
Eliminate the Payroll Tax
Covering the cost of Social Security and Medicare is critically important. Under this proposal, the federal government would shoulder the full cost of these programs. Payroll tax costs and Social Security/Medicare benefits would be calculated the same way as they currently are. Specifically, automatic transfers from the General Fund of the Treasury to the OASI and DI Trust Funds would be made in the amounts that would have been made in the absence of the payroll tax elimination. There would be no changes to Social Security/Medicare benefits and how these benefits are calculated. Simply stated, the federal government would pick up the full tab for these benefits.
More Money for Individuals and Businesses
The elimination of the payroll tax would have dramatic economic benefits. Since workers and businesses each pay an equal share of payroll taxes, they would split the $1.356 trillion the Congressional Budget Office (CBO) estimates will be paid in FY2021. This would amount to an additional $5,273 in tax-free income, on average, for each household. Much of this would go into consumer spending. The NWTP would also encourage savings and investment of these funds, since there would be no tax on interest and dividend income or capital gains, and no tax on asset value until an individual’s net worth goes over the $200,000 exclusion.
Elimination of the income tax would also provide a lot of money to households, although most of the money would go to the top 50% of households since they pay about 97% of all the income tax. The top 50% of households based on net worth would in 2021 gain, on average, about $28,710 in avoided income tax. The bottom 50% would only gain, on average, about $922 in avoided income tax since these households only pay about 3% of federal tax revenue.
Businesses would see a $678 billion savings in Social Security and Medicare payments in 2021. Hopefully, some of this would be put into the paychecks of employees. Realistically, most of the savings would go into the business; but regardless the benefit would be positive, significant, and immediate.
401(k) and IRAs Become Savings Accounts
All tax-deferred retirement plans, including 401(k) and IRA plans, would simply become savings plans under the NWTP and would be considered assets in the determination of net worth. Rules related to penalties for early withdrawals from those accounts would go away, and taxes on withdrawals would also end. Consider the impact of this change: the current value of IRAs and 401(k) plans is estimated to be about $17 trillion. Eliminating the penalties and taxes on withdrawals from these accounts would release this money for possible consumption and have a profound impact on the U.S. economy.
Balanced Budgets – How Much Revenue?
Based on the proposed tax rates the NWTP would generate all of the revenue needed to cover federal expenditures, deficit free, resulting in a balanced budget. Federal spending in 2021 is projected to be about $4.816 trillion according to the CBO. Payroll taxes will be about $1.356 trillion. If full responsibility for paying for Social Security and Medicare is assumed by the federal government as proposed under the NWTP, federal spending in 2021 would increase to $6.172 trillion. This would be covered by the proposed net worth tax.
The generation of revenue needed for a balanced budget distinguishes the NWTP significantly from Warren’s Ultra-Millionaire Tax. The Warren plan would only generate an estimated $3.75 trillion over ten years. It should also be noted that reducing federal spending would allow the NWTP tax rates to be reduced accordingly. The NWTP tax rates were calculated using very conservative assumptions and could be significantly lower in actuality.
The NWTP would generate substantially more revenue than the Warren Plan, allowing it to balance the budget, for three simple reasons: first, much more of the nation’s wealth would be taxed. Second, the net worth tax would apply to corporations and other taxable organizations in addition to individuals. And third, there would be a national sales tax.
How Many Households Would Pay the Net Worth Tax?
Households in the bottom 63% have a net worth of less than $200,000. Individuals within these households would not have to pay a net worth tax since they would meet the exclusion amount provided by the NWTP. It should be noted that under the NWTP a household would be able to divide its assets in a beneficial manner. For example, asset transfers would be permitted as long as the distribution was legally binding. Each person receiving a portion of the assets would be required to file a net worth tax return and would be entitled to the $200,000 exclusion. This would substantially reduce the number of individuals subject to the net worth tax. For example, if a two-person household had a combined net worth of $400,000, the net worth could be divided so each person would meet the exclusion amount and not pay any net worth tax. (About 76% of households have a net worth below $400,000.)
This provision would predictably result in transfers of asset ownership to minimize tax liability, but this does not create any problems for the NWTP. An individual who transfers an asset subject to the net worth tax would be required to document, certify and report the transfer of the asset to the IRS, including the asset’s assessed value at the time of transfer and the identity of the individual(s) receiving the asset. The individuals (household members and/or others) receiving any asset(s) would be the legal owners of the asset(s) with full rights of control.
Reporting of Financial Assets Under the NWTP
The Survey of Consumer Finances (SCF) issued by the Federal Reserve Board includes a detailed listing of the types of financial and non-financial assets and liabilities typically considered in determining an individual’s net worth. Exhibit A includes a listing of the financial assets identified in the SCF. The value of these assets in excess of the $200,000 exclusion would need to be included in an individual’s net worth tax return. Banks, brokers, and other financial management firms and organizations would be required to report these asset values to the IRS.
Reporting of Non-Financial Assets Under the NWTP
Typically, non-financial assets are considered within the SCF to include the following: vehicles (cars, vans, SUVs, trucks, motor homes, recreational vehicles, motorcycles, boats, airplanes, helicopters); primary residence and other residential real estate; net equity in nonresidential real estate (commercial property, a rental property with five or more units, farm, and ranch land, undeveloped land, and all other types of nonresidential real estate); net equity in privately-held businesses (sole proprietorships, limited partnerships, other types of partnerships, subchapter S corporations and other types of corporations that are not publicly traded, limited liability companies, and other types of private businesses); and other non-financial assets (tangible items, including, for example, artwork, jewelry, precious metals, antiques, hobby equipment, collectibles).
Importantly, under the NWTP vehicles and other non-financial assets will not have to be included in the determination of net worth. These asset categories are not included in order to keep reporting as simple as possible; including them would require annual value assessments with often complicated and vague determinations of depreciation and appreciation. The proposed tax rates for the NWTP were determined without including these assets in the evaluation of the potential tax base. This is a conservative approach since it lowers the values of total household net worth used to calculate the tax rates proposed for the NWTP. However, at some point following the implementation of the NWTP, if it is determined that individuals and households are increasing their purchase of Vehicles and Other Nonfinancial Assets solely or primarily for the purpose of lowering their net worth and net worth tax, this exclusion may need to be revisited.
Reporting of Liabilities Under the NWTP
Liabilities that would be reportable when determining net worth under the NWTP include the following: debt secured by residential property (primary residence and other), lines of credit not secured by residential property, installment loans, credit card balances, other lines of credit, and other debt (cash value life insurance loans, pension account loans, margin account loans, other personal loans). Meanwhile, liabilities associated with vehicles and other non-financial assets would not be reportable.
Valuing Real Estate Under the NWTP
One of the NWTP’s critically important innovations involves its valuation of real estate. Real estate would be valued based on the price paid at the time of purchase or its assessed value at the time of transfer to the current owner. For example, if an individual’s primary residence was purchased thirty years ago for $100,000 but is now valued at $400,000, its value for net worth tax purposes under the NWTP would be $100,000. However, if a property (or portion thereof) is transferred to one or more individuals either as a gift, donation, or as part of an inheritance, the entire property would have to be reassessed at the time of transfer and its new value used as the basis for the net worth tax paid by the new owner(s) or part-owner(s) of the property.
These rules would significantly inhibit tax avoidance through the gifting of real estate assets since the new owner would likely have to value the assets at a higher dollar amount. If a property is sold, the new owner would be required to value the property at either its purchase price or its assessed value, whichever is higher. This would prevent the sale of assets at well below their true value (e.g., the $1 sale transaction). If there is no clear record of the original purchase price or cost of a property (e.g., a long-held family farm), a special valuation of the property’s current value may have to be performed. Knowing the length of time the property has been in the possession of the current owners, the current value of the property could be reduced for net worth tax purposes to discount the appreciation over that period for the property or similar properties. Other methods of value adjustment might be considered.
This method of historical valuation should provide an incentive for property buyers to ensure that the purchase price of a property is reasonable and not inflated, as has been the case in recent “bubble” years, since an inflated value could result in a higher net worth tax. The NWTP would allow the baseline asset value to remain the same until the property is either sold or transferred; the property value would not need to be adjusted either up or down for tax purposes due to appreciation or depreciation.
Follow the Money
Net worth should be subject to taxation regardless of where it exists or how one intends to use it; the tax should follow the money wherever it goes. Consider how this would play out in the following transaction: a person buys a Picasso for $14 million with the objective of decreasing his or her taxable net worth since paintings are not considered an asset in the determination of taxable net worth under the NWTP. The buyer’s net worth would drop by $14 million but the seller’s net worth would increase by $14 million. This money is still taxable no matter who is holding it, and the buyer is left with a very expensive painting he or she needs to care for and insure against theft and damage.
The Concentration of Net Worth (Wealth) is Extreme and Getting Worse
While the NWTP would not stop even the very rich from accumulating wealth, it would slow the process. This is crucial given the increasingly unequal distribution of wealth in the U.S. In 2007, according to New York University professor of economics Edward Wolff, the top 1% of households owned 35% of the country’s total net worth; the top 5% owned 62%; the top 20% owned a whopping 85%; the bottom 80% owned only 15% and the bottom 20% of households had a negative net worth of -0.5%.
Things have not changed for the better since Wolff’s analysis based on 2007 data. For example, over the nine years between 2007 and 2016, the net worth of the top 1% went from 35% to 40%, according to Wolff, and the top 20% went from 85% to 90%. This begs the question: At what point is the ownership of the country’s wealth by the top 20% of households too high? 95%? 98%? This question never gets asked and answered. Clearly, there is a need for the imposition of some form of net worth tax to establish a reasonable limit on wealth accumulation and concentration.
Has the Share of Wealth Ownership Always Been So Disproportionate?
The simple answer is “yes.” In 1906, Italian economist, Vilfredo Pareto, created a mathematical formula to describe the unequal distribution of wealth in his country, observing that 80% of the wealth was owned by only 20% of the people. This observation came to be known as the Pareto Principle, or the 80/20 rule. The Pareto Principle basically says that, absent some specific and dramatic political and/or economic interventions, the distribution of wealth in a society will always be skewed in approximately an 80/20 split. Experience in many different economies has substantiated this observation. However, what is interesting about the distribution of wealth in the U.S. is that at 90/20 it is significantly more disproportionate than Pareto. Clearly, some out-of-the-box thinking with respect to how the government can invest in America and help the bottom 80% of households build wealth is called for.
Hiding assets is a problem with our current income tax system, and the problem would most likely increase, unfortunately, with the implementation of the NWTP. However, the IRS has instituted programs under the Foreign Account Tax Compliance Act (FATCA) to help identify these hidden accounts and penalize the owners. Under the FATCA, financial institutions must reveal details of American clients abroad or face a 30% withholding tax on any income earned in America. With the implementation of the NWTP, the government would have to increase further its efforts to get foreign governments and institutions to help identify hidden assets. In this regard, it is worth noting that the European Union is aggressively moving on several fronts to shed the stigma associated with being viewed as a tax haven.
Currently, the government can seize up to 50% of an account’s value for every year it existed; a separate fraud penalty can also be imposed. Additionally, the IRS offers rewards for information on tax evasion. More attention would be required in the future, and even stiffer penalties may be warranted. With the elimination of the income tax system, the IRS should have more resources available to focus on the inevitable attempts to hide assets from the government.
Also, U.S. citizens who choose to renounce their citizenship in order to evade taxes, a very significant decision, would under both the Warren Plan and the NWTP have to pay a significant exit tax on their net worth. A tax of 50% on net worth above the $200,000 exclusion would not be unreasonable.
For additional information and summary of the Net Worth Tax Proposal, please click on the supporting exhibits: