Wealth tax upends the foundational structure of the tax system- difficulty of calculating wealth creates insurmountable administrative burden

(Richard, Peter and Kirsten Bedford Senior Fellow (adjunct) at the Hoover Institution, is the Laurence A. Tisch Professor of Law, New York University Law School, and a senior lecturer at the University of Chicago. https://www.hoover.org/research/wealth-tax-poor-idea)

It should not, however, require this large a dose of reality to warn progressive states off yet another institutional blunder. The effort to impose a wealth tax runs afoul of the fundamental principles of taxation put in place throughout the course of the income tax era, which now spans more than a hundred years. The economic, or Haig-Simons, definition of income—the increase in net worth plus individual consumption—does not work when applied to any real-world tax system that must collect taxes from millions of people in a quick and efficient fashion. Instead, the standard way to tax wealth starts with the notion that the receipt of certain elements of wealth is taxable as income. In principle, that covers earned income and the realized gain from the sale or other disposition of property. However, it is widely known that certain kinds of benefit are so difficult to value that it is better not to recognize that gain upon receipt, so the tax is postponed until some later time when the taxpayer receives either cash or marketable securities. For instance, receiving a partnership in a business may vastly improve your financial prospects, but it doesn’t result in the taxation of that anticipated stream of income today. Instead, each year the tax is imposed as the owner takes money out of the entity as profit distributions. Similar logic applies to stock received in corporate reorganizations like mergers, spinoffs, and recapitalizations. By design, the law does not force taxpayers to calculate difficult asset values or dispose of some illiquid asset to pay the tax. The wealth tax stands in sharp contrast to this long-standing practice. Generally, rich people have diverse holdings because they have the resources to cultivate them. Many such assets, like artwork or fractional interests in a family corporation, are nearly impossible to value, impossible to sell, or both. The nonrecognition rules thus keep them out of the tax system. Today, however, we have an estate tax that requires individuals to include in their gross estate all of these difficult-to-value items, which often makes it impossible to settle a tax dispute on large estates in less than several years. Think of the wealth tax as if it were an estate tax imposed on an annual basis, but with the added logistical headache of being impossible to calculate in year two until the tax liability for year one has been established, and that establishing the tax for year one may take multiple years. These administrative burdens pile up in individual cases, and they become larger the wider the net is extended around the asset base. At this point, the acute tradeoff becomes clear: the only reliable asset class for wealth-taxation purposes is publicly traded stocks and bonds, which of course can decline rapidly in value after the tax is imposed, but also before it is collected. (Think of the position of Elon Musk and others in the class of 2022.) Necessarily, that type of tax will miss the portion of their wealth that they hold in unlisted and illiquid assets, and thus will not satisfy progressives for whom depriving the rich of wealth is every bit as important as providing additional income to the poor. National wealth taxes face this difficulty, which poses an even greater challenge for a state wealth tax, with its more limited territorial reach.