Senator Warren's wealth tax might prevent billionaires from paying nearly nothing in taxes – but it's probably not constitutional

A new report that shows America’s biggest billionaires paid barely any income tax^[1] from 2014 to 2018 has revived talk^[2] of a wealth tax^[3] – such as the one proposed by Sen. Elizabeth Warren^[4].

The report from ProPublica – which based its findings on a trove of tax records^[5] submitted by an anonymous source – found that investor Warren Buffett paid US$23.7 million in taxes on $125 million in reported income, while amassing $24.3 billion more wealth during that same five-year period. Amazon founder Jeff Bezos saw his wealth soar $99 billion from 2014 to 2018, yet paid just $973 million in taxes on $4.22 billion in reported income.

In total, the 25 richest Americans saw their wealth rise $401 billion over this period as the value of their investments such as stocks and properties grew. They paid just $13.6 billion in income taxes, or 3.4% of their wealth gain. For context, ProPublica noted middle-class Americans in their early 40s gained just $65,000 in wealth during the period – and paid almost the same amount in taxes

As an expert on tax policy^[6], I’m deeply familiar with how America’s system has exacerbated inequality. There’s at least one problem with Warren’s wealth tax as a solution, however: It may be unconstitutional.

Income and wealth inequality

Concerns about inequality have increased in recent decades.

Americans enjoyed substantial economic growth^[7] 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^[8] – twice – cutting the top rate on wages from 70% to 28%.

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^[9].

The wealthiest 1% controlled 39%^[10] of all wealth in 2016, up from less than 30% in 1989. At the same time, the bottom 90% held less than a quarter of America’s wealth, compared with more than a third in 1989.

Currently, the federal government taxes all income above $518,400^[11] at 37% for single filers with an additional 3.8% investment tax^[12] on incomes over $200,000. Of course, as the ProPublica cache of tax documents shows, loopholes and tax dodges result in actual income tax rates^[13] significantly lower.

Warren’s wealth tax

Warren’s wealth tax proposal^[15] aims to change that.

In March 2021, the Massachusetts Democrat introduced a bill^[16] to tax households worth over $50 million and up to $1 billion at a rate of 2%, and anything over that at 3%. She first proposed the idea of a wealth tax^[17] during the Democratic presidential primary in 2019.

The legislation, which could raise an estimated $3 trillion^[18] over a decade, is meant to reduce inequality by using revenue from the wealthiest Americans to pay for new federal programs to lift up some of the poorest.

Her tax would affect an estimated 100,000 families^[19], or fewer than 1 in 1,000, according to University of California, Berkeley economists Emmanuel Saez and Gabriel Zucman. The tax wouldn’t start until 2023.

President Joe Biden, for his part, hasn’t signaled support for a wealth tax. But he is seeking to raise the top rate^[20] the rich pay in income taxes from 37% to 39.6%. And, he wants to double the capital gains rate to help finance his infrastructure proposal.

The problem with taxing wealth

Unlike an income tax, a wealth tax reaches the root^[21] of both wealth and income inequality.

There’s only one snag: There are strong^[22] arguments^[23] that a federal wealth tax is unconstitutional^[24]. 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^[25].

A direct tax is a tax on a thing^[26], like property or income. An indirect tax is a tax on a transaction: for example, a sale or a gift.

The income tax is a direct tax and constitutional because of the 16th Amendment^[27], which specifically allows income taxes without apportionment. As for property, you may notice that only states levy real estate taxes^[28]. 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^[29] 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^[30].

Barring a victory before a conservative Supreme Court or an arduous amendment to the Constitution^[31], the federal government is shut out of taxing wealth.

Two other proposals

Two other proposals to tax the rich have also emerged in recent years.

Rep. Alexandria Ocasio-Cortez of New York wanted to create^[32] a new “60% to 70%” tax bracket for income earned from labor over $10 million.

One problem with that idea was that the wealthy can avoid or lower that tax^[33] by choosing when they receive the income^[34]. A second is that the rich earn most of their money from capital gains^[35], which are taxed at a much lower rate^[36] than wage income.

Vermont Sen. Bernie Sanders, who has since signed on to Warren’s plan^[37], in 2019 proposed^[38] going after wealth but targeted instances when it’s being transferred to someone else – which is what makes it constitutional. He wanted to lower the threshold at which the estate tax applies from $11 million – which touches just 1,000 estates a year^[39] – to $3.5 million, where the threshold stood in 2009. He would also levy a new 77% rate on estates over $1 billion.

Although this would bring in 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. And it wouldn’t pose a constitutional problem.

[Like what you’ve read? Want more? Sign up for The Conversation’s daily newsletter^[40].]

A rising tide

I agree with all three lawmakers that the United States should return to economic policies that seek to lift all boats^[41].

Although American wealth and productivity has surged in the last 40 years, most Americans have not fared nearly as well^[42] as the richest have^[43] – and are paying higher tax rates^[44]. In 2020 alone, America’s billionaires saw their wealth increase $560 billion^[45], even as tens of millions were unemployed^[46] or depended on food donations^[47] to get enough to eat.

The U.S. tax system is at least partly responsible for these gaps. A wealth transfer tax – rather than one that taxes wealth – seems to be the best approach to both pass legal muster and help solve the problem.

This is an updated version of an article published^[48] on March 2, 2021.

References

1. ^{^} paid barely any income tax (www.propublica.org)
2. ^{^} revived talk (www.newsweek.com)
3. ^{^} wealth tax (www.rollcall.com)
4. ^{^} one proposed by Sen. Elizabeth Warren (www.congress.gov)
5. ^{^} based its findings on a trove of tax records (www.propublica.org)
6. ^{^} expert on tax policy (papers.ssrn.com)
7. ^{^} enjoyed substantial economic growth (www.cbpp.org)
8. ^{^} President Ronald Reagan dramatically slashed taxes on the wealthy (www.brookings.edu)
9. ^{^} led to steadily rising income and wealth inequality (www.thebalance.com)
10. ^{^} controlled 39% (www.cbpp.org)
11. ^{^} taxes all income above $518,400 (www.nerdwallet.com)
12. ^{^} an additional 3.8% investment tax (www.thebalance.com)
13. ^{^} result in actual income tax rates (www.propublica.org)
14. ^{^} Evelyn Hockstein/Pool via AP (newsroom.ap.org)
15. ^{^} wealth tax proposal (www.congress.gov)
16. ^{^} introduced a bill (www.nytimes.com)
17. ^{^} first proposed the idea of a wealth tax (cdn.theconversation.com)
18. ^{^} could raise an estimated $3 trillion (www.warren.senate.gov)
19. ^{^} would affect an estimated 100,000 families (cdn.theconversation.com)
20. ^{^} he is seeking to raise the top rate (www.bloomberg.com)
21. ^{^} reaches the root (theweek.com)
22. ^{^} strong (taxfoundation.org)
23. ^{^} arguments (nymag.com)
24. ^{^} unconstitutional (theconversation.com)
25. ^{^} apportioned equally among the states (constitutingamerica.org)
26. ^{^} is a tax on a thing (www.salon.com)
27. ^{^} because of the 16th Amendment (www.law.cornell.edu)
28. ^{^} only states levy real estate taxes (www.financialsamurai.com)
29. ^{^} cites a small group (www.bloomberg.com)
30. ^{^} is sure to follow any attempt to enact a wealth tax (minnlawyer.com)
31. ^{^} an arduous amendment to the Constitution (www.archives.gov)
32. ^{^} wanted to create (www.cnn.com)
33. ^{^} can avoid or lower that tax (www.fool.com)
34. ^{^} choosing when they receive the income (www.moneytips.com)
35. ^{^} earn most of their money from capital gains (www.forbes.com)
36. ^{^} are taxed at a much lower rate (www.bankrate.com)
37. ^{^} since signed on to Warren’s plan (www.cnbc.com)
38. ^{^} in 2019 proposed (www.cnbc.com)
39. ^{^} touches just 1,000 estates a year (www.taxpolicycenter.org)
40. ^{^} Sign up for The Conversation’s daily newsletter (theconversation.com)
41. ^{^} seek to lift all boats (www.economist.com)
42. ^{^} have not fared nearly as well (www.latimes.com)
43. ^{^} richest have (inequality.org)
44. ^{^} are paying higher tax rates (www.propublica.org)
45. ^{^} America’s billionaires saw their wealth increase $560 billion (www.forbes.com)
46. ^{^} were unemployed (www.bls.gov)
47. ^{^} depended on food donations (philanthropynewsdigest.org)
48. ^{^} article published (theconversation.com)