Tax Machine Blog™

What if taxing wealth was constitutional? Would it be OK to do it?

It’s common phrase that we hear pundits throw around a lot – “Redistribution of wealth.”

The phrase has common appeal too, for obvious reasons. For most people, taking something that “belongs” to one person and “giving” it to another seems unjust. But – does redistribution of wealth really happen in in the U.S.? For the most part what is being “redistributed” is actually income, not wealth.

But perhaps the reason that we tend to call it redistribution of wealth is because that is actually what everyone is thinking about. We speak of the “Haves” and the “Have Nots” (apparently so much so that we need a TV show by the same title.) To many, it seems unjust that some “have” and some “have not.” For others, taking property from one person and giving it to another is so wrong- at the most basic level – that taking away something that belongs to the “haves” to give it to the “have nots” is a non-starter. Everyone is entitled to his or her opinion on this, I am not judging. But why don’t we make sure that we are having the right discussion. Let’s make sure we frame the debate correctly.

What the Internet is saying about President Obama’s SOTU Proposals:

Many bloggers have been making lots of noise recently about proposals President Obama made in the State of the Union two weeks ago. Some things have changed since the initial roll-out of the President’s proposals (which – let’s be honest – have a snowball’s chance in Dubai of ever becoming law). Most notably, the president backed away from his plan to tax 529 plans. The rationale was pretty simple – the optics of that idea were horrible.  As Robert Wood explains it “The backlash from that idea was unexpectedly bad for the President, so it was quickly dropped. Still, you have to admit that taxing someone who had saved for college so someone else could go to college for free had a certain Robin Hood symmetry to it.” Wood’s article makes the claim that President Obama’s proposed “Death Tax” would be 68%.  To get there, he cites that oh-so-reliable and unbiased “think tank” the Heritage Foundation.

So how does the Heritage foundation get to 68%? If you actually look at the article written by Stephen Moore, it is clear that he is relying on the a simple calculation made by Dick Patton that the “Obama Death Tax Rate” would be 57% and adding on state estate taxes to arrive at 68%. ( A 56.8% federal death tax rate is probably more accurate, for reasons I won’t get into here – but still misleading.)

What Wood, and others, are really saying about the proposal is that it is wrong. And why is it wrong? Because, you know, people are going to inherit less money. A Death Tax is the transfer of wealth, right?  Well not technically.

As the “fact sheet” about the President’s proposal on WhiteHouse.gov correctly points out – you only get a step-up in basis for property someone owns at death. If grandma sold her appreciated stock the day before she died – capital gains taxes would be due. But when grandma dies still holding the stock, we hit the reset button (on capital gains taxes).

I am sorry for getting into numbers and talking points. I know- numbers are boring, and unimportant when we are talking about principles of justice and equality. And the President’s talking points do not really matter – because the last time I checked, it is the legislature (or is it the Heritage Foundation) that gets to write the tax laws. In fact, I’m pretty sure that is in the constitution.

You know what else is in the constitution? An outright ban on direct taxes.

 

Taxing wealth is unconstitutional - but the government can tax any "transfer" it wants to tax.

Taxing wealth is unconstitutional – but the government can tax any “transfer” it wants to tax.

The federal government cannot tax wealth. It is unconstitutional.

Our founding fathers hated taxes. Rumor has it they dumped some tea in a harbor once because of it. When you think about it in that context, it makes sense that they saw fit to put a ban on direct taxes in the constitution itself. The colonies went to war because the idea of transferring the wealth of the new world to King George was just too unbearable. In forming a federal government, there was clearly a concern that poorer states might benefit from taxes drawn from the affluent in wealthier states (kind of like what happens today). To prevent that from happening, our founding fathers made sure that the federal government could not take property from the wealthy and spread it around. Thanks guys! For a short period starting in 1895, when the Pollock case was decided, and ending in 1913, when the 16th Amendment was ratified, the government was even prohibited from taxing gains on the sale of property.

But – yet – the government today seems to be in the business of spreading wealth around. It’s just that the government is stuck doing this in roundabout ways. So – instead of taxing wealth directly- the federal government taxes transactions. What we end up with is a crude approximation of tax measures which attempt to transfer wealth from one demographic to another. (The general scheme of things, and who benefits from that scheme, depends on who is writing the tax laws.)

The federal government taxes income and transactions. For example – the federal government can charge an excise tax on the sale of Medical devices, but it cannot charge an annual property tax on these devices. The federal government can also tax income, transfers during life, and transfers at death, but it cannot charge a recurring tax on the underlying property.

But – why not? OK, I know it would be unconstitutional. But what if it wasn’t? Would it be fair?

It could make things simpler

Currently, every tax season, Americans are required to report their income and deductions to the IRS. In order to do this, taxpayers must account for various items of income and expense throughout the year. We are required to tell the government who is paying us, who we are paying, and what we are spending our money on.  Imagine if every year you just needed to report to the government the property you had in your possession. Of course, there would have to be certain exemptions – or maybe a “standard deduction” for a certain amount of property to account for things like automobiles, clothing, computers, smartphones and other necessities of every day life. There would be schemers, and tax shelters, and cheaters – just like we have today. But we wouldn’t need to tell the IRS what we’ve been up to all year – just what we owned at the end of it. This could be far less invasive than the current income tax and estate tax regime in place in this country.

It could stimulate the economy

Taxing property would actually encourage people to spend instead of hoarding cash. Our current tax system favors those who can push their income tax liabilities to the future by simply buying and holding property and waiting for that property to appreciate in value. But if people were taxed on the money they held at the end of the year, they would have an incentive to spend instead of keeping their cash on the sidelines or tied up in investments that do little to help the “main street” economy.

It could simplify the tax code

Proponents of a “flat tax” preach the simplicity of such a regime. But – unless you do away with all of the deductions and exemptions that impact taxable income, a flat tax can still end up being complex (just less progressive). Taxing property is easy. Sure – some assets are hard to value, but hard assets, money, and cash equivalents are pretty straight forward.

It could be more just and fair

Under our current tax regime, professionals and self-employed individuals with uneven incomes see higher marginal rates in their banner years and lower marginal rates in their less-than-stellar years. Why should those with uneven incomes be punished for the reality of their professions?

It could be better than a consumption tax (“national sales tax”)

Many who argue for a simpler tax code suggest that an easier way to raise revenue would be to simply impose a national sales tax, or a consumption tax. The problem with this approach is two-fold. First, with a consumption tax – taxpayers would be required to report their spending habits directly to the government. That’s kind of creepy. Second, a consumption tax would actually discourage people from spending and – instead – encourage the hoarding of capital.

 

I have many more thoughts about this subject. But, just like President Obama’s State of the Union Proposals, all of this is largely academic. It is never going to happen. THAT would be unconstitutional But it sure is fun to think about.

 

What do you think? Let me know in the comments below.