For Fans of Warren's Wealth Tax, the Income Tax is a Cautionary Tale

Taxes targeting the super-wealthy today may target the rest of us later

Earlier this month, Senator Elizabeth Warren unveiled tax legislation targeting the country’s wealthiest people. Though her version of a wealth tax would only hit 75,000 households, the story of the federal income tax should prompt wariness that, once enacted, this narrowly-defined tax could someday be unleashed on a wide swath of America.

The Ultra-Millionaire Tax

While most tax proposals tinker with rates, deductions and other dials on the current tax system, Warren’s “Ultra-Millionaire Tax” would open an entirely new avenue of taxation—an annual tax on net worth, which is what you get when you subtract your total debts from your total assets.

It would apply to households with net worths starting at $50 million. The rate would start at 2% of every dollar over $50 million and, via a “Billionaire Surtax,” rise to 6% for each dollar of net worth exceeding $1 billion.

Since we’ve witnessed waves of migration within the United States away from high-tax jurisdictions, one might expect Warren’s tax to encourage America’s ultra-wealthy to leave the country altogether.

Anticipating that, Warren proposes holding America’s wealthy captive by way of a financial Berlin Wall—a whopping 40% tax on the net worth above $50 million for anyone renouncing their citizenship.

Public Opinion Favors Wealth Taxes

Polls find a majority favor instituting a wealth tax. That’s hardly surprising: The super-wealthy comprise a tiny percentage of the population, and people tend to think favorably of taxing somebody other than themselves. As George Bernard Shaw wrote, “A government which robs Peter to pay Paul can depend on the support of Paul.” 

The degree of polled support can differ substantially, however, depending on how the concept is framed.

For example, when a February Hill-HarrisX poll asked if “billionaires (should) be targeted and have to pay a wealth tax as part of the solution to wealth inequality,” 67% agreed.

A March Hill-HarrisX poll gave a choice of two opposing stances and rationales, and yielded more balanced results:

  • 56% chose “Wealth inequality is a significant problem facing the country and billionaires paying a wealth tax is part of the solution.”

  • 44% selected the alternative: “It is unfair to impose an additional tax on people who already pay income taxes because then it becomes a penalty for being successful.”

The stronger showing against a wealth tax in the latter poll seems to reflect a cultural dynamic that Dominic Frisby, a Londoner and author of “Daylight Robbery: How Tax Shaped Our Past and Will Change Our Future,” has observed from abroad.

“America has always celebrated the success of wealthy people, whereas in Europe there’s been a certain amount of resentment to the success of wealthy people,” he says.

That cultural touchstone may be eroding. “The left in America are deliberately fostering resentment of the super-rich,” says Frisby. Noting that younger generations are graduating college saddled with debts and finding themselves priced out of housing, he says “this belief that somehow one set of people are entitled to the wealth of somebody else will gather traction.”

The cultivation of resentment is evident in the hypothetical examples Warren uses in her promotional material, as she applies her wealth tax to a “hedge fund manager” and an “heir,” rather than, say, a “technological innovator” or “founder of a businesses that employs 75,000 people.”

Like the Wealth Tax, the Income Tax Initially Targeted the Rich

Before endorsing an entirely new way for the government to take someone else’s money, Americans should consider the possibility that the new mechanism could eventually target them too.

Little imagination is required, thanks to the example of the federal income tax. Like the wealth tax, the income tax was initially pitched as a way to take money from wealthy Americans or—in the parlance of the day—to “soak the rich.”

Expressed in 2021 dollars, the original 1913 income tax only applied to income over $80,514 for singles and $107,353 for married couples. It used a mere 1% tax rate all the way up to $537,000 in taxable income. Incomes over $13.4 million were taxed at 7%.1 Dividends were exempt.

Most significantly, however, the original income tax only hit 2% of U.S. households. Today, it reaches about 57%.

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How did a tax created to extract wealth from the top 2% of American households grow to become a financial and administrative burden for more than half?

According to tax historian Frisby, when it comes to the imposition of new tax or an increase to an existing one, “the first thing you need is some kind of crisis” and “after the crisis has passed, the tax remains.”

There’s no greater crisis than war, and the enormous expansion of the U.S. income tax can be attributed to two of them.

First came the U.S. decision to enter World War I. To pay for the war, which killed 116,708 American service members, Congress lowered income tax exemptions and hiked rates substantially, with the top rate soaring to 77%.

That expansion of the income tax, however, proved a rather humble precursor. World War II brought the Revenue Act of 1942, which Time magazine called “the biggest piece of machinery ever designed to separate dollars from citizens.” It increased the reach of the income tax to 50 million people.

As the war raged in 1943, the government next ordered employers to begin withholding federal taxes and paying them to the Treasury directly. The psychological impact is underappreciated: Contrasted with writing hefty quarterly checks to the government, this practice desensitizes citizens to the government’s presumptuous claim on the fruits of their labor.

Wealth Tax Expansion Could Come Incrementally, Then Precipitously

If Warren’s Ultra-Millionaire Tax is enacted, it won’t be long before Democrats propose a wider definition of “ultra-millionaire” along with a hike in the rate of wealth confiscation.

Indeed, Warren’s bill already reflects an expansion from what she’d proposed during her failed 2020 presidential run, as she’s doubled the tax rate on net worth over a billion dollars.

Calls for wealth tax expansion would intensify in the next election cycle, with various Democratic candidates seeking to distinguish themselves with the most aggressive proposal.

However, for the tax to reach garden-variety millionaires and perhaps lesser accumulators of wealth, it would probably take a crisis. Unfortunately, there’s a major one already lying in wait.

I’m not alluding to a war with a major power, but rather to the federal government’s looming fiscal crisis. Officially, the U.S. government is over $28 trillion in debt, and it’s projected to rise steeply from here.

The accompanying chart from the Congressional Budget Office (CBO) shows federal debt as a percent of gross domestic product over time. Already in alarming territory, this ratio is projected to soar in the coming decades, largely because of increased spending on interest alone.

As bad as that looks, the government’s true financial condition is actually far worse than what it presents to the public.

If you count unfunded liabilities—all the promised benefits of Social Security, Medicare and other government programs—the total U.S. debt could be somewhere between an astounding $113 trillion and a mind-boggling $239 trillion. Even the lower of those two estimates exceeds the combined annual economic output of the entire planet.

Considering those grim facts, and the historic tendency of taxes to grow beyond their initial targets, it’s easy to see why Warren’s wealth tax should be eyed with great wariness by people who aren’t “ultra-millionaires.”

To put it another way, your Uncle Sam compulsively makes financial commitments he can’t keep, and is addicted to foolishly spending other people’s money—on everything from the snake-bit, $1.6 trillion F-35 fighter program to $6.4 trillion on futile wars in Iraq, Pakistan and Afghanistan to $500 billion in unneeded COVID-19 “bailouts” for state and local governments and $400 billion in “relief” money handed out to people who didn’t even lose jobs or income during the pandemic.

Given your reckless uncle’s increasingly desperate fiscal condition, and the untrustworthiness of addicts generally, the last thing you should do is give him a new means of draining someone else’s account—even if he vigorously denies any intention to use it on yours.

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The 1913 income tax had personal exemptions of $3,000 for singles and $4,000 for married couples. I derived the 2021 equivalents using the Bureau of Labor Statistics CPI inflation calculator, which likely understates the true 2021 equivalent.