A Hybrid Tax on Income and Wealth

It’s been a few months since I wrote an op-ed in The New York Times to propose a wealth tax as a way to stem the harmful rise of inequality in the United States. Because of that article and a follow-up posted on this blog, I received a multitude of other, sometimes related tax proposals from people all over the country. Only one was simple and ingenious enough to be worth sharing here.

Last week, I received a series of tweets from Josh Oppenheimer, a medical student who apparently dabbles in public policy. Here they are:

@altmandaniel Variation on your wealth tax proposal: Keep taxing income, but base income tax brackets on wealth level not income

@altmandaniel 1) Places tax burden on those who can truly afford to pay their fare share.

@altmandaniel 2) Helps young workers pay off student loans, pay for childcare, and save for a rainy day fund, mortgage, and kids’ education.

@altmandaniel 3) Better to cut the tax break on high earners’ first dollar earned than on their charitable giving, as a deduction cap would.

@altmandaniel 4) Addresses the core issue of wealth inequality, just as a wealth tax would, but without requiring a constitutional change.

@altmandaniel Looking forward to your thoughts. Also avoids the wealth tax’s illiquidity trap for the family farmer/small business owner.

So, the idea is that only the wealthy would pay the tax, but they would pay it as a percentage of their income. Since most Americans have very little wealth, the income tax rates under this regime would probably have to be quite a bit higher than they are now, if the goal is to collect the same amount of revenue.

As in my version of the wealth tax, Josh’s version reduces the tax burden for young people who may have high incomes but are yet to accumulate wealth – and in fact may be in debt. Unlike mine, Josh’s version also ensures that people with no income are not forced to liquidate their wealth in order to pay taxes. I consider that a useful improvement.

The problem with Josh’s proposal is with marginal tax rates. In short, having simple brackets determined by wealth would create some very high ones. For example, imagine if people with up to $2 million in wealth paid a 20% income tax, but above $2 million the rate rose to 25%. For most people with wealth under $2 million, the marginal tax rate on their next dollar of income would be 20%. But if that extra dollar of income would add the $2,000,001th dollar to their wealth, it would cost them an extra 5% of all their income – something they’d probably try hard to avoid. The same thing would happen if one of their assets happened to increase in value by $1.

Average tax rates would also look a little odd. For people in the first bracket above, the average tax on income would always be 20%. But the average tax on wealth would actually drop at higher levels of wealth, holding income constant; it would be 4% on people with $1,000,000 in wealth and $200,000 in income, but 2% on people with $2,000,000 in wealth and $200,000 in income.

To deal with these problems, I’d suggest a sliding scale. Let’s say that we wanted tax rates to max out for people with $10 million in wealth, which covers almost everyone. We could set a top income tax of 50% for people at the top, and reduce the tax proportionally as wealth went down to zero. So people with $5 million in wealth would pay 25% of income, people with $4 million in wealth would pay 20% of income, and so on.

Using this sliding scale, the marginal tax rate on wealth is always the same for any given level of income; it only rises when income rises. Similarly, the marginal tax rate on income is constant for any level of wealth; it only rises when wealth rises, as Josh intended. At first glance, I think this variation on our ideas is the most economically attractive.

Would this kind of tax require a Constitutional amendment, as the income tax did? Josh Barro of Bloomberg thinks that even though the tax is technically on income, basing the brackets on wealth makes it a wealth tax. But we also base brackets on marriage, and we don’t have a marriage tax that goes by that name. I’m not a legal expert, but I hope to see a few more good ideas for reducing inequality in wealth – and hopefully some comments on the sliding scale plan.