A Better Kind of Wealth Tax

by Leon Friedman

The American Prospect magazine, November 16, 2000

Republicans claim it is unfair to impose a "death tax" on income already taxed during a person's lifetime. House Majority Leader Dick Armey said that it is like "someone showing up at the funeral home and saying, 'Hi, I'm from the government, and I'm taking half your money."' In a Republican weekly radio address, Representative Jay Dickey of Arkansas said that persons who create "something they can pass on to their children" should not be penalized. "Government shouldn't punish success." An article in Fortune compares Sam Spendthrift, who spends all his accumulated wealth during his lifetime and pays no estate tax, with Frank Frugal, who invests in the economy and uses his money for constructive purposes. Why should Frank Frugal have to pay a high estate tax for his thrift?

As President Clinton countered, repeal would primarily benefit the very rich (only 43,000, or 2 percent, of all estates are taxed), and half the estate tax is paid by the largest 5 percent of estates. In his veto message, Clinton noted that over half the benefits of repeal would go to 3,000 very rich families, who would receive an average tax cut of $7 million. Repeal would also cost the Treasury $100 billion in revenues in the first 10 years and as much as $50 billion per year when the estate tax is fully eliminated.

The fight over repeal has created odd alliances. Five members of the Congressional Black Caucus actually support repeal. Georgia Representative Sanford Bishop, Jr., reported that two friends from the past persuaded him to vote for repeal: One had founded a home health agency with more than $1 million in revenue, and another ran a small newspaper. The Dallas Morning News quoted an African-American doctor who wished to pass on his million-dollar medical practice to his children without taxation.

There is a solution to this debate that will save small farms and businesses, eliminate the "death tax" for all Americans, and still preserve the integrity of the federal budget: Tax the net worth of the very richest Americans on a regular basis during their lifetime. Eleven European countries already have such a tax. A 1 percent net worth tax on the top 1 percent of households would allow us to eliminate the estate tax, thus solving the family-business problem, while still raising enough revenue to pay off the national debt, save Social Security, and have money left over for targeted tax cuts.

Why? Because the top 1 percent has so much money.

Tax policies over the past two decades have allowed the very rich to accumulate an ever-greater proportion of the national wealth. During the Reagan presidency, the top marginal income tax rates were reduced from 50 percent to less than 30 percent. (They have since been increased to 39.6 percent.) In 1997 the capital gains tax was further reduced for individuals.

The effect of these policies has been underscored by a recent report of the Federal Reserve Board, which prepares its Survey of Consumer Finances (SCF) every three years. The SCF describes the change in net worth of all Americans, with particular reference to the top 1 percent of the population (those with a net worth over $3.3 million in 1998). The June 2000 report, "An Examination of Changes in the Distribution of Wealth from 1989 to 1998," was written by Arthur B. Kennickell and is available on the Federal Reserve Web site, www.federalreserve.gov/pubs/oss/oss2/method.html. Among other details, it notes:

* In 1998 the bottom 20 percent of families either had no net worth or owned less than $5,000 in assets.

* Median net worth in 1989 for all households was $59,700; it declined in 1992 to $56,500 and then increased in 1998 to $71,600.

* The most important asset for the bottom 90 percent of households (48 percent of all the wealth of this group) was their principal residence. The total value of principal residences for the bottom 90 percent increased from $5.319 trillion in 1989 to $6.219 trillion in 1998. However, the amount of debt on principal residences (mortgages) also increased in an even greater percentage so that the value of the equity in principal residences actually decreased.

* The value of stocks and bonds owned by the top 1 percent increased from $1.004 trillion in 1989 to $2.840 trillion in 1998. The value of stocks and bonds of the bottom 90 percent increased from $431 billion in 1989 to $1.063 trillion in 1998.

* The value of private businesses (all types of businesses except

corporations with publicly traded stock) owned by the top 1 percent increased from $2.493 trillion in 1989 to $3.628 trillion in 1998. This ;s the largest source of wealth for the top 1 percent.

The report also supplies important information on the debate over repeal of the estate tax. The total net worth of all Americans in 1989 (adjusted to 1998 dollars) was $22.391 trillion. Three years later, during the Bush administration, the net worth of all Americans actually went down to $20.382 trillion. (So much for the Republicans' claim that they know how to run the economy better than the Democrats.) From 1992 to 1998, the net worth of all Americans increased to $28.928 trillion, an increase of $8.546 trillion. But the bottom 90 percent of the population saw its wealth increase by only 34 percent. By contrast, the top 1 percent had an increase of total wealth of over 60 percent (from $6.132 trillion to $9.826 trillion).

In many ways, these numbers are astonishing. They reveal (1) that during the Bush years of 1989-1992, Americans actually saw a decrease in their total net worth when inflation is taken into account; (2) the Clinton economic boom of the past eight years was beneficial to all groups of Americans; (3) the group that benefited the most was the top 1 percent, who now own over 34 percent of our total wealth, up from 30 percent in 1992; (4) the top 1 percent now own more than the bottom 90 percent of the population do. No other industrial country comes close to matching this imbalance between the very rich and the rest of society.

If the estate tax is eliminated, the wealth of the very rich may never be taxed. Much of the increase in wealth among the rich is in stocks, bonds, or private businesses. At present no income or capital gains tax is laid on the increase in value in these assets unless and until they are sold. But if they are never sold during the owner's lifetime and the estate tax is eliminated, no tax of any kind will ever be laid on this increase in wealth, unless and until the stocks, bonds, or businesses that are inherited are sold.

A fairer tax system would focus on total wealth as well as income. An important study made in 1997 by Professor Edward N. Woff of New York University, called "Top Heavy," points out that 11 European countries (including Germany, Sweden, and Switzerland) have a combination wealth-and-income tax. Taxpayers must declare not only their income each year, but their total wealth, which is then taxed at comparatively low levels-at 1 percent to 3 percent of total assets.

If the same system were installed in the United States at the levels prevalent in Europe, but applied only to the top 1 percent of households, the federal government could easily increase its revenues by over $100 billion to $300 billion per year (1 percent to 3 percent of $9.8 trillion). There would be no need for an estate tax since total wealth is being taxed on a continuous basis.

The federal Constitution prohibits a direct tax on individuals. Article I, Section 9 reads: "No Capitation, or other direct, Tax shall be laid, unless in proportion to the Census." It took the 13th Amendment to authorize a direct income tax. Seemingly, therefore, Congress cannot directly tax individuals based on their wealth. (The estate tax was upheld by the courts on the grounds that the government was not taxing a person's wealth as such but focusing on a specific event, namely the death of the individual, as the basis for the tax.)

However, we could, consistent with the Constitution, tax gains in the value of property before it is sold. For example, we could take 1990 as a benchmark year and require persons with a net worth over $3.3 million in 2000 to pay income taxes on their increase in wealth between 1990 and the taxable year at issue. If a person owns a private business or stocks or bonds worth $1 million in 1990 but worth $30 million in 2000, he or she has realized an increase in wealth of $29 million. He or she could be required to pay income taxes on that increase whether or not the increase has been converted into cash through sale of the property. People in the market whose stock increases by $1 million in a year are not required to pay taxes on that gain unless and until they sell the stock. But the tax code already requires that certain kinds of securities be "marked to market" and taxed even if not sold. We could extend this theory and treat "paper gains" as real gains, at least with respect to the very rich, and tax them accordingly.

There may well be some political capital in taxing the top 1 percent based on their wealth. If there were a levy of "1 percent on the top 1 percent," such a tax would generate large revenues, reduce the national debt, shore up Social Security and Medicare, allow for significant tax decreases for the middle class, and eliminate the need for an estate tax. Congress would be hard pressed to reject a tax plan that affects only the people on the very top, who have been the chief beneficiaries of recent tax policies and the current boom. If any Americans can afford to pay taxes, they can. Let the Republicans say otherwise.

Leon Friedman is a professor of law at Hofstra University s School of Law

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