It’s bad for the innovation economy, doesn’t work in practice, and is fundamentally unAmerican
The presidential campaigns of Senator Bernie Sanders and Senator Elizabeth Warren sparked national debate about many progressive policies that failed to gain mainstream attention in the past. Both senators are pitching a “wealth tax” as part of their arsenal to disrupt an economic system that they believe is rigged against common Americans. The wealth tax — a special tax on ultra-high-net-worth individuals — sounds like a pretty good idea to many middle- and working-class Americans. The tax would be levied on the appraised value of everything an individual already owns — real estate, stakes in private companies, cars, and even furniture — above a certain threshold ($32M for Sanders’ plan, $50M for Warren’s). Surely rich people can afford to pay a few percent tax on their net-worth, right? It turns out that wealth taxes are actually pretty complicated and that implementing one would have disastrous consequences.
A wealth tax would hobble the most dynamic parts of our economy. In particular, Silicon Valley’s innovation economy is the most vulnerable to the worst effects of a wealth tax. A wealth tax would amplify the risks already associated with volatile startup valuations. Taxes levied on valuations of private companies would expose investors and other shareholders (like owners and employees) to higher risks in the form of massive tax liabilities on those valuations. The results would be substantial declines in investment, entrepreneurship, and, ultimately, innovation. At the same time, a wealth tax would undermine our country’s appeal to the wealthiest and most productive people in the world. Driving away foreign wealth would lead to further declines in investment and innovation. Beyond the material aspects of foreign investment, attracting foreigners also holds cultural significance. America has long been the shining city on a hill. We should not forfeit that coveted status under any circumstances, but especially not for a tax that would probably lose the government more money than it would collect. The problems with wealth taxes are plenty — it is no surprise that ten out of fourteen European countries that taxed wealth in 1995 have since abandoned wealth taxes as a source of revenue.
I am cognizant that it is unpopular for a rich person to complain about wealth taxes, but I am ashamed of the silence on this issue. My fellow leaders in business and finance know how disastrous wealth taxes would be. They must join me in speaking out against this policy before it is too late.
As Senator Sanders and Senator Warren make their pitches for a wealth tax, here are some of the strongest counterarguments to keep in mind:
Wealth Taxes Disincentivize Investment
Angel investors play an important role in the innovation economy by providing crucial support to startups at their earliest stages. Angel investors are sometimes venture capitalists or established entrepreneurs, but they can also be friends and family members or even professors, as was the case with Google. A wealth tax would dramatically change the way that angel investments work, disrupting the delicate ecosystem that keeps the innovation economy growing. Angel investors would face serious risks when investing in early enterprises that could jump in value suddenly and substantially. If a company’s valuation increases sharply, as is common in Silicon Valley, an investor would be liable for huge wealth taxes on her stake, despite having no real financial benefit from those shares or guarantee that she would be able to cash them in in the future. When a company rapidly increases in value, that value is often volatile and uncertain. Companies frequently fail before their investors ever see a return on their investment. WeWork’s valuation, for example, fluctuated by nearly $40 billion over the course of a month. IPOs are now often delayed indefinitely. Other taxes on property, such as real estate taxes, work because the asset has relatively stable value. Private companies, on the other hand, are among the most unstable assets.
A common misconception is that business owners and investors have billions in liquid cash sitting in a bank account. We don’t. Without liquid cash, investors and business owners would have to sell part of their company each year to get the cash required to pay wealth taxes. Coercing founders of companies to sell shares or business assets in order to pay taxes discourages innovation and entrepreneurship, which are the basis of a successful economy.
Some wealth tax plans allow people to defer their wealth tax payments to the future. For example, Senator Warren’s plan allows for people to defer wealth taxes for up to five years. Deferring taxes seems to make sense for owners or investors waiting for a company to sell or IPO, but after five years if neither has occurred yet, then they are still liable for the aggregate of the taxes. The average enterprise IPO takes about twelve years, but it’s not unusual for some startups to wait more than fifteen years to exit. Even those companies that do exit often see their values slashed in IPOs and acquisitions, giving investors and founders a much smaller pay day than their “net worth on paper” had suggested. These complicating factors make wealth tax deferrals extremely risky. Consider the following example:
- Suppose Linda wants to make her first big investment. One of her colleagues is building a promising startup, so she invests the most capital she can afford to risk — $500K — for a 20% stake to help get the company off the ground.
- A few years later, some New York investors have taken an interest in the company, valuing it at $500M. Linda’s stake in the once-humble start-up is now worth a whopping $100M.
- In the status quo, the high valuation is great news for Linda. She is excited about her investment and sees a payday on the distant horizon. But in a world with a wealth tax, the valuation makes Linda nervous. The tax on her 20% stake is now $1–2M a year (depending on the net worth threshold) and the company hasn’t located any buyers. The wealth tax perverts the incentive for a high valuation, so she actually wishes that the company were valued less.
- Three years later, the once promising start-up busts. In the status quo, Linda is bummed about losing her $500K, but she isn’t bankrupt. In the world with a wealth tax, Linda is in serious trouble. She decided to defer her wealth taxes for a few years until the start-up was acquired and she got her payday. Now, the company is worthless, but she is still liable for $3M in wealth taxes — 6x her losses from the original investment.
Normally, when a company fails an investor loses their investment and the potential earnings from the company. But when there is a wealth tax, as “Linda’s” investing experience shows us, an investor also loses the amount she pays in taxes on that investment’s valuation. The risk of additional losses to taxes would require investors to have enough capital to make an initial investment and keep more money in reserve for potential taxes on that investment. As a result, fewer people could afford to invest in early enterprises. Even people who could still afford to invest would have less capital with which to do so.
In general, investors would be inclined to invest in fewer companies to limit exposure to potential taxes, whereas now investors typically make investments in many different startups. When investment declines, the biggest losers are not the wealthy people who cannot invest. The real losses are felt by the small businesses and early enterprises that rely on both the capital investment and the expertise of these experienced businesspeople to grow their companies.
Wealth Taxes Drive Away Foreign Investment
A wealth tax would apply to foreigners and non-residents who have assets in the U.S. too. Imposing a wealth tax would make the U.S. less attractive to foreign investors and wealthy immigrants. A report by Alain Trannoy, a French economist and public policy advisor, admitted, “wealth tax in some countries seems more efficient to repel the very rich than to effectively redistribute wealth.” Including both foreigners and French citizens, an estimated 10,000 people with 35 billion euros worth of assets left France to avoid the wealth tax in that country. Most other European countries abolished their own wealth taxes, attracting France’s rich exiles.
Repelling wealthy foreigners would have real consequences for the U.S. economy: in 2018, foreign direct investment to acquire, establish, or expand U.S. businesses totaled $296 billion. An estimated 7.4 million jobs are attributable to foreign direct investment (FDI) in the U.S. A decline in FDI would also disproportionately impact rural communities because the average foreign direct investment in rural America is greater than the average in metropolitan areas.
America has long attracted industrious people from around the world to build great companies, create awe-inspiring art, and invent the new staple of everyday life. A wealth tax would reverse that trend, encouraging the most successful people to leave.
Wealth Taxes Misalign Incentives for Startups
A wealth tax would fundamentally change how Silicon Valley operates. Silicon Valley’s startups drive the innovation economy, which plays a massive role in America’s productive output and is responsible for much of its economic growth. Software engineers are at the center of Silicon Valley’s miracle, bringing their unique talent, risk tolerance, and dedication to disrupting the status quo. Startups attract top engineers by giving them a stake in the success of their companies. Engineers stomach the lack of job security because of the potential for those small numbers of shares to skyrocket in value. But a wealth tax would make it risky for some top employees to accept shares in their companies. Consider the following scenario:
- Suppose Lori is a highly respected software engineer in the middle of her Silicon Valley career. She’s had a very successful run at her first startup: she owns a house (median home price: ~$1.5 M), sets aside savings ($500K), and has $10M in illiquid shares in that startup. So, Lori has a net worth of about $12M.
- Lori is looking for a change, and she finds an exciting opportunity at a biotech startup focused on cancer treatment. The new startup offers her a role as a senior engineer, a $300K salary (enough to live on in Silicon Valley with little savings), and a 5% stake in the early company.
- Soon after she joins, the promising biotech startup raises capital investment at a $1.2B valuation. The company is still years away from knowing if its treatment will even work, but Lori’s stake is now worth $60M.
- In the status quo, Lori is living happily. Her shares in the two startups are looking like a lucrative retirement plan, but she knows that she won’t be able to cash in those shares for years, if ever at all.
- In a world with a wealth tax, Lori is devastated. Her total net worth is now $72M on paper, even though only $500,000 of that is actually cash-in-hand. The 2% wealth tax liability on her net worth above $50M (based on Senator Warren’s plan) is $440,000 annually. Between the high cost of living in the Bay Area and her other taxes, her regular income isn’t enough, so she dips into her savings to pay the remainder of the taxes. After two years, her savings are gone, and the tax burden forces her to re-mortgage her house. Her financial situation is dire.
- At the same time, the biotech startup is about to raise more funding at an even higher valuation to facilitate expansion and work on cures for more diseases. Lori, running out of options, will have to forfeit shares to stay out of bankruptcy.
- Lori’s friend Robert has a similar background and has two options for what to do in his career: help a risky startup that’s developing promising cures and disrupting the status quo or join a large established firm where he’s paid a much higher salary. Seeing Lori’s trouble, and having responsibility to his family, Robert decides to go work for “the man” instead.
Lori’s situation is more common in Silicon Valley than you might think. Fluctuating valuations, employee shareholding, and low liquidity among founders and employees alike are all characteristic of the innovation economy. Before a company’s IPO or acquisition, almost no one in that company has enough liquidity to pay taxes on its valuation. Thus, wealth taxes would have complicated and profound effects on how Silicon Valley operates. At a basic level, wealth taxes would create a perverse incentive for startup employees to forego or forfeit shares in the promising companies they work for, further entrenching wealth in the hands of owners, founders, and investors who might have access to more liquidity (or might not, in which case they would find themselves in the same unfortunate situation). Even if the wealth tax could be paid in shares — as some plans would allow — the incentive for shareholders would be to pressure the company to limit its size in order to keep the valuation low enough to avoid paying massive taxes. Disincentivizing growth in this way would make everyone worse off.
The Costs and Logistics of Implementation
One of the most basic issues with a wealth tax is that it relies on appraisals. The IRS would require wealthy people to annually appraise their entire estate — an onerous, arbitrary, and expensive process. High net worth individuals tend to have a greater variety of assets than the average person. Each year, the IRS would need an army of appraisers to determine the values of jewelry, cars, ancient pottery, furniture, and clothing, in addition to bigger assets like privately held companies, farms, and real estate. Real estate and business appraisals are exorbitantly expensive, costing between $10,000 to over $50,000 each. Appraisals of art, cars, boats, furniture, and heirlooms require appraisers with even more unique expertise.
The subjective nature of appraisals adds additional challenges. Expert appraisers frequently disagree on valuations with owners, with each other, and, most importantly, with the IRS. Disagreements on valuations would flood an already overburdened court system with expensive legal disputes.
The task of enforcing the new wealth tax would ultimately fall to the IRS. To contextualize the demands placed on the IRS, consider estate tax audits, which are the most similar to what wealth tax audits would look like. The IRS does about 1200 estate tax audits annually, or 30% of estate tax returns, which is the proportion estimated to ensure compliance. If 30% of potential wealth tax returns were audited to ensure compliance, that would mean 25,000 more audits each year! Tens of thousands of complex audits would overwhelm the IRS, which is already understaffed and shrinking. The institutional demands of a wealth tax would consume resources that could be used for the agency’s more important functions, like criminal tax evasion investigations.
Audits are more than just a burden for the IRS though. Wealth tax audits would be particularly intrusive since they apply to physical things inside of a household. Each year, the IRS would force thousands of families to open their homes to auditors who would then sift through their furniture, art, jewelry, and even clothing. Government agents rummaging through the households of law-abiding citizens should make us think of totalitarian dystopias — not the United States of America.
Every step of implementing a wealth tax is expensive. The costs of enforcement add up: hiring thousands of skilled appraisers, expanding the courts to accommodate disputes from elite legal teams, and equipping the IRS to carry out thousands more audits each year. Yet, the revenue a wealth tax would raise is quite small: an estimated $37.5 billion a year, or roughly a 1% increase in total annual tax revenue. Other countries ran into fiscal problems when they considered or implemented wealth taxes too. British Labour leader Denis Healey, who tried and failed to champion a national wealth tax, later wrote that even after five years of work, Labour could not draft a wealth tax that would yield enough revenue to justify the costly administrative challenges of enforcing it. In France, the “solidarity tax on wealth” failed to raise notable revenue, only generating about $3 billion annually at its peak. Between enforcement costs and lost taxes from the emigration of wealthy families, economist Eric Pichet estimates that the French government lost twice as much revenue as was collected by the wealth tax. French President Macron saw these issues and eliminated the tax in 2017, making good on his popular campaign promise to do so.
Wealth Taxes Aren’t the Answer
Americans are frustrated by wealth inequality, but a wealth tax will not achieve the results that progressives are looking for. Wealth is rarely hoarded by the “elite” — rather, most of today’s wealth is created from scratch by entrepreneurs who grow the economy. Wealth is typically reinvested in companies, leading to more growth and better quality of life for all Americans. Economic growth carries real promise for the average American. Investment in new businesses helps entrepreneurs build great companies, offer better goods and services for lower costs, and create more jobs — everyone wins. But a wealth tax would encourage investment in established companies with liquid stock rather over new ones with illiquid stock. A wealth tax would distort the incentives that foster economic growth, hurting the most innovative part of America’s economy and securing the position of incumbent businesses against newer, more efficient startups. America’s economic trajectory would regress, making everyone worse off.
In addition to causing economic pains, a wealth tax would be a more expensive and needlessly complicated approach to taxation. The costs of implementation and lost revenue from foreigners and citizens leaving the country would likely cause the government to break even or actually lose more money than it collected. In any case, using the tax levers that already exist is a safer and cheaper strategy to raise revenue than a new wealth tax.
Beyond the fiscal issues, wealth taxes simply go against the free spirit of America. Intrusive audits of property would go far beyond looking at spreadsheets — they would entail what is in essence a warrantless search of one’s home. The prospect of such incursions by government agents should be unacceptable to every American. They certainly are unacceptable to me.
I am an entrepreneur, an investor, and above all, a proud American. I care deeply about my country. I have worked hard building civically minded companies, many of which have been very successful. I use the wealth that I created to search for solutions to America’s toughest challenges. America needs effective solutions to the problems that working- and middle-class Americans face, like lowering housing costs through more development and reducing prices by eliminating crony capitalist protections on inefficient industries. But a wealth tax would not help Americans. Instead, a wealth tax would stomp on the liberties that make America exceptional and erase the essence of our republic for the immoral purpose of tearing down the success of others. I could not stand for such a reality. While I am confident that our constitution and courts protect us from this invasive, destructive idea, both political parties should oppose wealth taxes and focus on policy that actually helps the least well off.