There have been many recent proposals to tax the wealth of the very wealthy. Generally, our tax system only taxes income, so, it is hard to think about what it means to tax wealth. For example, a 4% wealth tax seems small compared to, say, a 37% income tax. 4% is way less than 37%! But, how do these numbers really compare? Luckily, there is a way to convert from one tax rate to another. All you need to know is the average rate of return that is earned on the wealth someone owns. For example, imagine someone has An example: Theresa Heinz Kerry is one wealthy person we have the tax return from, because her husband, John, ran for president. On her tax return, she had 5 million dollars of total income, even though she is wealthy. Under some reasonable assumptions about the rate of return on her tax exempt bonds and the dividend yield of her stock, lets assume she had 145 million dollars in wealth. A 4% wealth tax, forgetting about any threshold under which wealth goes untaxed, would cost Theresa about 6 million dollars a year in taxes. So, Ms. Heinz-Kerry would end up paying 6 million dollars in wealth taxes, on nearly 5 million in income on the tax return that was generated from her wealth. So, if you convert her wealth tax rate into an income tax rate, it would be 6 million/5 million, or, 120% tax rate, not to mention the ordinary income tax rate she was already paying. That’s high for an income tax rate!
Abstracting from this example, the simple formula to convert a wealth tax rate to an income tax rate is to take the wealth tax rate, and divide it by the rate of return on the wealth, and, you get the equivalent income tax rate. Ms. Heinz-Kerry was not earning very high returns. Lets say someone was earning a 10% returns on their wealth. Then, a 4% wealth tax rate is like a mere 40% income tax rate (4%/10%), on top of the existing 37% income tax rate, for a total tax on income of 77%. What if someone has a bad a bad year, and, earns 0% returns? Well, the equivalent income tax rate ends up being infinite, which is kind of a high income tax rate. But, you dont stay rich long if you have 0% returns every year. Abigail Disney, a wealthy heiress who is a proponent of the wealth tax, claims her wealth grows by about 6-8% a year. So, lets say somewhere in the 7% range is normal for a wealthy person with only passive wealth. A 4% wealth tax rate then becomes somewhere around a 57% tax rate, on top of the individual income tax rate of 37%, for a 94% rate total. Some people in this country would be perfectly happy with a tax rate of 94% on the income of the wealthy. But, others would not–it does seem somewhat high to me. But, regardless of whether or not you are ok with n 94% tax rate, now that you can convert between a wealth tax rate and an income tax rate, you can at least decide on your own.
