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How to model a wealth tax

I just came across this post by Paul Graham called, “modeling a wealth tax.” It’s from last year, but it recently resurfaced. In it, he paints a scenario. Let’s say you’re a successful entrepreneur in your twenties (i.e. you make some money) and then you live for another 60 years. How much of your stock would the government take with various wealth taxes?

With a 1% wealth tax, it means that you would get to keep 99% of your stock each year. But assuming the wealth tax gets applied every year, you would be left with 0.99^60, which equals 0.547. Put more simply, a 1% wealth tax would mean that over the course of the 60 years after you built your company, you would be giving the government 45% of your stock.

How did this number get so big?

The reason wealth taxes have such dramatic effects is that they’re applied over and over to the same money. Income tax happens every year, but only to that year’s income. Whereas if you live for 60 years after acquiring some asset, a wealth tax will tax that same asset 60 times. A wealth tax compounds.

Of course, Paul also points out that giving away a portion of your assets each year doesn’t necessarily mean that you’re becoming net poorer, so long as your assets are increasing in value by more than the wealth tax rate.

Still, these are massive numbers. A 2% wealth tax would translate, over this same 60 year time period, into the government taking 70% of your stock. A 5% wealth tax works out to 95%. For more on this, check out Paul Graham’s post.

6 Comments

  1. Dean Goodman

    Hi Brandon, I read your blog most days and find it interesting. However, today I was disappointed. Wealth taxes like all taxes are not ‘the government taking you money’. Governments exist so that we have a functioning society, hopefully an equatable one. Taxes are what pays for that society. When you discuss a topic like taxes and imply they just take your money it leaves the impression they take it for themselves, rather than the truth which is they tax people so that we have hospitals, school, roads, a military etc. A working equitable society. It’s only appropriate that the wealthier you are the more taxes you should contribute. My father in law always said if you owe taxes it’s because you made a lot of money and you should be happy to pay them.

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  2. Jakob

    45% sounds like a lot until you compare it to income taxes, which are in the same order of magnitude for high earners. Of course there’s the question of double taxation, and that’s not to be discounted either. But if the government wants to go for some of the inherited wealth of trust fund kids like the Donald or the Justin, who don’t otherwise have to make a lot of regular income because it’s all coming from capital growth, then it better add up to something non-trivial. Perhaps it can be combined with a tax cut for regular income, to smooth out the loss of investment potential for people who aren’t already very wealthy.

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  3. Jakob

    I also thing governments would likely leave registered accounts like RRSP & TFSA, or in American terms 401k & Roth IRA, untouched. Which regular people already struggle to max out, and even for $150k earners such as Yours Truly (that’s somewhere in the top 5% income distribution) it ends up making a very sizeable chunk of your portfolio. When you have $600k in registered accounts and $600k in taxable accounts, suddenly 45% become 22.5% and that’s already less tragic. So the people who will be disproportionally hit by a wealth tax are going to be people with significant savings outside of registered accounts, which… tends to be wealthy people, in particular those without the RRSP limit that regular high-income people earn for their regular non-investment income.

    I’m scared too about governments getting it wrong, specifically as an aspirational FIRE saver, but I also think there’s a lot of potential there. And in the end, the beancounters and policy experts generally make sure that whatever scheme they put in place will generally work out for even the top end of the “middle class”. The biggest risk, as always, is that all of our rich people emigrate to some other country and deploy their wealth there instead of within the country. So a unified initiative would be nice, but of course that’s not going to happen. As a result, I figure whatever governments put into place is more going to be a minor inconvenience than a ruinous event.

    (Personally, I still think that inheritance & gifting taxes are the most promising way to redistribute the centralized wealth – let people get rich during their lifetimes, but don’t let them build dynasties and pass on most of their wealth to the kids. Of course, as the aforementioned Donald and his dad have shown, it’s still possible for the uber-rich to find ways to find loopholes in the system. Making a bullet-proof system is hard.)

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  4. daniel b

    i don’t think the problem is not so much with the morality of it, as with the practical considerations. So, you have a private company that is the large majority of your net worth and relatively low liquidity (nb, oftentimes investors in your business have restricted you selling your interest for cash, so this can be a structural issue). Your valuation goes way up, and you get a huge tax bill. How do you pay it? I guess you have to continuously liquidate your interest to pay the tax bill thereby reducing your ownership and potentially giving up control. Further, whatever funds you do have, which could be used to fund the expansion of the business, are instead going to pay the wealth tax bill each year.

    Same problem with real estate. You buy a building that goes up dramatically in value, but you don’t have a lot of liquidity. Now you have a huge tax bill with no obvious mechanism to pay it.

    How do you do valuations on an illiquid business or asset? Anyone who works in these sectors knows that appraisals and valuation techniques are highly subjective.

    Lastly, i think this is a stupid solution to a problem that has an otherwise elegant and proven solution – raise the actual, effective income tax paid by corporations and individuals. One of the reasons the valuations are so insane is because the effective tax rate on wealthy people and corporations is so low. Raise that, and the valuations would come back to earth, and tax revenues would go up.

    On many public policy issues i try to keep an open mind, i think this one is just stupid and impractical…

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