David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: a wealth of state revenue?

The idea of a state imposing a wealth tax is, to put it mildly, controversial. Detractors often argue that if a state enacts a wealth tax, high-net-worth individuals will simply move to a lower-tax jurisdiction, eroding the overall state tax base.

But will wealthy households actually move in response to increased taxes? And could a wealth tax shore up state finances while increasing the progressivity of the tax system?

Professors David Gamage, Darien Shanske, and Brian Galle explore these questions and more in their recently published paper, "Money Moves: Taxing the Wealthy at the State Level." Professors Gamage and Shanske join me now to delve into their findings. David, Darien, welcome to the podcast.

David Gamage: Thank you.

Darien Shanske: Thank you.

David D. Stewart: Darien, why don't you start us off with a brief overview of how a state wealth tax works?

Darien Shanske: Obviously there's some flexibility; there's not just one way to do it. I think the easiest way to get into what we are envisioning is that for about a hundred years, states administered something called the general property tax, which included a tax on intangible wealth as part of property tax. So the idea would be there'd be a small tax on your intangible wealth that you'd pay either at the same time as your property tax or, more likely, as part of when you pay your income tax, and that's the basic idea of building on existing tax structures and concepts.

David D. Stewart: David, how does a state wealth tax differ from a federal approach to a wealth tax?

David Gamage: Yeah. The difference is levied by the state government instead of the federal government. So most viewers are probably familiar with state-level taxes. Most states, not all, have income taxes. Most states, not all, have sales taxes, among other taxes. The federal government also has an income tax, but no sales tax.

From a "why at the state level," as opposed to how does it differ, there are a number of reasons. One reason is for a combination of political reality at the federal level and constitutional issues that exist at the federal level but not state level. It's unlikely in the near future we're going to get anything that we would consider a wealth tax at the federal level, whereas the prospects, at least in certain states, are much more promising.

But also, as a matter of policy, the way American fiscal federalism works and has always worked is that tax innovation often happens first at the states. Before we got the federal income tax, we had state-level income taxes in a number of states that spread from state to state, and we learned how to do income taxes right at the state level. That is allowing states to be "laboratories of democracy," as the phrase goes, one of the values of our fiscal federalism system, but also tailoring local policies to local preferences and local conditions. There's different appetites for different forms of progressive taxation in different regions of the country, and the federal government has to take in the aggregate of voter preferences and realities across the nation, whereas different states can go different ways to reflect their different voters and different economic conditions.

David D. Stewart: So on that question of the activities of individual states, Darien mentioned the property taxes, including intangible property. I come from a state — I'm in Virginia — where we pay personal property tax on cars. So what does it look like overall? How much wealth is being captured by taxation currently at the state level?

David Gamage: We should clarify that the general property taxes Darien were talking about, that's a historic practice. States moved away from general property taxes when we entered the income tax era for a variety of historical reasons, but the argument now is that, just as the economy moved from an old farming base to a labor employment base where the old forms of property taxes weren't working as well for the new forms of economic development, leading to the rise of income taxes, in the last X number of decades, intangibles have massively risen in importance, financial wealth has massively risen in importance, and estimates vary, but most estimates agree that when we're talking about the extreme levels of wealth — you might call supermillionaires, billionaires — income taxes aren't working very well anymore. And that's part of the drive to do something about the failure, for the most part, of existing taxes to well capture the massive new wealth being created, especially in industries where intangibles are important.

Then related to that is the question of, how do existing state tax systems work? And most states' tax systems are regressive, meaning that someone who earns less annual income, or certainly has less wealth, is going to pay a higher percent overall in state taxes in most states than someone with more annual income or wealth. And every state, even California, which has a relatively progressive tax system, that breaks down again when we talk about the superwealthy, especially those who make lots of wealth from intangibles, think Silicon Valley. Famous billionaires who live in California, Mark Zuckerberg, for instance, pay a teeny fraction, relatively, of their wealth as tax as compared to the average middle Californian, who pays a much higher percentage of their wealth or economic income in state tax.

Darien Shanske: So obviously I agree with that. I just want to add, states are also different from the federal government in a couple of ways. First of all, they provide most frontline government services and have balanced budget constraints. And so that means that it's sort of a fixed sum. If people with real property or limited amount of personal property are paying the property tax and funding state and local governments, then they're carrying the load for a certain amount of budget relative to people with much greater wealth and income would.

So there's a question about whether that's fair. It's a question about whether it's efficient, not to capture this new and growing part of the economy. And in light of the retrenchment of the federal government, there's further question about, to the extent of the states and localities are being asked to do more, to what extent should they go back to the well to the same groups that are already overpaying relative to their capacity versus expanding the base? So that's another reason this topic is particularly, we think, urgent.

David D. Stewart: As you mentioned, even in a state such as California, which one would assume would be more progressive than other states, they still have regressive tax systems. So what is driving that as a reality?

David Gamage: By most estimates, California's tax system isn't regressive overall. So we should be clear. Most states have tax systems that are regressive overall, and a lot of that's driven by the sales tax. Sales taxes tend to be very regressive. As a percent of income or wealth, lower- and middle-income state residents tend to pay much higher percentages in sales tax than upper-income [residents], and many states don't have a very progressive income tax system to make up for that.

California does have a very progressive income tax system. So if you're comparing a lower-middle-class individual in California to a middle-class individual to an upper-middle-class doctor or lawyer or somebody with salary income, and even going up to, imagine a Hollywood star that's making a lot of money in salary income, California's state tax system is going to look progressive where most states would be regressive.

Where California's progressivity breaks down is if you start looking at the next level of wealth, or even below that, that has wealth from financial — almost anyone working in Silicon Valley, think anyone working in finance, think those in Hollywood who have money not from movies directly, but from investing in movies or tequila businesses or all the other side businesses that people do. This is where California's income tax and every state's income tax and the federal government's income tax breaks down and is not able to effectively reach most of that economic income and wealth from intangibles. So that's where the progressivity breaks down, even in a state like California.

Darien Shanske: And that's because of the realization rule, just to wrap it up with a bow, that you only have income when you sell something, typically, and so you have a realization event. So the very wealthy don't need to have realization events, therefore they don't have income. And that's true at the federal level, and it's true of states that follow the feds in having the realization rule as part of their income tax system.

David Gamage: So that's where, at the federal level, we often call it "buy, borrow, die," which is coinage of Ed McCaffery of [University of Southern California] Law. The idea is get your wealth from assets or ownership of businesses. If you need money, borrow. You pay no tax. In theory, there's a tax bill that could come due eventually, but if you die before selling that massive amount of wealth, then due to what's called stepped-up basis on death, all that untaxed accumulation is never taxed. And in the paper, we talk about how there's a state-level equivalent of "buy, borrow, or die" to move to Texas or Florida.

If your name happens to be, let's say, to pick a hypothetical name, Elon Musk, and you make hundreds of billions of dollars in a state like California, but you mostly don't take dividends, you mostly get it in the form of appreciation of shares, or if your name is Larry Ellison, to pick another one, and you fund your purchases of Hawaiian Islands by borrowing against your appreciated shares, you can pay almost nothing in tax, relatively, to California. And then you don't have to wait until death. You can move to a state like Texas or Florida — or Hawaii has an income tax, so it doesn't work quite as well, but it has nice weather — and escape California tax forever.

Darien Shanske: To build on that, that is the distinction between mobility and exploitative mobility. If somebody wants to move to get a different job, different opportunities, that's what our federal system is supposed to do and that's fine. Exploitative mobility is when you've really benefited from the goods and services of a location and you've really underpaid for them and you have acted in order to continue underpaying for them, as in the examples David just went through.

David D. Stewart: So let me first ask, what is your case for states should be instituting some form of wealth tax? What is the strongest argument in favor of doing that?

David Gamage: If you think tax systems at a state level should be progressive and not regressive, we argue, one, there's lots of reasons, not just one reason, but a confluence of reasons why they should be. That's for fairness reasons; it's for funding state programs, which states have substantial funding requirements, as Darien pointed out; and it's also for efficiency reasons. Even if you have mixed feelings about progressive taxation overall, by taxing certain forms of wealth very highly — salary income — and other forms of wealth minimally — financial income — you create lots of incentives for economically harmful forms of tax planning to turn salary income into minimally taxed income.

So lots of reasons why in the literature, and in our view, a state should aim for a somewhat consistently progressive tax system. And then the argument is then how to do it. In the paper, we say that something that we would call a wealth tax, which we include in that reforms to the income tax to address the realization requirement, often called mark-to-market, but something in this family of reforms is needed to address the failures of state tax systems to effectively reach financial wealth.

David D. Stewart: Is there an argument to be made that this is a tax base that is better suited to the states, or is it something where the federal government could step in and tax the same base?

David Gamage: The federal government could step in and tax the same base if it had the political will to do so. There's some constitutional hurdles that, in my view, at least, this is different work, are overcomeable. But going back to the earlier discussion, there's no reason to think the federal government is going to effectively tax at the moment. But American fiscal federalism works differently than — there are some other countries that have similar fiscal federalism arrangements, like Australia is often cited, but is not the norm. And the American fiscal federalism system was designed from the beginning for states to play a going-first role, at least a lot of the time, and that's how this country has always worked to a substantial degree.

Again, the notion that the federal government is just going to solve problems for the states, if we had followed that route, we probably would never have gotten a federal income tax. The federal income tax was designed based on the lessons we learned from state-level income taxes, and that's just one of many such examples. There's all sorts of reasons, we think, for at least certain states to implement policy without for the federal government, and we think that's not only consistent with the design of American fiscal federalism, it's the intended way that American fiscal federalism is supposed to work.

Darien Shanske: So I would just build on a little bit and distinguish between two arguments. There's one argument, "Well, should there be a federal wealth tax? Wouldn't that be a good thing?" And I think the answer is yes, it would be a reasonable thing, but given that it's not going to happen, should states act? And you think about, there are certain superhigh-value public policy reforms, universal pre-K, universal free lunch. Should those ideally be funded centrally by the federal government? Sure. Would it be great if there was a wealth tax that was funding these things? Definitely, at the federal level. Are they happening? No.

So the question is — every cohort that doesn't go through universal pre-K that has universal lunch is hurting. And so the question is, should the state step in, given that these are high-value interventions, and impose their own wealth tax in order to do them? That's one question.

Then there's a separate question of, if the federal government got its act together and did have a wealth tax, should states, at least certain states, have wealth taxes anyway? And I think the answer there too is yes because, again, why should people who have real property be the only ones paying a tax on their wealth and much more wealthy people not paying a small tax on their intangible wealth as well?

David D. Stewart: Now, David, you mentioned at the federal level that there might be a constitutional question. Could you tell us about where that comes in?

David Gamage: Sure. There is a distinction in federal constitutional law between direct taxes and excise duties and imposts, which are sometimes called indirect taxes. Now the word indirect tax isn't in the Constitution. That's just a label for excise duty and impost. The classical example of a direct tax is a property tax, like every state has at a local level typically on real property, right? If the federal government was going to try to levy a federal-level real property tax, which by the way, we had multiple times prior to the Civil War, that would be subject to the rule of apportionment.

By contrast, every existing federal tax is in the excise duty impost category, which is subject to the rule of uniformity. The federal government hasn't tried to do a direct apportion tax since the Civil War, and there's extra hurdles in doing a direct apportion tax. We could get into that if you want, but it would be a pretty long tangent. The 16th Amendment resolved disagreement in constitutional law about whether a federal income tax would have to be a direct apportion tax, like the property tax, or would be a excise duty impost, subject to the role of uniformity. After the 16th Amendment, there's a question of a federal wealth tax, not a property tax, or a mark-to-market reform to the income tax that — we have mark-to-market provisions in the income tax for certain types of assets that don't wait for realization, but they're fairly limited.

But a comprehensive mark-to-market reform, like President Biden's proposed billionaire minimum income tax, we don't have clarity in federal constitutional law whether those would be subject to the role of uniformity or the role of apportionment. And in the recent Supreme Court case Moore v. United States, the majority opinion does not answer the question, but most of us think that a fair reading is that there's a majority of justices who would require apportionment for a federal wealth tax or a mark-to-market tax that was comprehensive, but with a lot of ambiguity about what that means, etc.

So that's the constitutional hurdles: one, some lack of clarity and uncertainty about which rule applies, and then if the rule of apportionment applies, then there's extra hurdles on how to do apportionment, which is something we haven't done since the Civil War. All of that federal constitutional law only applies to federal-level taxes, right? Every state has a real property tax, which would clearly be an apportioned direct tax at the federal level, or at least it's the archetype of what we think would be in that category. None of this is clear.

And why do we have these different rules? There's disagreement, but most of the literature suggests it's sort of to protect states, right? So this is federal constitutional law designed to protect states in some ways, and thus doesn't apply at the state level. Now, some states have their own constitutional rules, which put limitations on certain forms of wealth taxes, but those are located in the state constitutions, not the federal Constitution, and state constitutions vary.

David D. Stewart: Given the past where some states have had these general property taxes, what leads them to not have them these days? I know that there was a shift away from them, but why give up on them entirely up till now?

David Gamage: Yeah, you have to understand how we do taxes in this country has changed a lot. In the late 1700s, early 1800s, you didn't have the internet, among many, many, many other things we didn't have. How do you value property? Well, sometimes it meant someone on a horse riding out to the locality, checking it out, and then riding back on a horse, and then — you can imagine. So the economy has transformed a lot. No taxes worked well in a modern sense, with information reporting and modern technological apparatuses that make tax administration efficient, in the late 1700s, early 1800s, and property taxes and general property taxes were messy, but so was everything else.

There was a thought, mostly a consensus in thinking, that as we learned how to do income taxes reasonably well in the early to mid-1900s, that we didn't need these general property taxes anymore because they were messy. We hadn't learned how to do them very well. And for the new forms of wealth that were being created then, the income tax was seen to work sufficiently better, that there wasn't a need for these old, what were viewed as outdated, taxes. But again, now we're in a new era. Now we're in an era where financial wealth from intangibles is dominating the international scene in terms of increases in economic activity, and the traditional realization-based income tax doesn't get at this very well.

So academics have been debating for decades, what should we do? There's certainly not a consensus. I think there's a consensus that there is a problem. I don't think there's a consensus about what should be done about that problem. But in this paper, we, building on a large literature, with many others writing on similar topics, argue that at the U.S. state level in particular, if we want to solve this problem — and we argue that we should solve this problem because it creates lots of harmful economic effects — that some variation of a state wealth tax or mark-to-market income tax reform, something in that family, is needed to be part of the solution set.

David D. Stewart: What does the current opposition to a wealth tax look like at the state level?

David Gamage: People don't like to be taxed. And especially the people who would be subject to these taxes, which would be largely wealthy people, have large voices, right? There are a lot of think tanks, media apparatuses, political organizations that reflect an antitax agenda generally, "let's not tax the wealthy more" in particular. And then there's also disagreements among well-meaning economics and policy experts that are on what are the economic effects, how big a problem is, different types of mobility, what are the effects on investment in business activity, and we cover the literature on these topics in the paper and in other scholarship.

Our view is these types of tax reforms would do a lot more good overall across a multitude of dimensions, but people can disagree with some of those readings of the literature in good faith. Some of this is, the literature suggests answers, but doesn't suggest it conclusively because we have limited data on some of these questions.

Darien Shanske: And this core intuition that we address, which is that rich people will just move, the question is we have limited information what that would look like or could look like, and we're skeptical. That's true, right? That's the big distinction we're making, that part of the nice thing about being rich is you live where you want and you stay in the community you want to stay in, and that's what the data — again, nothing's perfect, but — indicates that that would generally be the case.

Now, if somebody comes and says, "If you give me just a little bit of money, I can save you a hundred times that in taxes. Fill out this paperwork, create this trust, do this thing," well, then a certain number of people might well do that, but that's a different kind of mobility, right? That's paper mobility, and paper mobility, that's something that lawyers and legislators can work with in terms of reducing. And so the main headline numbers about, "Oh, there'd be all this mobility," is a kind of mobility that could be tamped down. And the kind of actual moving, we think, is likely to be much less, based on everything we know about the behavior of very wealthy people.

David Gamage: Yeah, there's a robust literature on these questions from prior looking at tax changes and different tax situations in the United States and abroad, and there's just, as we review in depth in the paper, there's large evidence suggesting that real mobility responses are very small, or relatively small. That means they're measurable sometimes, but they're small compared to revenues.

And sometimes large responses we see are paper mobility, as Darien explains, where if it's easy to set up an out-of-state trust to escape tax, people do that. In Spain, where they have regional wealth taxes at much higher rates than we're talking about at the U.S., for a while you could escape your province's wealth tax by having an extra house in Madrid and spending a few days a year there, and people did that. When those loopholes were shut down, we see very, very small real mobility responses.

David D. Stewart: That gets us to what you're proposing in your paper. Could you walk us through how you would go about taxing wealth at the state level?

David Gamage: We present multiple options. The argument is that something in this family of reforms is needed and would be desirable, not a specific plan that we're suggesting is the plan. Darien, did you want to jump in there?

Darien Shanske: Oh, no, no, that's exactly right. Obviously one option would be just to loosen or eliminate the realization rule so it's part of the income tax. We'd say, "Well, look, you may have all this money and unappreciated gains. We're going to tax that." That's one kind of family of solution. Or a solution more continuous with the general property tax said, "You have this intangible wealth. We're taxing 1 percent of your intangible wealth, just like 1 percent of your tangible wealth," the same kind of thing. And since most intangible wealth is our public assets, it's not going to be that difficult to give us the number.

David D. Stewart: And how would you deal with that mobility question of, let's say someone accumulates a large amount of wealth in a state like California and then moves to Texas where maybe a wealth tax doesn't exist?

David Gamage: The main answer is we don't think it's that much of a problem, based on all the literature and studies available. That said, we don't think it's not something to be addressed, and we have some design elements in the paper. For a mark-to-market reform, there's a question, if you built your wealth, say, in Washington state, where there's no income tax, then you move to California, and then you move to Texas, what portion of that should be attributed to California versus the other states? And we have some suggestions to make that work.

For a wealth tax, take the property tax that everyone is used to on houses, that in Virginia and Missouri, we also have on vehicles, and expand it to financial assets of the very wealthy. Now, if somebody moves, say, from Washington state to California to Texas, what portion of that wealth [would] be taxable? And we argue for a phase-in, phaseout rule, the notion being if you move to California from Washington state and you built up $100 million in wealth in Washington state, California shouldn't tax it 100 percent in year 1. It should phase in over time to reflect the fact that that wealth was largely created in Washington state. But similarly, symmetrically, if you move from California to Texas, California should phase out that taxing right over a period of years.

But these are refinements on the basic idea that we don't think are necessary for these forms of taxation to work, based on the existing literature. They're just ways we think these forms of taxation can work better.

Darien Shanske: Worth pointing out as a matter of federal constitutional law, apportionment is subject to rational basis review. And this kind of temporal apportionment is something we do with athletes where they're only in certain places. We do it with people who earn money in stock options and then they realize them much later; you have to figure out where the appreciation happened and stuff like that. And again, there's going to be a temporal component, again, under certain state laws and regulations. So our proposal is continuous in this area with current practice and consistent with current law, but I would emphasize what David just said is that the big headline is most people are not going to make real moves in response to attacks like this.

David D. Stewart: Another question that occurs to me is the sort of compliance burden that might be created by a tax along these lines. Now, first of all, what sort of threshold are you looking at before this burden comes into place, and then how much of a compliance burden do you see this sort of tax having?

David Gamage: We view this as a tax on the very wealthy that doesn't make sense as a tax on the middle class because the middle class are already paying high tax rates in existing taxes, and the compliance burden would be excessive compared to the benefits.

Now, what's an appropriate threshold? I think in Vermont, which explored some of these ideas, we discussed having a threshold in the $10 [million] to $15 million level of wealth, and that's about as low as we could imagine it. To make that work, we had some extra exemptions for — you could exempt $1 million of various certain types of assets that are harder to value. Most states, we're thinking more like $25 million or above in wealth. That's about where, if you look at just the populations, that tends to be where the existing income tax starts breaking down with respect to large numbers of people where financial intangible wealth becomes big as a source of economic income or wealth.

All forms of taxes have some form of compliance burden. We have some refinements in this in our other research to make it work better. For instance, the federal estate tax that exists in some states is outdated and could be done better. You could just extend estate tax evaluation mechanisms to a general wealth tax, and we don't think that would be disastrous, but we think we can do a lot better than that through modern forms of tax administration technology. And this could be a long conversation on all the ways we think that should be done. But bottom line, when you're talking about a population that already has accountants, the additional administrative compliance costs as compared to revenue at this level of wealth, additional administrative compliance costs are relatively small.

Darien Shanske: I would just add to that, if you think about a lot of these wealthy people, not only have accountants and they're making lots of money through passthroughs and partially have to deal with the partnership tax regime, the idea that their accountant who's already dealing with their allocative shares of dozens of partnerships with all these different layers can't also figure out, as part of their practice, the public value of their assets and figure out the number for that. It's a cost, but it seems a non-crazy cost for a sophisticated taxpayer to bear.

David D. Stewart: Do you foresee any legal or potentially constitutional questions to be raised in general? If, let's say, California starts to institute a wealth tax, is there some avenue that might create legal questions for a wealth tax?

David Gamage: As a general level, no. States had general wealth taxes, general property taxes, which were early versions of not very well, by our view, designed wealth taxes. Our constitutional structure makes it clear that states can do that. Now, as to specific design elements, of course. There are a lot of very well-funded antitax groups. They will challenge specific design elements.

In California, this would presumably be done as a constitutional amendment. If it weren't, then there'd be California constitutional challenges. And different states have different constitutional restrictions at the state level, but that's a state-by-state analysis. So, again, as a general high-level matter, a challenge saying states can't do this sort of thing, there's no plausible argument. As a challenge to specific elements incorporated in any specific bill, I expect that there would be some litigation.

David D. Stewart: All right, so I guess my final question for you is just more of a, how likely do you see states taking on wealth taxation over the next, let's say, decade?

Darien Shanske: I hate to prognosticate on politics. I would say that what seems difficult to imagine becomes much more plausible under extreme stress. To the extent that the federal government is retrenching and putting a lot more burden on the states, as well as even further throwing windfalls at the ultrawealthy, I would think that the odds are getting higher. Higher than what, I'm not sure, but higher. The need has only become more urgent across multiple dimensions.

David D. Stewart: Well, this has been a very interesting discussion of a fascinating aspect of taxation. David, Darien, thank you for being here.

David Gamage: Thank you. It's been a pleasure.

Darien Shanske: Really been a pleasure. Really appreciate the opportunity. Thank you.

David D. Stewart: That's it for this week. You can find me online @TaxStew, that's S-T-E-W, and be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.

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