America does not have an income inequality problem so much as it has a wealth inequality problem. The top 1% make about the same total income as the bottom 40% combined, which is significant, but it is nothing compared to the wealth gap.
The top 1% have 139x as much wealth as the bottom 40%.
So, why are income and capital gains tax rates based on income, not wealth? This is an outdated and oversimplistic way to ballpark wealth, and modern technology makes it much easier for track wealth now than in the past.
If we want to devise a more sensible tax system, we should strongly consider basing income and capital tax rates on a metric I will call Liquid Net Worth, instead of the traditional “taxable income”. This ensures that tax rates are assessed on a more full picture of someone’s financial situation, not just their year-to-year income.
This idea is a work in progress and would surely create some unintended consequences, so I look forward to your thoughts and comments. I would add that it is important to remember that our existing tax laws have plenty of unintended consequences of their own.
Liquid Net Worth would be defined as the sum of:
- Taxable income for that tax year
- Cash & cash equivalents
- Publicly traded stocks and bonds
- Any positive net real estate assets (e.g. if you have $300k in equity, $200k in debt, this counts for $100k. If you have $200k in equity and $300k in debt, this counts for $0.)
Your Liquid Net Worth would be calculated (and easily verified by the government because your social security number is attached to all these assets), and from this calculation, you would figure out your marginal income tax and capital gains tax rates.
Tax rates would be stretched out of a much wider range, moving from the current structure for a single person filing:
|Income Tax Rate||Taxable Income Bracket||Capital Gains Tax Rate|
|10%||$0 to $9,325||0%|
|15%||$9,325 to $37,950||0%|
|25%||$37,950 to $91,900||15%|
|28%||$91,900 to $191,650||15%|
|33%||$191,650 to $416,700||15%|
|35%||$416,700 to $418,400||15%|
To an income tax structure like this (these are sample numbers), where rates are based on Liquid Net Worth (with the caveat that these numbers would need to add up in a way that funds the government):
|Income Tax Rate||Liquid Net Worth Bracket||Capital Gains Tax Rate|
|10%||$0 to $30,000||0%|
|20%||$30,000 to $100,000||0%|
|30%||$100,000 to $500,000||0%|
|40%||$500,000 to $5,000,000||10%|
|50%||$5,000,000 to $20,000,000||25%|
For example, a 30 year-old who makes $80,000, but still has $40,000 in student debts and virtually no savings would only pay a marginal income tax rate of 20%.
A different 30 year-old who makes $80,000, but has $1m of illiquid equity in the small business he started or invested in, would also only pay a marginal income tax rate of 20%. It would not be until the potential of this business was realized (either through dividends or liquidity) that he would pay the higher marginal rate.
A different 30 year-old who makes $80,000, but has no student debt and was given a stock portfolio from his parents worth $250,000, would pay a marginal income tax rate of 30%.
A different 30 year-old who makes $80,000, but has no student debt and was given a stock portfolio from his parents worth $2,000,000, would pay a marginal income tax rate of 40%.
By basing marginal income and capital gains tax rates on Liquid Net Worth, we will be able to accomplish a few things:
- Create a more economically mobile and anti-fragile system – tax people less when they are trying to pay down debt and build up their net worth. Make it easier for those at the bottom to improve their lot and make saving and investing cheaper when you are poor.
- Tax people more they have reached a point where they can bear the burden – which has much more to do with Liquid Net Worth than taxable income.
- Encourage investment (especially by the wealthy) in “illiquid assets” – like small businesses and startups, which are job-creating investments, as opposed to investment in “liquid assets” like stocks, bonds, and income-producing real-estate, which are lower-risk and generally not job-creating.
- Encourage immediate consumption by the wealthy by making the marginal growth of huge wealth more expensive.
I imagine there would be plenty of downsides/adjustments to this. Debt based real-estate speculation would increase, while stock prices would decrease. Liquid net worth would be calculated at the end of the year, which could encourage all sorts of weird behavior. Altogether though, I think this is a more logical system than the one we presently have.
Would love to hear people’s thoughts.