May 7, 2021

Five Different Ways of Raising Taxes on the Wealthiest Americans

The administration and Congress are debating a range of new proposals under the banner of “infrastructure” while considering ways to pay for, or offset, that spending through the tax code. With the national debt at $28 trillion and growing, paying for priorities is a critical part of building a more sustainable fiscal outlook — and many options are available.

Well-designed tax policies could help improve our fiscal outlook while also addressing rising concerns over income and wealth inequality. Proposals to increase taxes on wealthier households have generally taken one or a combination of these five approaches:

  • Creating a wealth tax
  • Adjusting how capital gains are taxed
  • Increasing marginal tax rates on high-income earners
  • Raising the estate tax
  • Increasing or eliminating the cap on payroll taxes

Keep reading for an overview of each approach, common criticisms, and the potential for raising additional revenues.

Wealth Tax

A wealth tax would impose a levy on an individual’s or household’s net worth above a certain threshold. Most proposals recommend implementing this new form of taxation as an addition to our current tax system rather than as a replacement for features such as the income tax. Proponents highlight its potential to enhance the tax code’s progressivity and its ability to raise revenues to reduce the deficit or fund spending proposals.

For example, a 2 percent tax on net worth above $50 million, with an additional 3 percent tax on net worth above $1 billion, would yield a $79 million wealth tax bill for an individual with a net worth of $3 billion (see table below).

Example: 2 percent wealth tax with a $100 million exemption threshold on an individual with $3 billion in net worth

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Critics of a wealth tax question its constitutionality; they also argue that a wealth tax would be difficult to enforce, resulting in lower additional revenues than projected. Those concerns are amplified when examining the varying levels of success of certain European countries that have implemented versions of a wealth tax.

Revenue estimates diverge based on assumptions about thresholds for applying the tax, measurement of assets, and the ability to evade the provisions. Estimates of potential additional revenue from a 2 percent tax on net worth above $50 million, with an extra 3 percent tax on net worth above $1 billion, range from $366 billion to $2.96 trillion over 10 years.

Take a deeper dive on the wealth tax

Capital Gains Tax

The capital gains tax is an existing levy on income received from the profitable sale of a capital asset — such as stocks, bonds, or real estate. That profit, known as a capital gain, is generally taxed at a lower marginal rate than ordinary income. Capital gains from assets held for more than a year are taxed at rates of 0, 15, or 20 percent depending on an individual’s income; profits from assets held for less than a year are currently taxed at the same rate as ordinary income for individuals.

Higher-income households derive a larger share of their income from capital gains. In 2017, households in the top 1 percent of earners received 26 percent of their income from capital gains compared to less than 1 percent of income for households in the bottom 80th percentile.

High-income individuals receive a greater portion of their income from capital gains

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In 2020, revenues from capital gains totaled $186 billion, or 11.6 percent of total individual income tax revenues.

Proponents for increasing the tax’s burden note that it could raise additional revenues and promote a more equitable tax system. Critics of the capital gains tax argue that lowering the tax rates could increase economic growth and encourage entrepreneurship.

Proposals related to capital gains include:

  • Increasing the capital gains tax rates: The Penn Wharton Budget Model (PWBM) estimated that increasing the top rate from 20 percent to 24.2 percent would increase revenues by $66 billion over 10 years.
  • Removing the ‘step-up’ clause for capital assets bequeathed after death: Property or stock bequeathed to heirs is taxed on the appreciation in its value after it is transferred to them, not from the original date of the investment, effectively reducing an heir’s tax liability. According to the Tax Foundation, eliminating that clause would increase revenues by $116 billion over 10 years.
  • Taxing capital gains on an accrual basis: If assets held by just the top 1 percent were taxed annually based on their current value, it would raise around $1.7 trillion over 10 years, according to a study from tax policy experts at New York University
  • Indexing capital gains for inflation: Unlike the other proposed changes discussed here, indexing would effectively reduce capital gains taxes. PWBM estimated that this could decrease federal revenues by $102 billion over 10 years.

Read more about how the capital gains tax works

Marginal Income Tax Rates

About half of federal revenues stem from the individual income tax. That tax is based on a set of tax brackets and marginal tax rates.

A marginal tax rate is the rate applied to specified ranges of taxable income. There are seven marginal tax rates in the current individual income tax system. Taxable income ranges are referred to as tax brackets and those brackets vary according to filing status.

The Congressional Budget Office estimated that an increase of 1 percent on the two highest existing brackets would increase federal revenues by $123 billion over 10 years. There are also proposals to add new tax brackets for top earners. The Tax Foundation estimated that adding a tax bracket for income over $10 million at a marginal rate of 70 percent would raise $291 billion in additional revenues over 10 years.

Skeptics assert that higher-income taxpayers will use their resources to avoid taxation through clever accountants and tax attorneys. Furthermore, since the top 1 percent earn a significant portion of their income from capital gains (which are taxed at lower rates), an increase in marginal tax rates on wages and salaries might not be that impactful.

Learn more about marginal tax rates

Estate Tax

The estate tax is a levy on assets, including real estate, stock, and cash, that are transferred upon the death of an individual. In 2021, the federal estate tax rate will be 40 percent and will apply only to estates valued above $11.7 million — that threshold is referred to as the exemption amount. The Tax Cuts and Jobs Act set the exemption amount at more than twice its previous level, but that provision expires at the end of 2025, at which point the exemption amount will return to $5.49 million (adjusted for inflation thereafter).

Estate taxes constitute less than 1 percent of total tax receipts, but several proposals suggest making adjustments to increase revenues.

Proposals include:

  • Replacing the estate tax with an inheritance tax based on how much a person receives rather than how much a donor gives or bequeaths. This method is already in place in several states.
  • Tightening up loopholes — such as special trust arrangements or valuation discounts — that allow wealthy individuals to lower their tax liability.
  • Returning to prior parameters — for example, in 2002, the exemption amount to the estate tax was $1 million and the rate was 50 percent. In 2011, the threshold was $5 million and the tax rate was 35 percent.

Opponents argue that the tax provides a disincentive for asset accumulation, thereby reducing the amount of savings and investments and therefore restraining economic growth.

Get more information on estate taxes

Payroll Taxes

More than 35 percent of revenues collected by the federal government take the form of payroll taxes, which are paid by both the employee and employer to fund social insurance programs like Medicare and Social Security. The Medicare payroll tax is levied on all income; both employees and employers contribute 1.45 percent of workers’ earnings to the program. However, the Social Security portion of the tax is levied at 6.2 percent on income only up to a certain amount. That tax cap automatically adjusts annually, with the 2021 maximum set at $142,800.

Economists consider the Social Security tax to be regressive because as an individual’s earnings increase above the cap, the portion of total income that is taxed decreases. Each year, 6 percent of the working population earns more than the taxable maximum.

High earners pay a lower proportion of their income in payroll taxes

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Proponents of increasing or eliminating the Social Security tax cap argue that it would strengthen the Social Security trust fund and make the tax less regressive. An analysis from the Congressional Budget Office estimated that phasing out the tax cap could boost revenues by up to $1.2 trillion over 10 years.

Opponents argue that increasing or removing the taxable maximum would weaken the correlation between the amount individuals pay in Social Security taxes and the amount they receive from the program during retirement.

Read more about how payroll taxes work

Conclusion

As lawmakers consider a range of ambitious new proposals, they have many options for offsetting that spending by raising new revenues, including approaches that may also reduce income and wealth inequality in our nation. Ultimately, to make our budget more sustainable over the long term, we need to not only pay for new initiatives but also address the structural issues of our debt.


Related: Infographic: How the U.S. Tax System Works


 

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