Eight States Have Joined Forces to Raise Taxes on America's Wealthiest

Tomorrow morning, I’ll join CNBC’s Squawk Box to talk about a new effort to tax the rich. The segment will air at 7:50 ET.

I’m not referring to the so-called billionaire tax that President Biden called for in his State of the Union address last week. That almost certainly isn’t going anywhere. I’m talking about a state-led effort to raise taxes on multimillionaires and billionaires living in California, Connecticut, Hawaii, Illinois, Maryland, Minnesota, New York and Washington.

Legislators in these eight states say they’re looking for ways to deal with some of the inequities in the federal tax code. They point to the fact that income from investments gets preferential treatment versus income from labor.

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And they complain that the rich have avoided “paying their fair share” by exploiting the tax code to—legally—avoid paying up to $163 billion in taxes each year.

The Inflation Reduction Act, which includes $45.6 billion for beefed up enforcement at the IRS, would deal with some of the problem, but it still leaves a lot of money on the table. Money that lawmakers in these eight states would like to tap in order to fund investments in their communities.

Unlike the federal government, individual states really do need to “find the money” to pay for their spending. And since more than 60 percent of the nation’s wealth resides in these states, it’s easy to see why lawmakers have focused on their high net worth residents. It’s a bit like asking the notorious Willie Sutton why he robbed the bank.

Each state has a slightly different plan to capture some of that money. As The Washington Post put it:

Some of the state bills resemble the “wealth tax” that Sen. Elizabeth Warren (D-Mass.) pitched during her 2020 presidential candidacy. It’s a form of taxation never before attempted in the United States, in which very wealthy people would have to pay taxes annually on assets that they own, rather than just their income that year. Other bills focus on raising money from more conventional forms of taxation, including capital gains taxes and estate taxes.

I have no idea how many of these states will be successful, but I wouldn’t be surprised if some of them manage to pass legislation that boosts taxes on their wealthiest residents. Of course, many states already have estate taxes or inheritance taxes so taxing wealth isn’t entirely new, but some of the more novel proposals have already run into court challenges.

In addition to constitutional objections, critics maintain that the wealthy will simply move to more tax-friendly states.

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And there are plenty of them. Right now, at least 24 states are considering legislation that would move them in the opposite direction, reducing personal income tax rates, enacting flat taxes, cutting property taxes, and so on.

Of course the argument is always that cutting taxes will make states more attractive places to work and do business, which ultimately means that states will have even more revenue to work with. In reality, as we have seen time and again, things tend to work out differently.

[A] decade ago in Kansas, after Republican Gov. Sam Brownback instituted tax reductions on the wealthy that [Art] Laffer hailed as a “revolution in a cornfield,” state leaders had to impose severe cuts to education and infrastructure as they scrambled to close a massive deficit. The state legislature then reversed the tax cuts.

“It turned out pretty badly,” said Bruce Bartlett, a former domestic policy adviser to Reagan and a Laffer critic. “It lost so much revenue that the same people who passed the tax cut had to pass an increase to keep the whole financial enterprise afloat. It shows the lack of seriousness that underlies all of Arthur’s analyses.”

I was living in Kansas during Brownback’s tax-cutting disaster, and I had two kids in public school when things started to get really bad. As Heather Boushey explained:

[T]he experiment was such a failure that his party turned against him. In 2017, the Republican-dominated legislature, overriding the governor’s veto, rolled back the tax cuts.

We moved to New York that summer.

In general, I’m sympathetic to what these eight states are trying to do. They’re looking for a way to tackle problems—like the lack of affordable child care and homelessness—in their communities in a way that is politically popular. And polls show that there is substantial bipartisan support for raising taxes on the rich.

Recent polling indicates a huge spike in voter appetite to tax wealthy Americans. Throughout the 20th century, Gallup polling found that less than half of all Americans favored taxing the wealthy, before a slim majority — just 52% — turned in favor of a wealth tax in 2012. But a Vox/Data for Progress poll in 2021 found 71% support for raising the taxes of the wealthiest 2% of Americans, while a Reuters poll from 2020 found 64% support for a wealth tax — a slight increase from a 2019 Brookings poll that found 61% support for taxing the rich.

I do wish that Congress would do more to clean up the federal tax code, which is a huge mess and a big part of the reason that income and wealth inequality have risen so sharply over the decades. Enforcing the laws that are already on the books would deal with some of the problem, but there are hundreds (if not thousands) of ways that Congress could make the tax code more efficient and more equitable. 

Ending the step-up-in-basis and doing away with (or substantially limiting) asset-based lending would help. So would closing the carried interest loophole. And it makes no sense—in my view—to retain the preferential treatment on capital gains. The bottom 80% of households only get about 1% of their income from capital gains, whereas the top 1% get more than 20% of their earnings from capital gains. 

By making changes like these, Congress could address some of what lawmakers in these eight states are hoping to achieve in terms of tax justice. But they would not—by themselves—result in better public services at the state level. For that, these states need more money to spend.

Nothing that’s being proposed by these eight states would substantially reduce income and wealth inequality in America. That’s not to say that it wouldn’t help. It would slow the rate of growth (of wealth and income) among a small segment of the population in exchange for upgrading education, child care, housing, transportation, etc. within these states. And that would make an enormous difference in the lives of tens of millions of Americans.

As an alternative, the federal government could relieve more of the strain on families by reinstating the expanded Child Tax Credit (CTC), passing Medicare-for-All or making public colleges and universities tuition-free. But none of that is happening anytime soon.

Hence the Willie Sutton solution.

1. Under the federal tax code, capital gains —i.e. income that a person makes from selling a stock or similar asset — are taxed at a different rate from other income. The highest earners pay 37 percent tax on income from wages/salaries but just 20 percent on capital gains.

2. Proponents of the legislation have largely dismissed that concern.