Adam N. Michel
Wealth taxes are back in the US policy conversation. In November, California voters will consider a ballot measure that would impose a broad-based wealth tax on the state’s billionaires. The Illinois legislature also recently debated a similar unrealized gains tax proposal before ultimately shelving it. These renewed efforts to tax high-net-worth Americans are a good opportunity to review how wealth taxes work and why they have been called “one of the most harmful taxes ever created.”
Wealth taxes are unique in that they are not levied on an annual flow of income or consumption (like a sales tax). Instead, wealth taxes apply to a stock of assets and are usually intended to be primarily redistributive, aiming to reverse a perceived inequality in the distribution of resources.
Wealth taxes promise redistribution but more often deliver high economic costs, administrative complexity, and disappointing revenue. California’s proposal illustrates how these taxes distort investment decisions, magnify fiscal volatility, and tend to evolve from one-time levies into permanent features of strained budgets.
Wealth Taxes In the Real World
Wealth taxes impose an additional layer of tax on the income generated by the underlying asset. Most wealth consists of productive assets deployed in the economy, such as active businesses and other physical investments. The annual income streams generated by the underlying assets—capital gains, dividends, and interest—are taxed through the normal income tax system.
The existing tax system already charges the wealthiest Americans high tax rates. A Biden administration Treasury study found that the wealthiest 92 Americans faced total state, local, federal, and international income tax rates of 59 percent. Recent research by four prominent liberal economists concludes that US billionaires pay higher tax rates than their counterparts in the Netherlands, Sweden, Norway, and France, and, contrary to the headline claim, the wealthiest taxpayers also pay the highest tax rates among all Americans.
Because wealth taxes are assessed on a stock instead of an annual income flow, expressing the tax rate as an equivalent income tax rate is more informative. Unless the taxpayer is expected to slowly sell off their underlying assets, the tax will be paid from annual income. Table 1 shows the equivalent income tax rate on underlying assets with different rates of return at different wealth tax rates. At the California top wealth tax rate of 5 percent, any asset earning less than a 5 percent annual pre-tax return would face income tax rates above 100 percent before paying other taxes. Bernie Sanders’ 2020 campaign proposal included a top wealth tax rate of 8 percent.
Net wealth taxes have been tested in other countries and repealed due to high economic costs and administrative burdens. Peaking at 12 in the 1990s, only four Organisation for Economic Co-operation and Development (OECD) countries still impose broad-based net wealth taxes today: Colombia, Norway, Spain, and Switzerland. The figure below shows the trend of wealth taxes over time.
Economic and Administrative Costs
Wealth taxes can impose confiscatory effective tax rates with predictable economic consequences. By directly reducing the after-tax return to saving and investment, they weaken incentives to build businesses, expand productive capacity, and take entrepreneurial risks. Because most large fortunes are not gold bars under the mattress but ownership stakes in operating companies, real estate, and other productive assets, a wealth tax functions as a direct penalty on those investments. That penalty doesn’t remain confined to the wealthy. Capital formation is what drives productivity growth and wage gains, and policies that discourage it ultimately leave everyone worse off.
Wealth taxes also distort capital allocation. Investors have a strong incentive to shift portfolios toward assets that are harder to value, easier to shelter, or more mobile across borders, rather than toward their most productive use. This encourages tax avoidance rather than genuine economic activity. It can mean less investment in long-term projects, more leverage, and greater reliance on complex financial arrangements to reduce reported net worth.
Wealth taxes are also administratively complex. Valuing a broad range of assets every year is extraordinarily difficult. Unlike easy-to-value publicly traded stocks, most wealth is tied up in closely held businesses, partnerships, real estate, artwork, and other illiquid or unique assets. Annual valuation invites avoidance and disputes, which raises compliance costs for both governments and taxpayers. It took 12 years for the IRS and the Michael Jackson estate to reach a court-mediated agreement on the value of its taxable assets. Going through such a process every year for all taxpayers with assets above or near the tax threshold is administratively impracticable.
Because of persistent administrative difficulties and taxpayers’ behavioral responses, wealth taxes raise comparatively little revenue. Countries that experiment with wealth taxes repeatedly find that taxpayers adjust their behavior or move in large numbers, undermining optimistic revenue forecasts. Before France repealed its net wealth tax in 2018, the government estimated that “some 10,000 people with 35 billion euros worth of assets left in the past 15 years.”
Spain experienced a similar behavioral response following the 2023 “solidarity tax,” which raised just 40 percent of the projected revenue. Cato’s Chris Edwards summarizes that “European wealth taxes typically raised only about 0.2 percent of GDP in revenues. Given the little revenue raised, it is not surprising that they had ‘little effect on wealth distribution,’ as one study noted.”
California’s Proposal Is a Warning for the Country
California’s proposed 5 percent wealth tax is especially notable because it would layer on top of the most progressive tax system in the OECD. The state already relies on taxpayers making over half a million dollars a year (the highest income 2.5 percent) to pay 49 percent of income tax revenue. They do this by combining high marginal income tax rates and heavy reliance on capital gains taxation, which makes revenues volatile and highly sensitive to the fortunes and domiciling decisions of a small number of taxpayers.
Although framed as a narrow one-time levy on “excessive accumulations of wealth,” the California proposal includes multiple mechanisms that inflate taxable wealth well beyond economic reality. As the Tax Foundation’s Jared Walczak has detailed, the rules systematically overvalue voting control relative to ownership, apply rigid valuation formulas to private businesses, impose severe penalties that discourage good-faith valuation disputes, and include anti-avoidance rules written so broadly that they can tax assets no longer owned or wealth that may never be realized.
The initiative’s own findings make clear that this will not be a one-time tax. The ballot text explains that the wealth tax “would only modestly slow” the growth of billionaires’ fortunes in California. That admission undermines the premise that the tax solves any underlying fiscal or wealth distribution problem. If a tax leaves wealth largely intact, political pressure to repeat, expand, or permanently extend it is inevitable. This is what happened in Spain, when its “exceptional and temporary” wealth tax became permanent. California’s proposal should be understood in this light, not as a one-off correction, but as a test case for permanent wealth confiscation.
The lesson extends beyond California. Chronic spending growth cannot be solved by ever more aggressive taxes on a narrow subset of high-income taxpayers. Wealth taxes are not a solution to budgetary or economic gaps; they are a symptom of a broken fiscal system grasping for short-term revenue while postponing the difficult but necessary work of restraining spending growth.