The U.S. Already Has Cyprus-Style Taxes

When bailout negotiations among European finance officials and Cypress proposed seizing a portion of bank balances, an enormous outcry arose in many countries at the idea that people's savings could be confiscated by governments with essentially no warning. There have been whisperings in Europe recently that any future bailouts (Spain?) will also include such requirements. People should not be so shocked because wealth taxes or policies that act in a similar manner are much more common than they realize, even in the U.S.

Wealth taxes are currently levied in Europe by France, Iceland, the Netherlands, Norway, and Switzerland, as well as in India. They also have been used within the last twenty years by Austria, Denmark, Finland, Germany, Luxembourg, Sweden, and Spain. They generally charge an annual tax of less than two percent and usually measure nearly all forms of wealth including bank balances, stocks, bonds, real estate (including primary residences), and equity in private businesses.

The U.S. federal government is prohibited from directly levying a wealth tax by the Constitution which restricts such a "direct" tax, allowing it only if the amount is proportional to each state's population. Clearly, a "wealth" tax that is proportional to population instead of wealth makes no sense. This restriction on direct taxes is why a constitutional amendment (the 16th) was needed before the U.S. could have a national income tax.

Absent another constitutional amendment, an overt federal wealth tax would appear to be prohibited. However, the federal government has found a few ways around this restriction, states have no such restriction and freely use wealth taxes, and then there are a myriad of indirect and sneaky ways that financial penalties are put on those who have acquired wealth that serve very much like wealth taxes.

The most obvious way the government gets around the restriction on wealth taxes is patience. The government simply waits until you die. Then the estate tax takes a share of your wealth (currently after an exemption on the first $5.25 million in wealth). Seventeen states also levy estate taxes with exemptions ranging from $675,000 to $5.25 million. So we tax wealth in the U.S. now, on the total value of all assets (even counting non-financial assets like your possessions), we just wait until you cannot complain about it.

Most local and some state governments levy a property tax on real estate (and sometimes other property such as cars, boats, and business inventories). These property taxes are clearly wealth taxes. They simply happen to exclude financial assets such as stocks, bonds, and bank accounts. We accept these wealth taxes without thinking.

Many economists have pointed out that because capital gains taxes on investment gains are not indexed for inflation, part of what is taxed is really just the wealth you invested. To the extent that gains equal to inflation are really just a preservation of wealth, the federal government already taxes wealth while you are alive.

Furthermore, income taxes on social security payments depend on your income. If you have accumulated wealth and invested it in ways that generate income, you are taxed at a higher rate. This looks suspiciously like a backdoor wealth tax since you get taxed not just on the investment income, but then the investment income causes you to pay a tax on your social security payments that you would not have owed otherwise. To make clearer that this is a wealth tax, remember that the IRS requires people over 70 ½ to make withdrawals from retirement funds such as IRAs. These people are forced to turn some of their wealth into income which can then cause their social security payments to face an income tax.

Similarly, Medicare premiums are partially based on income. Thus, once again, the wealth of the elderly causes them to pay the federal government more than if they did not have that wealth. If these rules on benefits for the elderly are not a wealth tax, they are at least a cousin.

Another example arises surrounding Medicaid. Medicare, the government health insurance for the elderly, does not cover nursing homes, but Medicaid does. Medicaid is government health insurance for poor people. Unlike many government benefit programs for the poor where qualification for benefits is income-based, Medicaid looks at both income and wealth. If you have over $2,000 in assets ($3,000 for a couple) other than your primary residence, you don't qualify. Forcing people to spend their wealth before qualifying for a federal program may be fair (why should taxpayers pay nursing home fees for somebody who can pay out of wealth?), but it is effectively a 100% tax on wealth in exchange for access to free nursing home care.

Finally, there are a variety of indirect ways that wealth is penalized that do not result in the government directly collecting money, but are clearly designed to emulate wealth taxes. If you send a child to college, you have to fill out the Free Application for Federal Student Aid (FAFSA) form. Not only does this form determine your eligibility for federal student financial aid for college (both subsidized student loans and Pell Grants), it also is used by virtually every U.S. college and university in making their own financial aid decisions.

And the FAFSA looks not just at income, but also wealth. Financial assets (bank accounts, stocks, and bonds), home equity, and business equity all count against you in determining how much you can afford to pay for your child's college education. It is colleges that make the wealthy pay more, but it is the federal government setting the rules because their formula generally serves as the basis for determining need. Two families with equal income will pay different amounts for the same college if they have different wealth levels. This is not strictly a wealth tax, but it is certainly a wealth penalty.

I don't expect to see a direct tax on bank balances in the U.S. any time soon. The Constitution will make obvious wealth taxes difficult. However, the above column has detailed a litany of wealth taxes and their close cousins that are already in place. We deal with effective wealth taxes every day in our financial lives and don't blink.

Taxing and penalizing wealth creates a disincentive to the accumulation of wealth (and thus an implicit encouragement to spend your money as fast as you make it). While the above mechanisms work in such a way that many people may not realize it, the federal government is in the wealth redistribution business just like it is in the income distribution business.

In order to reverse the trend toward government dependence in this country, we need to remove features of our laws and policies that tax or penalize, directly or indirectly, those who save money so that they can avoid dependence. As long as wealth is taxed and penalized and the lack of it is rewarded with government (and private) benefits, people will to varying degrees avoid building wealth, assuming that they will be more richly rewarded with government benefits than what they might reap from their own efforts.

Taxing and penalizing income makes little sense (since it discourages earning), but taxing and penalizing wealth is even worse. It discourages people from earning money (that might become wealth) and then, if they do earn money, encourages them to spend it rather than save it. Higher savings makes future generations richer, an historical American point of pride that is now in danger. Given the low U.S. savings rate of around five percent, we need a national policy to encourage saving, not discourage it.

People should push back against these sneaky wealth taxes and design public policies that encourage financial independence. If we don't, the last days of our constitutional experiment are approaching faster than most people think.