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A wealth tax is like a property tax, but instead of just taxing buildings and land, it taxes everything someone owns, diamonds, helicopters, paintings, rare pets, you name it. Senators Elizabeth Warren and Bernie Sanders have each proposed that the federal government, for the first time, impose this tax on the ultra-rich — but there's a sizable group of legal scholars who believe the Supreme Court would likely knock this policy down.

While supportive of a wealth tax, Lily Batchelder is one of the legal scholars worried about the Supreme Court. She's a law professor at NYU and the former Deputy Director of the National Economic Council under President Obama. We recently spoke with her at NYU, and she pitched us an alternative to the wealth tax.

Instead of just straight up taxing people's wealth, Batchelder says, the government could instead be more aggressive in taxing the gains from wealth. What she proposes is known as an accrual tax.

Closing The Gap Between Taxes on Investment And Work

For decades, progressives have complained that the federal government taxes income from work at a higher rate than income from investment. When people invest their wealth in places like stocks, bonds, or mutual funds and hold them over a year, the income ("capital gains") is taxed at a top rate of 20%, which is much less than the 37% top tax rate on salaries and wages. This disparity benefits the rich, who tend to see a greater share of their income from investments. Warren Buffett infamously observed that he pays a lower income tax rate than his secretary for this reason.

But beyond facing lower tax rates, people with investment income have another huge benefit: the power to defer taxation. Under current law, the federal government taxes salaries and wages every year, but it generally doesn't tax investment income until investments are sold or exchanged.

"So when, say, Jeff Bezos owns stock that's worth billions of dollars, but he hasn't sold it, he doesn't pay tax on all that appreciation," Batchelder says. "And it would be perfectly constitutional to tax that appreciation as it accrues before he sells the stock." The 16th Amendment hands the federal government broad power to tax income, and the gains from investments, even if just on paper, are arguably a type of income.

The gap between how the federal government treats labor income and investment income hands the rich a whole smorgasbord of tax avoidance strategies. They can, for example, decide to get paid in lower-taxed stocks instead of higher-taxed salaries. And they can avoid taxes by not selling their stocks and meanwhile borrow money at cheaper rates thanks to their ballooning, untaxed fortunes. Accountants and lawyers have a field day with these sorts of opportunities.

All of which is why Batchelder is supportive of new tax proposals by Democrats that would have the government tax the investment income of the ultra-rich like it taxes ordinary income – not only at the same rate, but also in the same way.

A Wealth Tax Alternative

Recently, Senator Ron Wyden, the top Democrat on the Senate Finance Committee, proposed such a reform. He wants to get rid of the "two tax codes" for workers and investors. He proposes the government create "one tax code" by taxing investment income at the same rate as labor income and taxing investment gains annually whether or not they're sold. Julian Castro and Senator Cory Booker, each running for president, have proposed similar tax policies.

Wyden proposes an "anti-deferral" tax system in which people with over a million dollars in annual income or ten million in net worth over three consecutive years would lose the ability to defer tax payments on publicly listed assets, like stocks and bonds. Harder-to-value private assets, like artwork, real estate, and ownership shares of private businesses, would face a retroactive "deferral charge" when they're sold. He estimates the tax would raise between $1.5 to $2 trillion over ten years, and he wants to use the money to strengthen the Social Security program.

Proposals for accrual taxes face similar criticisms to the wealth tax. The policy would require, for instance, significant resources to administer. It could distort saving and investment decisions and have unintended consequences for the broader economy. And while proposals on the table include measures to avoid such problems, it's possible the tax could be hard on some taxpayers who look rich on paper but are in fact short on the cash needed to pay the tax.

A key question over an accrual tax is how it will deal with investor losses. If rich investors get hammered in a financial crash, for instance, will they be able to write off their paper losses? If they make a huge gain one year on Amazon stock and pay a lot in accrual tax, but then next year Amazon stock tanks, do they get to claw back those taxes previously paid? If so, how much? Wyden expresses support for allowing deductibility of losses from tax bills, but he doesn't provide many specifics. As of September, when he released a white paper about the policy, he sought public comment.

Batchelder believes a wealth tax has a number of advantages over an accrual tax. For one, a wealth tax is easier to explain, which is an asset to politicians, who have to convert complicated policies into easy-to-digest talking points. An accrual tax, which necessitates more wonky details and dull explanations, just isn't as sexy. "It hasn't gotten, obviously, the media attention that a wealth tax has," Batchelder says.

But Batchelder thinks an accrual tax could go a long way toward raising revenue and addressing inequality, and she suggests the policy could even be included as a "backup mechanism" in wealth tax legislation that could kick in if the Supreme Court knocks a wealth tax down.

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