The Alchemy of Wealth Taxation

“Transmutation” is the process of changing one substance, element, or form into another.  We owe this word to the ancient pursuit of alchemy, which sought “the artificial production of gold” from base metals.  While it is now considered a pseudo-science, in our rational age, its aspirations survive in currently popular proposals for taxing billionaires. 

The most advanced of these proposals is California Proposition 40.  Appearing on this fall’s’ ballot, if passed would levy a “one time” balance sheet tax of 5% tax on taxpayers with ten or more figures to their name. U.S. Rep Ro Khanna (D-CA), in Why I Support a Billionaire Wealth Tax, likes the idea. He likes it a lot.  But unlike CA-40’s one-time imposition, Khanna’s projects the results for at least ten years:

“This [tax] will raise $4.4 trillion over a decade. This is enough to establish a $60,000 salary floor for every public school teacher in America, cap child care at 7 percent of a family’s income, and restore the $1 trillion stripped from Medicaid and the ACA, with a $3,000 check left over for every household under $150,000.”

The intention of these plans is to increase access to goods and services for those at the lower end of the income tier, at the expense of the wealthy.  The revenue from CA 40, should there be any, is earmarked for “Medi-Cal and other health coverage programs for low-and moderate-income individuals; health care access, benefits, and services; public education from K-14; and food assistance programs such as CalFresh, CalFAP, CalFood, or California’s Universal Meals Program for school meals.”

Billionaires have a lot; working people, not so much. Take from one, give to the other. Make those at the bottom of the pile better off at the expense of those at the top.  How hard can this be?  As often is the case in economic matters, intended results differ from actual.  

To determine if these measures achieve their stated goal, we must first ask: “What is the composition of the wealth being taxed?”  The point is not just to transfer money. Advocates of these schemes want to increase the consumption of important goods, such as health care and housing. Where, exactly, will they get those things? Billionaires do not have them in large quantities. While the average billionaire might have a few houses and a private jet, yacht and some nice cars, their net worth is not a warehouse.  Their net worth does not consist of hospitals, MRI machines, or pharmaceuticals.  

Rep Khanna’s arithmetic might be correct, or at least as correct as his assumptions. Where he runs into problems is in thinking that the net worth of billionaires can be transmuted. Stockpiles of unused consumer goods, such as health care, and housing, do not exist in the quantities that Khanna wants to provide. Likewise there do not exist  large pools of the types of unemployed skilled labor needed in those fields. The super rich do not have on their payroll thousands of idle doctors, nurses, and teachers.  Any trained health care providers whose license is in good order can find work if they wish to do so. 

The key point that backers of these proposals miss is that the net worth of the wealthy consists almost entirely of capital goods or assets which are financial claims on capital goods. Capital goods are tools and infrastructure. Most of the durable wealth in the world consists of capital goods. A wealthy society  means a society that has accumulated vast amounts of capital goods.  

The Bureau of Economic Analayst’s Fixed Assets Accounts reports the value of the U.S. gross capital stock held by businesses, government, and households in 2024 at around $92 trillion. This total includes consumer fixed assets, consisting of residential housing, of $33 trillion. Whether housing is a capital good or a durable consumer good is debated, but, outside of housing almost all long duration wealth consists of capital goods. 

Capital goods and labor are the variable factors in the production of consumer goods.   A higher standard of living means more consumer goods per capita.  This requires a greater  concentration of capital goods per unit of labor. 

All of the preceding points are true because capital goods are scarce, in the economic sense.  Scarcity means that  “there exists only a finite amount of human and nonhuman resources which the best technical knowledge is capable of using to produce only limited maximum amounts of each economic good.”  

Factories, oil wells, and pharmaceutical plants are not  the things that Khanna wants the tax recipients to have more of.  The things he does want, such as medical care, schools and affordable housing, are scarce goods. At any time existing flows of these goods are consumed by someone.  Taxing rich people and forcing them to sell assets does not immediately create any more of them.  

To be clear on what can and can not happen: 

Imposition of a tax can force rich people to sell some of their capital goods to pay a tax. Government actors can, then, take the monetary proceeds from the sale and use them to buy consumer goods that were already produced.  Those consumer goods were produced with labor and other capital goods.  It is these consumer goods that the government provides to the poor.  

Imposition of a tax cannot transmute capital goods into consumption goods. The government can only purchase consumer goods that were already produced, with the use of other scarce labor and capital goods.

Many popular criticisms of these taxation schemes circle around the target but fail to make a direct hit because they do not address the fundamental issues of the scarcity and heterogeneity of both capital and consumer goods.  These critiques such as:

• rich people do not keep their entire net worth in cash
• billionaires would have to sell off some of their assets to pay the tax
• for every seller, there must be a buyer
• for positions  in the necessary size, there are a limited number of potential buyers

Are all true, without quite grasping the important part about why they are true.

If the beneficiaries of the tax receive funds are able to obtain more health care, they will not be displacing billionaires. Billionaires do not have stockpiles of, or consume billions of dollars of health care. The working class person who receives the tax benefit will displace the marginal existing consumer.  Who is that  consumer? That depends on which margin can the consumer be most easily displaced. That margin might be price. Or it could be waiting time, connections, or the ability to work the system. If California is able to use revenue from this tax to hire a doctor from Missouri, then patients in MO will have one fewer doctor. 

But wait – if there is more money to be spent on those goods won’t the free market economy respond by producing more of them? Well – yes – but that requires more capital goods and skilled labor. Remember capital goods? Those things that the rich were forced to sell to pay their fair share. Saving is the source of capital accumulation. This form of taxation would dis-incentivize saving in favor of consumption. Over the long term fewer consumption goods will be produced.

Another problem with Khanna’s ten-year projection is to assume a sustainable  recurring revenue projection each year.  Did he think that the base net worth that is subject to the tax  will regenerate itself each year?” One might similarly ask, “Do capital goods reproduce themselves, without savings?” 

Can the first year’s haul can be relied on, as Khanna does, for ten years?  Probably not.  That view ignores at least three problems. First the rich taxpayer  might have to sell 8-9% of his net worth to pay the capital gains tax and have 5% left.  In some years after tax return on a portfolio is 9% but on average, it’s not.  The investor’s base would not recover year after year of nine percent compounded erosion.  

Second, Khanna assumes that asset prices would remain unchanged by this tax. Advocates of wealth taxation look at the net worth of billionaires as a fixed number of dollars. This is not so. The monetary value of businesses and assets  is variable, not fixed. Each and every asset has a price, which changes from minute to minute in response to market conditions.  

Such a tax would put downward pressure on asset prices, for the following reason.  Any one person can increase his nominal cash balance by selling something – for money. It is possible to sell only because there is at least one other person who wishes to buy, at the same time.  Assets find their price because there are always some people on both sides of the trade. 

But an entire society cannot all sell, all at once. While I don’t usually align with Keynes, he made a similar point, that “”no such thing as liquidity of investment for the community as a whole”.  

According to Khanna, the $1Billion marker is only a proof of concept: the eventual tax boundary should be $50 million. As the tax cutoff goes lower, there would be more sellers and fewer potential buyers. If enough people want to, or are forced to sell at the same time, the only adjustment is for real – not nominal – cash balances to increase.  The real value of cash balances are increased through lower prices.  The new equilibrium under the tax would be higher real cash balances and lower asset prices.  That would self-defeating from the tax standpoint because the net worth of all wealthy people would fall, whether they were above or below the line.  Some who were above the line would fall below, which would remove them from tax obligation. 

The third problem with Khanna’s projections is he assumes that the market price of assets does not depend on who owns them.  As Mises showed, the owners of capital goods determine how each particular good will be integrated into the framework of economic calculation.  In the market economy, the people, or firms, that can use any specific capital good to the best effect tend to end up as the owner.  That person or firm  is the one who can pay the most for the asset and still make a profit.  The tax under consideration not only would cause forced selling of assets to different people.   The consequences of this are unknown, but the pattern is a change of ownership from one who values the asset the most to someone who values it less.

Absent transmutation, there is a way for society to have more consumption goods.  This is called “production.” Production is where labor and capital goods are provided as inputs into a process of manufacturing, moving, or arranging, according to a plan, to yield something useful at the other end.  That is the way – the only way – for everyone, including those in the lower income tiers – to have more of the things that the tax cannot provide.

A version of this article originally appeared in Mises.org.