California’s proposed wealth tax is coming in for a lot of criticism these days. From Gov. Gavin Newsom, who counts many billionaires as friends and donors and yet was raised by a single mother juggling three jobs, to Anduril founder Palmer Luckey‘s vociferous objections, to the Google guys Larry Page and Sergey Brin voting with their feet, much of the Golden State’s ultrawealthy is objecting to this policy. But what if the policy wouldn’t even work that well, once implemented? That’s what budget expert Kent Smetters thinks.
The Wharton School professor and faculty director of the Penn Wharton Budget Model (PWBM), speaking to Fortune from his office in Philadelphia, recently argued that the measure is an inefficient revenue tool born from a “perfect storm of craziness” in the current economic and social climate that makes “populist” ideas like this so sticky. As the state grapples with a significant budget shortfall, Smetters warns that taxing the ultrawealthy would simply fail to provide the expected windfall. Blame behavioral economics and “the money illusion,” he said.
Smetters’ PWBM is widely used in Washington DC to analyze the fiscal and macroeconomic effects of federal policy proposals. And he brings a lot of Beltway policy chops to the role, with a background that includes serving as an economist at the Congressional Budget Office and as Deputy Assistant Secretary for Economic Policy at the U.S. Treasury. He has advised Congress on dynamic scoring, and policymakers from both parties consult him while drafting major tax and spending legislation. Smetters has described much of the PWBM’s work as private analysis, even a “sandbox,” for legislators to workshop ideas before bills are written. He lives and breathes economic policy.
According to Smetters, the primary issue with wealth taxes is that they rarely meet revenue expectations. “When you think about the wealth tax itself,” he told Fortune, “it’s not really a super efficient way of raising money over time, and it also often doesn’t actually raise as much revenue as people think.” He noted that many countries that adopted a wealth tax “gave up on it, partly just because it raised a lot less revenue than what they were thinking.”
Examples are legion of countries abandoning wealth-targeted taxes, from Austria in 1994 to Denmark and Germany in 1997, to France in 2018. As of June 2024, only four countries in the OECD had a wealth tax, and the U.S. does not have any on the books; it’s unclear whether any would be constitutional. Smetters noted that almost all repealed wealth taxes raised an amount less than or equal to 0.3% of GDP, often much less, showing his point that there just isn’t as much money in them as people think. Also, the administrative costs were high relative to revenue, especially due to asset valuation and avoidance. Noting that most repeals were permanent, not experimental reversals, he said France was an exception, replacing a general wealth tax with a narrow real-estate tax.
Smetters cited some PWBM research, provided exclusively to Fortune, that asked the question: what would happen if it were illegal to be a billionaire, as some far-left figures such as Zohran Mamdani have previously suggested. If the federal government seized every dollar from every individual above $999 million at current market value, the resulting “wealth grab” would only fund the federal government for about seven to eight months, he said. (For calendar year 2025, it would be 8.8 months, based off $5.9 trillion for all U.S. billionaire wealth above $1 billion, and slightly over $8 trillion in government spending through December 31.) “What people don’t realize is [there’s] just not as much money there as people think.”
A Different Path Forward
Instead of “jacking up” income taxes or implementing a wealth tax that targets illiquid assets—such as sports teams or startups—Smetters suggested that California could do with “broader participation in tax revenue,” recommending that the state consider more stable, broad-based options like a large sales tax or a value added tax (VAT). Without such discipline, Smetters warned that the state’s reliance on a highly progressive and volatile tax system will continue to leave it vulnerable to economic shifts.
Some progressive policy analysts and economists argue that PWBM, under Smetters’ direction, builds in assumptions that overstate the growth costs of deficits and taxes while understating the benefits of public investment, which they claim biases the model against expansive social spending.. If anything, Smetters argues, the PWBM does the opposite. Critics argue this biases PWBM’s results against expansive social spending, whereas Smetters offers examples of spending that grows the economy if designed well, including investments in pre-K education, healthcare, the environment, and some public goods. PWBM analysis also shows that, contrary to popular opinion, more high-skill immigration generally raises all wages, including for native-born workers.
Smetters said that he has a free-market bias somewhat, in the sense that he jokingly calls himself “80% libertarian,” meaning he generally thinks free market principles are the most effective at increasing human welfare, with some regulatory exceptions including pollution control and some human capital investments, especially at younger ages. In contrast, a lot of government spending today goes higher-income and older people.
Could the economy actually be harmed, Fortune asked Smetters, if the massively improved standard of living means that life is full of annoying, hidden expenses, prompting a widespread dissatisfaction with the economy and a populist thirst for wealth taxes? Smetters noted that even some conservative economists such as Milton Friedman and Martin Feldstein (his own dissertation advisor), had a very strong free-market orientation, “but they would basically agree that markets work well when you don’t deceive people and exploit people.”
A ‘Perfect Storm of Craziness’
When asked why he thinks there is such a push for a billionaires tax at the moment, Smetters described what he saw as a “perfect storm of craziness” involving the rise of artificial intelligence (AI) and the influence of social media. The concentration in the S&P 500 is one thing, he said, with only 10 companies at the top really driving all the gains in the three-year bull market since ChatGPT was released, and an existential fear (driven on by tech billionaires) about AI coming to replace everyone’s job. Smetters said this was making people “unnecessarily anxious” that “we’re getting replaced by robots and so forth.”
Standing in front of a row of terminals working away on his budget analyses, Smetters insisted that “the reality is that AI is not going to be that as impactful as people think.” Pointing at the computers all around him, he noted, “I literally have models running right now, and so I am a big user of AI,” but many were “probably embellishing how much impact it’s going to potentially have.” He distinguished between the two types of technologies: labor-augmenting versus labor-replacing, insisting that AI would be the former.
The economist cited a well-known phenomenon in behavioral economics known as the “money illusion,” where people don’t believe that they have, in fact, actually gotten richer because they are shocked by higher prices they see around them. “The reality is that, in fact, we have a much higher standard of living than we had even 20 or 30 years ago,” Smetters said. He allowed that much of this is poorly measured, and some goods are even priced at zero. “I’m not saying there’s no problems,” he allowed, but he said it’s a much different world from when he was growing up, and his low-income family had to budget for, say, their car breaking down every so often.
There’s a similar, wider money illusion at work around American debates over who should be taxed and how much. “What people don’t realize is just how progressive the United States income tax system is,” he said, describing it as “by far” the most progressive in the OECD, meaning that the wealthy pay a disproportionate amount of tax in the U.S. and the poorer you are, the less you pay, at times even a negative tax burden due to programs like the earned income tax credit. It’s also true, he noted, that the U.S. raises a lot less revenue from its tax system than many other OECD counrties. “You know, it’s really hard to raise a lot of revenue with with such a progressive tax system … This whole idea of who pays taxes and the debates about it, it’s actually a very American debate.”
