Elizabeth Warren is trying to crowd the left lane of the Democratic primary race with her recently unveiled wealth tax. Some soundbites of my thinking:
As one of her proponents explains, the US tax code allows unrealized capital gains to go untaxed. This has been a big driver of the recent wealth surge, as Bezos, Gates and Zuckerberg can attest. But if untaxed capital gains is "the problem" why not address that? Change tax rules to force recognition of unrealized capital gains above some wealth threshold. Taxing wealth has dubious Constitutional validity (although John Roberts is smart enough to rationalize whatever he wants). Taxing income has a longer history and mark to market on capital gains is already used by financial institutions and individuals trading futures and index options (see tax straddles).
A high threshold and deferred payment of the tax liability will prevent the sort of cash flow crunch also addressed in the estate tax for closely held businesses - we don't want Ma and Pa Kent to be forced to sell the farm because they have a big unrecognized gain on the value of their land. Many of us also don't want Jeff Bezos to lose control of Amazon just to pay his taxes. A mechanism to allow deferred payment over, eg, ten years (the estate tax deferral is fourteen years) should leave folks plenty of time to work out the financing. Another benefit to the deferred payment idea: if a household has a mark to market gain of $20 million this year but a loss next year of $10 million, there is no need to write them a refund check; just adjust their deferred taxes due.
Of course, some folks out there DO want Bezos to lose control of Amazon, after which they would like to decide on a public flogging. The idea of taxing the rich is not exactly novel. The battle lines were drawn centuries ago between those who think wealth is attributable to the exploitation of others and those who believe in free markets and free people. For better or (mostly) worse, a lot of tired old arguments by unreconstructed Marxists and Socialists who believe that Wealth Is Evil will be trotted out yet again, and yet again they will persuade only the already-convinced.
Greg Mankiw pushes back, wondering who Taylor Swift exploited en route to her $300 million. Same question about JK Rowling of Harry Potter fame and fortune. Then again, if Warren could have stopped George Lucas in his tracks after "Return of the Jedi", she might have had my vote. Bygones.
On to some details. Here are proponents of a wealth tax explaining the problem with the deferred recognition, often forever (stepped-up basis at death), of capital gains:
ITEP
The U.S. Needs a Federal Wealth Tax
Another, closely related problem with relying on income taxes is that much of the income received by the richest Americans is “unrealized capital gains” which are not taxed. When the value of an asset rises, for all practical purposes that increase in value is income for the owner of the asset, but our current laws do not tax this income until the asset is sold. (In other words, capital gains on an asset are not “realized” until the asset is sold.)
This means that wealthy individuals who own a disproportionate share of all assets can defer paying tax on much of their income for years, allowing their wealth to grow much more rapidly. Meanwhile, most income of working Americans (income like wages or interest on a savings account) is taxed annually.[7]
While this may seem like an arcane matter, it allows the net worth of the wealthiest to build up much more rapidly and substantially. For example, one tax expert estimated in 2015 that Warren Buffett, whose net worth was then nearly $70 billion, would have been worth $9.5 billion if his capital gains had been taxed each year regardless of whether assets were sold.[8]
Well, OK - if the problem is that we are not recognizing that capital gains income, the obvious solution would be to recognize it, rather than taxing a bunch of other stuff.
I understand that fairness and logic will find no traction with the "Wealth Is Evil" crowd, but the rest of us might look at this upcoming example and see some problems:
Imagine Susan and John are co-founders of HotTech Inc. They each hold founder's shares worth $100 MM. The shares don't pay a dividend so their taxable income is basically their salary, which is small.
So far, we see two people who had an idea, took some risks that paid off, created jobs and value, and are doing very well. Or, they're evil because they underpaid their workers and relied on basic research financed by the US government, not to mention taxpayer-funded roads. Not important right now, because their paths are about to diverge.
Susan sells her $100 MM, pays $20MM in capital gains taxes and puts the remaining $80MM in a money market fund yielding 2%. Her annual taxable interest income is now $1.6MM, so put her down for another $0.6MM in Federal taxes on that.
John holds his shares, so his taxes remain tiny.
Now, hit them both with the Warren Wealth Tax. Susan, having already paid $20MM and owing $0.6 per annum, will pay an additional 2% on $30MM, or another $0.6MM per year. Over ten years that sums to $32MM.
John will pay 2% on $50MM, or $1MM per year. Over ten years that sums to - no calculators, please - $10MM.
Susan pays $32MM, John pays $10MM. This is fair, logical or desirable why? If the 20% capital gains tax is Susan's "fair share" and she has paid it, why keep taxing her on her wealth? If the income from her investments is an issue, well, she is paying tax on that too. Why keep taxing the poor woman?
Well, because Wealth Is Evil, sure. But other reasons?
Well, maybe that 20% capital gains rate is "too low". It does represent some compromise between our desire to encourage capital formation and risk taking on the one hand without allowing absurd concentrations of wealth on the other. And maybe we have tipped too far in one direction. All debatable, but that is not likely to be the debate we get.
On the other hand, this debate may not be hopeless! Here is just what we did NOT expect - common sense from a Matt Yglesias Voxsplainer:
Warren’s proposal, of course, is for a progressive wealth tax in which the 2 percent rate does not apply to the first $50 million and the 3 percent rate only kicks in when you have more than $1 billion, so nobody would actually be taxed that much. The operation of the tax would, however, exert a dramatic gravitational pull on large fortunes and tend to pull them down to the tax thresholds.
That’s especially true because the mere existence of the wealth tax would, on the margin, encourage wealthy individuals to dissipate their fortunes on charitable giving and lavish consumption. If you try to horde wealth the government is going to tax it, so you might as well spend it.
This is, in turn, exactly the standard economic case against wealth taxes. In a very basic, stripped-down view, the accumulation of capital (buildings, machinery, business equipment, etc.) leads to higher wages and living standards. A wealth tax, by discouraging the accumulation of financial capital, could also discourage the accumulation of physical capital and thus lead to lower wages and living standards.
Most everyone agrees that a highly simplified two-factor model of how the economy works is not accurate, but the extent to which a wealth tax appears even remotely attractive will hinge on whether you think it’s a decent approximation of the real world or a wild fantasy cooked-up to serve the self-interest of plutocrats.
Wait, what? Capital formation is a Good Thing and deferring taxes on capital gains might encourage it? Fortunately, I was sitting down when I read this.
Let's segue to macroeconomics briefly, with Paul Krugman as a launching pad. I mostly agree with his point on individual incentives, subject to some jeering in which I will later engage:
Wouldn’t it hurt incentives? Probably not much. Think about it: How much would entrepreneurs be deterred by the prospect that, if their big ideas pan out, they’d have to pay additional taxes on their second $50 million?
Fair enough, but what about the overall economy? I will guess that whatever wealth tax is paid will come exclusively out of savings. *IF* the government uses the tax revenue to reduce the deficit (under President Howard "Half Caf Venti" Schultz) then private savings has gone down, national savings has gone up, and not much else will happen.
But let's suppose President Warren gets that tax revenue. She will surely spend it on new programs, as per her mandate from the voters. Standard economics will describe that as a fiscal stimulus.
Now, in 2009 the conversion of savings to spending would have been a great idea. But in 2019? Well, the unemployment rate is low (as is labor force participation, so where are we really?) and the Fed is worried that the US economy is near full throttle. They may choose to offset fiscal stimulus with monetary tightening. The effect of higher interest rates will be to discourage investment and consumption.
So, hmm - even though John and other would-be entrepreneurs still have that gold-rush gleam in their eyes, the Fed is making the pursuit of their dreams more difficult, and total investment is falling. Is that a Good Thing? Debatable!
That is my stab at the macroeconomics, anyway - a tax that discourages capital formation, however slightly, reduces capital formation. Or so I think. The pundit with a Nobel doesn't address that. And yes, I'm with you - I too would rather know what he thinks. And he may be thinking what I am wondering - maybe the world has too much savings and fiscal stimulus in the US can create jobs here or elsewhere.
Or one might argue that the wealth tax can't be timed - it will be a long term feature of the US economy. We will be just a mite less friendly to capital formation and it won't hurt us.
I did promise some jeering. An obvious guess is that the $50MM threshold is just an opening bid. Once the principal is established, that threshold will be moving down, not up. It may even reach the point where Warren (net worth variously estimated at $8MM to $18MM) is paying it. Even Prof. Krugman of the lucrative book deals may be asked to pay up! Keep in mind - unless you're talking to Jeff Bezos, the definition of wealth is "more than I've got". The Wealth Is Evil crowd will never lack for ideas on how to spend Other People's Money, and they will never believe that if you can pluck one feather from the goose laying the golden eggs you shouldn't push your luck and pluck ten.
As to the level of compliance with a wealth tax, the discussion seems optimistic. Matt Yglesias does note that the OECD countries have been scaling back their wealth taxes. Paul Krugman offers this:
Would such a plan be feasible? Wouldn’t the rich just find ways around it? Saez and Zucman argue, based on evidence from Denmark and Sweden, both of which used to have significant wealth taxes, that it wouldn’t lead to large-scale evasion if the tax applied to all assets and was adequately enforced.
That is actually pretty comical. Saez and Zucman are both French and have focused on the economics of wealth so the odds are pretty good they are familiar with the debacle of the French wealth tax. Let's say, compliance was less than hoped for, as many of the targeted rich simply left the country. The tax has now been scaled back to include real estate (harder to relocate abroad) but not financial assets. Why is the French experience not talked up by wealth tax advocates? Well, I have my guess.
And I have to clip these stories: first, from 2014 the French stab at a top income bracket of 75%:
France forced to drop 75% supertax after meagre returns
François Hollande’s unpopular tax changes that imposed a 75% rate on earnings above €1m (£780,000) will quietly disappear into the history books from Thursday.
...
Although supported by the left, the reform sparked accusations of an anti-business agenda. After the “supertax” was announced in September 2012 the government was accused of shooting itself in the foot by risking an exodus of high-profile personalities. Business leaders expressed fears that investors would pull out of France.
France’s richest man, Bernard Arnault, the chief executive of luxury group LVMH, took out Belgian nationality, and the actor Gérard Depardieu also moved across the border to Belgium before obtaining Russian citizenship.
High-earning French footballers threatened strike action, while league bosses warned they would no longer be able to attract world class players.
Why can't the US be more like France?
And from 2017, their wealth tax:
Exodus of the richest: Wealth tax is forcing 12,000 millionaires PER YEAR out of France, says Prime Minister as he lowers tariffs for the better off
- Prime Minister Edouard Philippe says change in tax on wealth is necessary
- In 2016 alone, some 12,000 millionaires left France - highest in the world
- French wealth tax currently applies to personal assets over 1.3 million euros
- President Macron's new tariffs will only apply to real eastate over 1.3m euros
Per this story, more tax exiles were fleeing France than China. Again, why can't the US be more like France and stop with the stupid ideas?
EXHORTATION: Don't dump on Warren because of her faux Native heritage scam; dump on her because of her faux medical bankruptcy scam. Gail Heriot, Todd Zywicki and Megan McArdle cast light into this darkness years ago.
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