December 18, 2004
Wealth taxation
By now, everyone should realize that the federal government is headed for some kind of fiscal crisis. Tax cuts may be a good thing, but combine that with bloated spending increases and the looming implosion of both Social Security and the Mediplans, and well, things just aren't good.
Progressives, roundly trounced in the last election cycle (yay!), have started to regroup a bit, and one Gar Alperovitz has an essay (Google cache HTML version of this pdf) suggesting that the solution is the direct taxation of wealth.
I, obviously, think this is a Bad Thing.
I will freely admit that Alperovitz's suggestions would probably create the kind of revenue he's talking about, at least until the American gentry learn to move their assets overseas.
But long-term, this is a very, very bad idea. There are several reasons for this. First, we've already got a system that targets the "rich". It's called income tax. The top 5% of income earners pay 56% of all income taxes. So when you talk about any kind of tax cut, of course it's going to benefit the rich "more" than the poor. The rich are really the only ones paying taxes, with the top 1% paying more combined income taxes than the lowest 100 million filers. If that isn't a massively unfair yet suitably progressive tax structure, I don't know what is. We're already penalizing income generation. Do we really want to penalize savings as well? The savings rate is already negative, so I don't know why we should discourage it any more than we already are.
Second, when the 16th amendment legalizing income taxes was passed in the early twentieth century, everyone said, "Oh, don't worry. It'll never come to more than 1%." Yeah. Right. Try 35% and more. For just income taxes. Payroll taxes add another 10% or more. So, if you make a lot of money, something like half of your paycheck goes to the government. Alperovitz says that all we'd need is a 1% asset tax, and we'd get all the money we need. This conveniently ignores the indeniable fact that all governments expand to fill all available space and use all available funds. Let them start taxing wealth and you'll soon see tax rates skyrocket, just like the income tax rates have.
Third, this would make the acquisition of wealth all but impossible. This, as it turns out, is a really, really bad thing. It would be literally dipping into capital. The reason our government has as much money as it does is because the rich essentially pay for it out of pocket. But do you really think that a person who files a tax return with $1 million in income is actually earning over $400 an hour? Most likely not. Most likely a significant portion of that income comes from assets. Wealth begets wealth. Wealth is used to create income, which is taxed. When you start taxing wealth, you do get a short-term increase in government revenues, but this reduces the amount of wealth that will be used to create further income down the road. It's literally killing the goose that lays the golden eggs.
Okay, let's make this simple. Say you win the lottery and wind up with $5 million in the bank after taxes. Once it's there, you can treat it in one of two ways: as wealth or as income. Spend it all, and you'll have nothing left. But wisely invest it, and you'll never have to work a day in your life. You won't be able to go on a $5 million spending-spree, but you'll have a guaranteed $150,000 or more in income forever, provided you don't touch the $5 million. But if the government taxes the $5 million as well as the income it generates, you have to divert some of that money back into capital just to preserve your current income, let alone increase your pile. This makes it harder for the rich to do business, and since they're the ones who are actually paying for the government to operate, this means that there's less government revenue.
So please, for pity's sake, don't tax wealth. It's bad for everybody. The only income redistribution pattern that works long term is for everyone to be poor.
Hey, it's your alter ego up in Canada again. It just so happens that I'm a grad student in economics and I've dabbeled in tax theory a bit.
Actually, this is a really interesting issue. It has to do with "dynamic consistency" and it's dealt with in a seminal paper in 1990 by a guy named Besley. I think it's The Journal of Political Economy.
The story goes like this: In theory, a one-time "wealth tax" such as the one that Alperovitz says that Donald Trump (?!) proposes is actually very efficient. I know this seems hard to believe, but it is actually true. The reason is that such a tax would have no distortionary effects on incentives. Think about it: with an income tax hike, you know the government is going to take a bigger slice of your comming paycheques, so you'll probably work less; but with the one-time wealth tax you just swallow the bitter pill and then continue on the way you did before.
But here's the "dynamic consistency" part: the government can only do it once. Otherwise there would obviously be a whole slew of disasterous incentives distortions. Strictly speaking, if we are all "rational consumers" in the economic sense, the government would have to pre-commit NEVER using wealth taxes because (being rational) we'd all see it comming!
In reality, as you pointed out, the government doesn't have a whole lot of credibility when it comes to its revenue generating policy tools (in Canada, the income tax was a "temporary measure" to pay for WWII). Besley shows that the scenario of an economy living in expectation of a sequence of "one-time" wealth taxes is a worst-case scenario; thus, the conclusion is (in my opinion) that it's probably not a good idea for governments to be talking about wealth taxes at all.
Man, it's 11:30 on a Saturday and I'm writting about economic theory on some guy's blog. Who's the biggest geek now? Look out, there's a new Ryan Davidson on the block: king of the geeks!
Ryan A. Davidson
Toronto
Yes, a one-time tax could, in theory, be something like efficient. But 1) I don't believe for half a second that the government would settle for taxing anything once, as you've already touched on, and 2) a one-time tax isn't a revenue stream. You can't fund any programs with a single cash infusion. The only thing you could really do would be to pay off existing debt, and no politican has ever been elected by running on a debt-reduction platform.
Posted by: ryan at December 19, 2004 07:07 AMOk, so I think we agree. The wealth tax is a thoroughly ridiculous proposal and this Alperovitz guy ought to be tarred and feathered. But it sounds like the issue that you have stronger opinions about isn't actually the wealth tax itself but the broader idea of redistribution through taxation.
You made several points in the first posting that concern efficiency losses from progressive taxation, i.e., deadweight-loss from evasion and a general "shrinking of the economic pie" due to incentives distortions. Any economist not residing on the lunatic-fringe would agree with you.
But there's always a "ying" and a "yang" to these things. In this case, it's called "the equity efficiency trade-off."
Clearly, the most efficient tax system (disallowing our one-time wealth tax) is the one with absolutely no redistributive attributes. The more you tinker with the system to meet redistributive goals, the more efficiency you loose.
So what's the optimal level of efficiency that should be sacrificed in the name of equity? The theory abdicates on this point because it's essentially a normative question, i.e., it depends on an individuals personal set of values and ethics. I will, however, say this:
In Canada, we've chosen a trade-off point that leans more heavily to the equity side. I don't know why this is, but I suspect it has something to do with the fact that when it's minus 40(C) outside and you see a destitute person you feel *really* bad. At any rate, the decision has its pros and cons. For one thing, we get to take on an air of smugness and moral-superiority when talking to Americans (just kidding! ... or am I?)
But seriously, there are a lot fewer people up here who are severely pissed-off about their lot in life. This probably translates into less urban violence. In fact, all the cross-country studies I've seen show a strong correlation between income-inequality and crime or violence. I suppose this isn't a particularly shocking observation, but it gives you something to think about when your balancing the equity-efficiency trade off in your head (or the next time your dumping on progressives!). Efficiency is easy to measure. Social justice isn't.
I hope these postings don't seem to pedantic. It's the holidays, so I've had a lot of time on my hands lately.
Ryan A. Davidson
Toronto
Seems like a blind one-time tax would work, but the problem is that people are talking about it already, which means that there are already disincentives involved.
I just mean that with all the time it would take to legislate, everyone would see it coming. It will never be blind.