Taxing Wealth and Capital Income

Bill Gates sort of captured the idea of consumption‐​based taxation when he said: “Think about the three wealthy people I described earlier: One investing in companies, one in philanthropy, and one in a lavish lifestyle. There’s nothing wrong with the last guy, but I think he should pay more taxes than the others.”102 A better framing would be to say that the last guy, who spends lavishly, is favored under income and wealth taxes, while the first guy, who saves, is penalized. Consumption‐​based taxation would fix that problem by taxing income and wealth only if consumed.

Because wealth taxes suppress savings and investment, they undermine economic growth. A 2010 study by Asa Hansson examined the relationship between wealth taxes and economic growth across 20 OECD countries from 1980 to 1999. She found “fairly robust support for the popular contention that wealth taxes dampen economic growth,” although the magnitude of the measured effect was modest.103

The Tax Foundation simulated an annual net wealth tax of 1 percent above $1.3 million and 2 percent above $6.5 million.104 They estimated that such a tax would reduce the U.S. capital stock in the long run by 13 percent, which in turn would reduce GDP by 4.9 percent and reduce wages by 4.2 percent. The government would raise about $20 billion a year from such a wealth tax, but in the long run GDP would be reduced by hundreds of billions of dollars a year.

Germany’s Ifo Institute recently simulated a wealth tax for that nation.105 The study assumed a tax rate of 0.8 percent on individual net wealth above 1 million euros. Such a wealth tax would reduce employment by 2 percent and GDP by 5 percent in the long run. The government would raise about 15 billion euros a year from the tax, but because growth was undermined the government would lose 46 billion euros in other revenues, resulting in a net revenue loss of 31 billion euros. The study concluded, “the burden of the wealth tax is practically borne by every citizen, even if the wealth tax is designed to target only the wealthiest individuals in society.”106

Conclusions

Nations around the world have cut taxes on capital in recent decades, and most nations that had annual wealth taxes have repealed them. Recent U.S. proposals to increase taxes on wealth and capital income run counter to the lessons learned about efficient taxation in the global economy.

The Europeans discovered that imposing punitive taxes on the wealthy undermined economic growth. They found that wealth taxes encouraged tax avoidance and generated capital flight. European wealth taxes raised little money and became riddled with exemptions.

Wealth is accumulated savings, which is needed for investment. The fortunes of the richest Americans are mainly socially beneficial business assets that create jobs and income, not private consumption assets. Raising taxes on wealth would boomerang against average workers by undermining their productivity and wage growth.

Senator Warren says that she wants rich people to “pay a fair share, so the next kid has a chance to build something great and the kid after that and the kid after that.”107 But encouraging the wealthy to invest in new and expanding businesses is what creates opportunities for those young people, not redistributing more income through the tax code.

Creating a fair and efficient method of taxing capital is a challenge, but experts are widely agreed that wealth taxes are an inefficient way to do so. Rather than sin taxes, wealth taxes are virtue taxes that penalize the wealthy for being frugal and for reinvesting their earnings.

Rather than imposing a wealth tax or raising tax rates on capital income, policymakers should rethink the overall federal approach to taxing capital. A better way is through consumption‐​based taxation, which would tax wealth but in a simpler way that does not stifle savings, investment, and growth.

Notes

The author thanks David Kemp and David Titus for research help and David Burton for outside review.

1. Office of Sen. Elizabeth Warren, “Senator Warren Unveils Proposal to Tax Wealth of Ultra‐​Rich Americans,” press release, January 24, 2019. And see Naomi Lim, “Bernie Sanders: ‘Damn Right I Will Raise Taxes on the Rich,’” Washington Examiner, February 25, 2019.

2. Chris Edwards, “Options for Tax Reform,” Cato Institute Policy Analysis no. 536, February 24, 2005.

3. Warren, “Proposal to Tax Wealth of Ultra‐​Rich Americans.”

4. Tim Hains, “Elizabeth Warren: ‘Just Wrong’ to Call Me a Socialist, ‘But Markets Have to Have Rules,’” RealClearPolitics, March 10, 2019.

5. Lim, “Bernie Sanders: ‘Damn Right I Will Raise Taxes on the Rich.’”

6. Rocky Mengle, “2020 Election: Tax Plans for All 24 Democratic Presidential Candidates,” Kiplinger, June 28, 2019.

7. Average effective tax rates are total taxes paid divided by the Congressional Budget Office’s measure of income. Congressional Budget Office, “The Distribution of Household Income, 2016,” July 2019. Data are for 2016.

8. Congressional Budget Office, “The Distribution of Household Income, 2016.”

9. Organisation for Economic Co‐​operation and Development, “Growing Unequal? Income Distribution and Poverty in OECD Countries,” 2008, p. 104. And see Chris Edwards, “U.S. Tax Code Too Progressive,” Cato at Liberty, November 2, 2017.

10. Congressional Budget Office data show that the top 1 percent has increased its share of overall federal taxes since 2008. See Congressional Budget Office, “The Distribution of Household Income, 2016.”

11. About 90 percent of the municipal bond exemption goes to the top income quintile. See Harvey Galper, Kim Rueben, Richard Auxier, and Amanda Eng, “Municipal Debt: What Does It Buy and Who Benefits?,” National Tax Journal 67, no. 4 (December 2014): 901–24.

12. Organisation for Economic Co‐​operation and Development, “Revenue Statistics,” https://​stats​.oecd​.org/​i​n​d​e​x​.​a​s​p​x​?​d​a​t​a​s​e​t​c​o​d​e=rev.

13. Elizabeth Warren, “Ultra‐​Millionaire Tax,” https://​eliz​a​beth​war​ren​.com/​u​l​t​r​a​-​m​i​l​l​i​o​n​a​i​r​e-tax.

14. Paul Krugman, “Elizabeth Warren Does Teddy Roosevelt,” New York Times, January 28, 2019.

15. Edward N. Wolff and Maury Gittleman, “Inheritances and the Distributions of Wealth or Whatever Happened to the Great Inheritance Boom?,” Bureau of Labor Statistics Working Paper no. 445, January 2011, Table 8. The share fell from 23 percent in 1989 to 15 percent in 2007.

16. Organisation for Economic Co‐​operation and Development, “The Role and Design of Net Wealth Taxes in the OECD,” 2018, p. 76. The OECD study does not have the year introduced for Iceland, so I took the first year that wealth tax revenue shows up in OECD’s tax revenue database. See also Alexander Krenek and Margit Schratzenstaller, “A European Net Wealth Tax,” Austrian Institute of Economic Research, April 15, 2018, Table 1. This study shows earlier enactment years than the OECD for a number of the countries. Also note that some countries have taxes that cover a portion of wealth. For example, Belgium imposes an annual charge on financial securities and Italy imposes a tax on real estate and financial assets held abroad.

17. Marcus Drometer et al., “Wealth and Inheritance Taxation: An Overview and Country Comparison,” Ifo DICE Report 16, no. 2 (June 2018): 49.

18. Katrine Jakobsen, Kristian Jakobsen, Henrik Kleven, and Gabriel Zucman, “Wealth Taxation and Accumulation: Theory and Evidence from Denmark,” National Bureau of Economic Research Working Paper no. 24371, March 2018.

19. European Commission, “Cross‐​Country Review of Taxes on Wealth and Transfers of Wealth,” October 2014, p. 42. The report was completed by Ernst and Young.

20. Michel Rose, “Macron Fights ‘President of the Rich’ Tag after Ending Wealth Tax,” Reuters, October 3, 2017. And see Harriet Agnew, “French Government Opens Door to Wealth Tax Concession,” Financial Times, December 5, 2018. The wealth tax was replaced by a tax on high‐​end real estate.

21. “France in 14bn‐​euro Tax Black Hole,” BBC News, May 28, 2014. And see Anne Penketh, “France Forced to Drop 75% Supertax after Meagre Returns,” The Guardian, December 31, 2014.

22. PriceWaterhouseCoopers, “Will Germany Revive Its Net Wealth Tax?,” European Tax News Alert, June 5, 2012.

23. Alena Bachleitner, “Abolishing the Wealth Tax: A Case Study of Germany,” Austrian Institute of Economic Research, WIFO Working Paper no. 545, 2017.

24. Thomas A. McDonnell, “Wealth Tax: Options for Its Implementation in the Republic of Ireland,” Nevin Economic Research Institute, September 2013, p. 23.

25. Drometer et al., “Wealth and Inheritance Taxation.”

26. Magnus Henrekson and Gunnar Du Rietz, “The Rise and Fall of Swedish Wealth Taxation,” Nordic Tax Journal 1, no. 1 (2014): 31.

27. Raymundo Larrain Nesbitt, “Andalusia to Abolish Inheritance Tax in 2019,” Spanish Property Insight, January 29, 2019. And see Carlos Gabarro, “Spain’s Wealth Tax and 10 Legitimate Ways to Reduce It,” Tax Notes International, April 2, 2018. Madrid provides a 100 percent credit against the tax.

28. Marius Brülhart, Jonathan Gruber, Matthias Krapf, Kurt Schmidheiny, “Taxing Wealth: Evidence from Switzerland,” National Bureau of Economic Research Working Paper no. 22376, June 2016.

29. OECD, “The Role and Design of Net Wealth Taxes in the OECD,” pp. 16–17.

30. OECD, “The Role and Design of Net Wealth Taxes in the OECD, p. 88.

31. OECD, “The Role and Design of Net Wealth Taxes in the OECD,” p. 20.

32. Robin Boadway, Emma Chamberlain, and Carl Emmerson, “Taxation of Wealth and Wealth Transfers,” in Dimensions of Tax Design (Oxford: Oxford University Press, September 2010), p. 787. This is volume 1 of the Mirrlees Review.

33. OECD, “The Role and Design of Net Wealth Taxes in the OECD,” p. 18.

34. Michael Schuyler, “The Impact of Piketty’s Wealth Tax on the Poor, the Rich, and the Middle Class,” Tax Foundation, October 2014. And see Marcus Drometer et al., “Wealth and Inheritance Taxation: An Overview and Country Comparison,” Ifo DICE Report 16, no. 2 (June 2018).

35. Thomas Piketty, Capital in the Twenty‐​First Century (Cambridge: Belknap Press, 2014).

36. Jean‐​Philippe Delsol, Nicolas Lecaussin, and Emmanuel Martin, ed., Anti‐​Piketty: Capital for the 21st Century (Washington: Cato Institute, 2017); Chris Giles and Ferdinando Giugliano, “Thomas Piketty’s Exhaustive Inequality Data Turn Out to Be Flawed,” Financial Times, May 23, 2014; Richard Sutch, “The One Percent across Two Centuries: A Replication of Thomas Piketty’s Data on the Concentration of Wealth in the United States,” Social Science History 41 (Winter 2017): 587–613; Alan J. Auerbach and Kevin Hassett, “Capital Taxation in the 21st Century,” National Bureau of Economic Research Working Paper no. 20871, January 2015; and Matthew Rognlie, “Deciphering the Fall and Rise in the Net Capital Share: Accumulation or Scarcity,” Brookings Papers on Economic Activity, Spring 2015.

37. Warren and her wealth tax advisers claim that all assets above the exemption amount would be included. Emmanuel Saez and Gabriel Zucman, University of California, Berkeley, letter to Sen. Elizabeth Warren, January 18, 2019.

38. Rebecca S. Rudnick and Richard K. Gordon, “Taxation of Wealth,” in Tax Law Design and Drafting: Volume 1, ed. Victor Thuronyi (Washington: International Monetary Fund, 1996), p. 13.

39. Miranda Perry Fleischer, “Not So Fast: The Hidden Difficulties of Taxing Wealth,” San Diego Legal Studies Paper no. 16–213, March 14, 2016, p. 2.

40. Saez and Zucman, letter to Senator Warren.

41. Chicago Booth, IGM Forum, Economic Experts Panel, April 9, 2019, http://​www​.igm​chica​go​.org/​s​u​r​v​e​y​s​/​w​e​a​l​t​h​-​taxes.

42. Brian Raub, Barry Johnson, and Joseph Newcomb, Internal Revenue Service, “A Comparison of Wealth Estimates for America’s Wealthiest Decedents Using Tax Data and Data from the Forbes 400,” presented at National Tax Association 103rd Conference on Taxation, November 20, 2010.

43. Raub, Johnson, and Newcomb, “A Comparison of Wealth Estimates,” p. 134.

44. James Mirrlees et al., “Taxes on Wealth Transfers,” in Tax by Design (Oxford: Oxford University Press, September 2011), p. 347. This is the final report of the Mirrlees Review.

45. OECD, “The Role and Design of Net Wealth Taxes in the OECD,” p. 64.

46. Quoted in Robin Boadway, “Taxation of Wealth and Wealth Transfers,” p. 782.

47. Matt Phillips, “Forget Inequality, India Is Scrapping Its Wealth Tax,” Quartz, March 4, 2015.

48. Rajalakshmi Nirmal, “Why Jaitley Decided to Scrap Wealth Tax,” Hindu Business Line, March 8, 2015.

49. Boadway, “Taxation of Wealth and Wealth Transfers,” pp. 741, 781.

50. International Monetary Fund, “IMF Fiscal Monitor: Tackling Inequality,” October 2017, p. 37.

51. OECD, “The Role and Design of Net Wealth Taxes in the OECD,” p. 90.

52. Asa Hansson, “Is the Wealth Tax Harmful to Economic Growth?,” World Tax Journal 2, no. 1 (January 2010): 24.

53. OECD, “The Role and Design of Net Wealth Taxes in the OECD,” p. 93.

54. Chris Edwards and Daniel J. Mitchell, Global Tax Revolution (Washington: Cato Institute, 2008).

55. OECD, “The Role and Design of Net Wealth Taxes in the OECD,” p. 17.

56. OECD, “The Role and Design of Net Wealth Taxes in the OECD,” p. 17.

57. Drometer et al., “Wealth and Inheritance Taxation.”

58. OECD, “The Role and Design of Net Wealth Taxes in the OECD,” p. 23.

59. OECD, “The Role and Design of Net Wealth Taxes in the OECD,” p. 82. And see Rudnick and Gordon, “Taxation of Wealth.”

60. Gilbert Paul Verbit, “France Tries a Wealth Tax,” University of Pennsylvania Journal of International Law 12, no. 2 (Summer 1991): 181–217.

61. OECD, “The Role and Design of Net Wealth Taxes in the OECD,” p. 68.

62. James Brumby and Michael Keen, “Game‐​Changers and Whistle‐​Blowers: Taxing Wealth,” International Monetary Fund (blog), February 13, 2018.

63. Piketty, Capital in the Twenty‐​First Century, p. 517.

64. Warren, “Ultramillionaire Tax.” And see Saez and Zucman, letter to Senator Warren.

65. As discussed in McDonnell, “Wealth Tax.”

66. McDonnell, “Wealth Tax,” p. 23.

67. McDonnell, “Wealth Tax,” p. 25. McDonnell relies for his description of the 1970s Irish tax on a detailed 1985 study by Cedric Sandford and Oliver Morrissey. McDonnell himself is in favor of a new wealth tax in Ireland, but he wants a well‐​designed one this time around.

68. Henrekson and Du Rietz, “The Rise and Fall of Swedish Wealth Taxation,” p. 30.

69. Henrekson and Du Rietz, “The Rise and Fall of Swedish Wealth Taxation,” p. 30.

70. Gabarro, “Spain’s Wealth Tax and 10 Legitimate Ways to Reduce It.”

71. Jakobsen et al., “Wealth Taxation and Accumulation.”

72. David Seim, “Behavioral Responses to Wealth Taxes: Evidence from Sweden,” American Economic Journal: Economic Policy 9, no. 4 (2017): 395–421.

73. Brülhart et al., “Taxing Wealth: Evidence from Switzerland,” p. 4.

74. Henrekson and Du Rietz, “The Rise and Fall of Swedish Wealth Taxation,” p. 30.

75. Verbit, “France Tries a Wealth Tax,” p. 217. And see p. 193.

76. Éric Pichet, “The Economic Consequences of the French Wealth Tax,” La Revue de Droit Fiscal 14 (April 2007): 15.

77. Pichet, “The Economic Consequences of the French Wealth Tax,” p. 25.

78. Matthew Smith, Owen Zidar, and Eric Zwick, “Top Wealth in the United States: New Estimates and Implications for Taxing the Rich,” July 19, 2019, p. 46, http://​ericzwick​.com/​w​e​a​l​t​h​/​w​e​a​l​t​h.pdf. See “preferred estimate.” And see Edward Wolff, “Household Wealth Trends in the United States, 1962 to 2016: Has Middle Class Wealth Recovered?,” National Bureau of Economic Research Working Paper no. 24085, November 2017, Table 6.

79. “The Wealth‐​X Billionaire Census 2019,” Wealth‐​X, May 9, 2019, p. 16.

80. I am referring to the results of optimal tax theory developed in a series of papers in the 1970s and 1980s. Economist Greg Mankiw asks, “What is the intuition for a zero optimal capital tax?” He answers, “uniform taxation is optimal absent any differences in elasticities or cross‐​elasticities of supply or demand.… Taxing capital income is undesirable because it means taxing future consumption more heavily than current consumption, which violates the presumption for uniformity.” N. Gregory Mankiw, “Commentary,” in Inequality and Tax Policy, ed. Kevin A. Hassett and R. Glenn Hubbard (Washington: American Enterprise Institute, 2001), p. 188. See also N. Gregory Mankiw, Matthew Weinzierl, and Danny Yagan, “Optimal Taxation in Theory and Practice,” National Bureau of Economic Research Working Paper no. 15071, June 2009; and George R. Zodrow, “Should Capital Income be Subject to Consumption‐​Based Taxation?,” James A. Baker III Institute for Public Policy, April 2006. For a contrary view, see Peter Diamond and Emmanuel Saez, “The Case for Progressive Tax: From Basic Research to Policy Recommendations,” Journal of Economic Perspectives 25, no. 4 (Fall 2011): 165–90. Optimal tax models assume that redistribution is a good thing and it is to be traded off with the damage caused by higher tax rates within a “social welfare function.” The utilitarian premise is dubious, but that is the starting point of these models.

81. Mankiw, “Commentary,” p. 189.

82. Mankiw, Weinzierl, and Yagan, “Optimal Taxation in Theory and Practice,” p. 21. And see Zodrow, “Should Capital Income be Subject to Consumption‐​Based Taxation?”

83. Mankiw, Weinzierl, and Yagan, “Optimal Taxation in Theory and Practice,” p. 11.

84. In particular, the Council of Economic Advisers examined taxes on corporate income. It noted that “reductions in the corporate tax rate incentivize corporations to pursue additional capital investments as their cost declines. Complementarities between labor and capital then imply that the demand for labor rises under capital deepening and labor becomes more productive. Standard economic theory implies that the result of more productive and more sought‐​after labor is an increase in the price of labor, or worker wages.” Council of Economic Advisers, “Corporate Tax Reform and Wages: Theory and Evidence,” October 2017. And see Council of Economic Advisers, “The Growth Effects of Corporate Tax Reform and Implications for Wages,” October 2017.

85. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (Chicago: University of Chicago Press, 1976) book 5, chapter II, p. 376.

86. Edward J. McCaffery, “Grave Robbers: The Moral Case against the Death Tax,” Cato Institute Policy Analysis no. 353, October 4, 1999, p. 14. And see Edward J. McCaffery, “The Uneasy Case for Wealth Transfer Taxation,” Yale Law Journal 104, no. 2 (1994): 283–365.

87. Edward J. McCaffery, “The Political Liberal Case Against the Estate Tax,” Philosophy & Public Affairs 23, no. 4 (Autumn, 1994): 296.

88. N. Gregory Mankiw, “How Inherited Wealth Helps the Economy,” New York Times, June 21, 2014.

89. For the flat tax, see Robert E. Hall and Alvin Rabushka, The Flat Tax (Stanford: Hoover Institution, 1995). For the X‐​Tax, see David F. Bradford, Taxation, Wealth, and Saving (Cambridge: MIT Press, 2000), p. 67. And see David R. Burton, “Four Conservative Tax Plans with Equivalent Economic Results,” Heritage Foundation, Backgrounder no. 2978, December 15, 2014.

90. Glenn Hubbard discusses the four parts of capital income: returns to waiting, returns to risk taking, returns to market power, and luck. Income and consumption taxes treat these sources of income the same except the first item. See R. Glenn Hubbard, “Would a Consumption Tax Favor the Rich?,” in Toward Fundamental Tax Reform, ed. Kevin A. Hassett and Alan J. Auerbach (Washington: American Enterprise Institute, 2005). Tax economists refer to normal and above normal returns fairly loosely, but this OECD paper discusses some of the complexities. Hayley Reynolds and Tom Neubig, “Distinguishing Between ‘Normal’ and ‘Excess’ Returns for Tax Policy,” Organisation for Economic Co‐​operation and Development, Taxation Working Papers no. 28, 2016.

91. Hubbard says the claim that “consumption tax reform is a sop to the rich is almost certainly unfair, especially if a progressive consumption tax like that proposed by Bradford” were being considered. R. Glenn Hubbard, “Would a Consumption Tax Favor the Rich?,” p. 91. David Bradford similarly discusses why it is a misconception that consumption‐​based taxation is regressive. See David Bradford, Blueprints for Basic Tax Reform (Arlington: Tax Analysts, 1984), p. 122.

92. Bradford, Taxation, Wealth, and Saving, p. 334. And see David F. Bradford, “Fundamental Issues in Consumption Taxation,” American Enterprise Institute, 1996, pp. 10, 16.

93. Policymakers may add narrow breaks and unneeded complexity to both income and consumption‐​based taxes. However, the basic accounting under consumption‐​based taxes is simpler and they would do away with complex aspects of income taxation including depreciation, inventory accounting, and capital gains. See Chris Edwards, “Simplifying Federal Taxes: The Advantages of Consumption‐​Based Taxation,” Cato Institute Policy Analysis no. 416, October 17, 2001. David Bradford discussed how consumption‐​based taxation would be simpler than income taxation in many essays. For example, see Bradford, Taxation, Wealth, and Saving.

94. This is Edward McCaffery’s phrase. It is true that one needs to build wealth first before the strategy works. You buy and hold an asset, such as land, that appreciates while providing little current income flow, then you borrow against the appreciating asset for your personal consumption, and when you die your asset gets a step‐​up in basis. Edward J. McCaffery, “Taxing Wealth Seriously,” University of Southern California Legal Studies Working Paper, 2016.

95. Joseph Bankman and David A. Weisbach, “The Superiority of an Ideal Consumption Tax Over an Ideal Income Tax,” Stanford Law Review 58 (2006): 1413–56. And see Zodrow, “Should Capital Income be Subject to Consumption‐​Based Taxation?”

96. Bankman and Weisbach, “The Superiority of an Ideal Consumption Tax,” 1413–56. The authors note a “properly designed consumption tax is Pareto superior to an income tax.” Bankman and Weisbach are expanding on an idea explored in a 1976 study by Anthony Atkinson and Joseph Stiglitz.

97. Bankman and Weisbach, “The Superiority of an Ideal Consumption Tax,” 1413–56.

98. Auerbach and Hassett, “Capital Taxation in the 21st Century,” p. 20.

99. A wealth tax would tax normal returns and “any foreseeable above‐​normal returns associated with tradable assets,” but would exempt other types of above‐​normal returns that may not be capitalized in asset prices. See S. Cnossen and A. L. Bovenberg, “Fundamental Tax Reform in the Netherlands,” METEOR research memorandum no. 024, Maastricht University, January 1, 2000, p. 4.

100. OECD, “The Role and Design of Net Wealth Taxes in the OECD,” p. 59.

101. Auerbach and Hassett, “Capital Taxation in the 21st Century,” p. 19.

102. Quoted in Jon Hartley, “Why Economists Disagree with Piketty’s ‘r – g’ Hypothesis on Wealth Inequality,” Forbes, October 17, 2014.

103. Asa Hansson, “Is the Wealth Tax Harmful to Economic Growth?,” World Tax Journal 2, no. 1 (January 2010): 19–34.

104. Michael Schuyler, “The Impact of Piketty’s Wealth Tax on the Poor, the Rich, and the Middle Class,” Tax Foundation, October 2014.

105. Clemens Fuest et al., “The Economic Effects of a Wealth Tax in Germany,” Ifo DICE Report 16, no. 2 (June 2018).

106. Fuest et al., “The Economic Effects of a Wealth Tax in Germany,” p. 26.

107. Hains, “Elizabeth Warren: ‘Just Wrong’ to Call Me a Socialist.”

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