The Wall Street Journal discusses Elizabeth Warren’s tax plan:
Consider a billionaire with a $1,000 investment who earns a 6% return, or $60, received as a capital gain, dividend or interest. If all of Ms. Warren’s taxes are implemented, he could owe 58.2% of that, or $35 in federal tax. Plus, his entire investment would incur a 6% wealth tax, i.e., at least $60. The result: taxes as high as $95 on income of $60 for a combined tax rate of 158%.
The rate would vary according to the investor’s circumstances, any state taxes, the profitability of his investments and as-yet-unspecified policy details, but tax rates of over 100% on investment income would be typical, especially for billionaires.
Warren’s plan is every bit as bad as the WSJ suggests, but not for the reasons they provide. There is nothing wrong with rich people paying more in tax than they earn in income. And this example does not actually involve a 158% income tax rate, rather the tax rate on income is 58.2% and the tax rate on wealth is 6%.
Consider the following analogy. An Illinois farmer has a 640-acre soybean farm, which usually provides an income of $140,000/year. In 2019 his income falls to only $10,000 due to low soybean prices. Suppose his annual property tax bill is $12,000. Would you say the farmer pays a 120% income tax rate? Of course not. And note that a property tax is similar to a wealth tax, but only applies to one type of wealth.
To see the actual problem with Warren’s plan consider a billionaire who donates a fraction of her wealth to charity. For the remainder of her wealth she has two choices, consumption and saving. (I.e. choice between current consumption and future consumption.) If she consumes the wealth immediately, then no wealth tax must be paid. If she saves the money, then an annual wealth tax of 6% must be paid. That distinction is illogical, unfair, and inefficient.
The reader might assume that I am just being an apologist for privileged rich people. Not so. I actually have no problem with very high tax rates on the rich, if done correctly.
Consider a retired billionaire with several mansions full of servants, a big yacht, and a private jet. Assume they have an annual investment income of $50 million and an annual consumption level of $100 million. I see no problem with making that person pay a 60% consumption tax, or even more. If we accept the methodology of the WSJ, that tax ($60 million) would represent a 120% tax on income. It would not be an income tax, however, it would be a consumption tax.
In the past, when I’ve suggested that income is meaningless and that we need to focus on consumption, some of my progressive commenters would defend the relevance of income. They point out that under my progressive consumption tax proposal some very thrifty rich people would pay very low rates of income tax. Ok, but two can play that game. If you really want to insist that income is the correct variable for tax purposes, then you open yourself up to exactly the sort of criticism made by the WSJ.
Yes, the Journal’s criticism of Warren’s plan is somewhat unfair, but only because consumption is the correct base for a tax system, not income. And that means that Warren’s wealth tax is highly flawed for an entirely different reason. The real problem is that it favors current consumption over saving (future consumption), not that it imposes high tax rates on the rich.
READER COMMENTS
Phil H
Nov 18 2019 at 4:39am
If a wealth tax encouraged extra consumption, would that increase the velocity of money? I don’t actually know how it’s calculated, so I’m not sure how the econometrics work here. My thought is that it would increase the velocity of money, and so raise gdp and increase economic activity… is that wrong? I thought there was a glut of money following the injections of cash in 2009, so I wasn’t under the impression that the U.S. economy lacks pots of savings for investment. Under those conditions, isn’t encouraging consumption a good thing?
Matthias Görgens
Nov 18 2019 at 8:09am
A competent central bank gets exactly the amount of total spending it wants.
Any increase or decrease in velocity of money would be offset by the central bank to stay at their targets. (Be that inflation or price level or NGDP targets or otherwise.)
So it’s an interesting question what kind of impact (if any) a wealth tax would have on the velocity of money, but it shouldn’t have much of a practical impact.
Scott Sumner
Nov 18 2019 at 10:31am
I doubt it would affect velocity and Matthias is right that the Fed would offset the effects.
Brandon Berg
Nov 18 2019 at 5:02am
You made a post a few years ago in which you advocated a progressive consumption tax topping out at 80%. At the time that struck me as unreasonably high, but what I had overlooked is the fact that an 80% consumption tax takes only a 44% (0.8/1.8) bite out of consumption spending.
Even if you save nothing and consume all your income as it comes in, an 80% marginal consumption tax rate is not much heavier than the 40.8% top marginal federal tax rate.
Another good illustration of the absurdity of comparing consumption tax payments to income: There was a year in which I had zero income. As I had plenty in savings, I simply continued to spend as I had while employed, and consequently paid an ∞% tax rate on my $0 in income.
Scott Sumner
Nov 18 2019 at 10:32am
I was contemplating a consumption tax that took an 80% bite out of consumption.
robc
Nov 18 2019 at 6:28am
The Georgist Single Land Tax is far preferable to the Consumption Tax ( which is much better than the income tax).
Plus it has the added benefit of being able to raise maybe 1/3 of what the government currently spends, so would necessitate drastic spending cuts.
Matthias Görgens
Nov 18 2019 at 8:06am
From what I can tell from Scott’s other writings, he seems happy with a land value tax, but thinks that the government needs more money than that.
(I am not an economist, but I’m not actually sure the LVT would raise less: if you lower other taxes, land rent will go up. So just because total land rents are perhaps only a third of total taxes at the moment, doesn’t mean they they wouldn’t be higher when other taxes drop.)
robc
Nov 18 2019 at 8:25am
SLT would eliminate, not just lower, all other taxes, so you may be right.
The key part of the SLT is SINGLE.
MarkW
Nov 18 2019 at 7:18am
They point out that under my progressive consumption tax proposal some very thrifty rich people would pay very low rates of income tax.
Under a progressive consumption tax, wouldn’t non-thrifty rich people also pay low rates simply by spending their money in places where there is no progressive consumption tax? The ways that EU countries apply VAT taxes to private yachts and aircraft (and the ways that owners try to evade those taxes) makes for interesting reading.
Matthias Görgens
Nov 18 2019 at 8:03am
Just make them pay an exit tax.
(Similar to how VAT gets applied when goods move borders.)
Floccina
Nov 19 2019 at 2:41pm
I don’t think you need an exist tax. you would allow a person to put as much money as they want, pre-tax, into an IRA. Then allow people to take as much as they want out of their IRA at any time but when they do they will have to pay taxes on all of the withdrawals.
You would also tax any income not put in the IRA along with the withdrawals at a progressive rate. You could also allow people to buy cars and homes in their IRA and rent them at market rates. The result would be a progressive consumption tax.
Scott Sumner
Nov 18 2019 at 10:34am
Tax evasion is a problem for both income and consumption taxes.
robc
Nov 18 2019 at 11:14am
Another advantage of the SLT. Its Its to have a black market in deeds.
robc
Nov 18 2019 at 11:15am
Insert the word hard where appropriate.
MarkW
Nov 18 2019 at 3:34pm
Right, but the kind of avoidance I mentioned would be perfectly legal absent an exit tax. To prevent that you’d need both consumption and exit taxes and enforcement mechanisms for each. Right now, I don’t believe the EU attempts to collect exit taxes from private individuals (they are free to take their money abroad and spend it as they see fit and only owe VAT any on goods they bring back into the EU). But EU VATs are ‘only’ 20%. With a 60% (or higher) progressive consumption tax that you mention, the incentive to spend abroad would be much more powerful, wouldn’t it? Nothing could be taken or shipped out of the country without concerns that cash or valuable items were being concealed. You might have to get rid of cash entirely. It all sounds really unappealing to me.
Thaomas
Nov 21 2019 at 8:52am
In a progressive tax on consumption (income minus saving/asset accumulation) where the consumption occurred is irrelevant.
Thaomas
Nov 19 2019 at 8:02am
One makes a consumption tax progressive not by having high excise rates on certain goods, but by having progressive rates on (income-savings).
Alan Goldhammer
Nov 18 2019 at 9:20am
I don’t know if I’m the most liberal leaning reader of this blog but certainly must rank up there. I agree with Scott’s premise on a consumption tax and think the Warren proposal is just bonkers. I’m against all tax preferences and think the tax code can be really streamlined. I well remember several decades ago when there was a lot of discussion about a flat tax. Maybe it was Dick Armey who was proposing it. I ran the numbers for that tax year and lo and behold I would have paid the same amount in Federal taxes (within 1%) with the flat tax (I think it was 20% that was being discussed) compared to my itemized return.
I read TR Reid’s book on taxes when it came out a couple of years ago, “A FINE MESS: A Global Quest for a Simpler, Fairer, and More Efficient Tax System.” It’s a book that readers of this blog will enjoy! One of his key points is to get rid of the corporate income tax as it’s inefficient and brings in a decreasing amount of revenue on a % basis each year. This would get stories like the “FedEX pays no income tax” off the front page of the papers. Put a VAT in place. Get rid of the carried interest loophole, and don’t allow un-taxed capital gains to be passed on via inheritance.
Thaomas
Nov 19 2019 at 8:17am
I’m probably even more centrist than you. 🙂
I’d “replace” the corporate income tax revenue with part of the income from the progressive personal consumption tax. I would not rule out preferential kids of consumption, like charitable giving although I prefer this kid of incentive to be done as a partial tax credit so everyone has the same incentive to give regardless of income . I’d reserve the VAT to replace the wage tax funding SS and Medicare trust funds (I still like the idea of having them rise and fall with demographic changes rather than strict PAYG.) I’d rebate the tax on net CO2 emissions through some some kind of per capita payout. And the whole kit and caboodle should raise enough revenue to mainly eliminate the full employment deficit.
Floccina
Nov 19 2019 at 2:48pm
I think you need to pay out all proceeds of a CO2 for removal of co2 from the air (biochar enhanced weathering etc.) because ideally a CO2 tax raises no revenue.
Bob Murphy
Nov 18 2019 at 11:44am
Scott,
I agree wit you that the WSJ article could’ve been more precise, and that your property tax analogy is perfect for showing the problem with their framing.
However, I think they were trying to show the same ultimate problem that you were: Namely, a wealth tax+progressive income tax combine to impose an incredibly high penalty on deferring consumption, meaning that owners of wealth will not have the same incentive to preserve it.
(Another way of seeing my point: If the annual property tax were such that most property couldn’t generate enough rent to cover it, then no business owner would want to own commercial property. People would still live in houses and effectively pay a fee for the privilege of doing so, but nobody would own non-residential property if there were associated tax liabilities higher than the net pre-tax income the property generated in a typical year.)
On another matter, when you say Scott, “I actually have no problem with very high tax rates on the rich, if done correctly,” do you have any ethical framework for that statement, besides, “It would give more total utility to do that than not to do that”? E.g. if people propose to take kidneys by force from those with 2 healthy ones to give to those on dialysis machines, is that just a matter of computation for you, or do you instinctively want to say, “No, you own your body organs, period.” ?
Scott Sumner
Nov 18 2019 at 3:25pm
I’m a utilitarian, and so that’s my motivation. I don’t believe in “natural rights”.
I oppose the forceable removal of kidneys for utilitarian reasons, and support a kidney market for that very same reason.
Thaomas
Nov 18 2019 at 2:03pm
That the US taxes income rather than consumption is the reason that the “Tax Cuts for the Rich and Deficits Act of 2017” was such a disaster. It failed to offset the reductions in income taxes with progressive taxation of consumption.
As a minor matter, the bill actually removed one “non-consumption” deduction, the tax paid to SLG.
As a political strategy, I think it makes sense to stop all the preference for “capital” income to get high income lower consumption people on board with a change to consumption taxation
MJ
Nov 19 2019 at 12:01am
Income taxes already approximate consumption taxes for most people considering most don’t max their pre-tax account savings. For the very small amount of people actually effected by the proposed wealth taxes, the whole point is to reduce their wealth and incentivizing consumption is a good way to do that.
Thaomas
Nov 19 2019 at 8:21am
The best argument for a wealth tax is that it would encourage more risk taking higher income investments, not to reduce wealth per se. Still I don’t think its worth the trouble when we have the alternative of a progressive consumption tax.
LK Beland
Nov 19 2019 at 9:05am
Reducing lifetime consumption inequality is not the only objective of a Warren-type plan. It’s also about reducing inequality of influence. Possessing lots of capital no only enables future consumption, but also provides decision-making power.
Furthermore, politically speaking, having the ability to make big campaign contributions once or twice is very different from having the ability to bankroll a party or candidates for, say, decades.
Of course, an ultra-wealthy person can evade the tax and become greatly influential by creating a foundation.
Scott Sumner
Nov 19 2019 at 1:05pm
Check out the recent debate between Summers and Zucman. Summers demolishes that argument.
MarkW
Nov 19 2019 at 1:56pm
Yes, if their wealth was going to be taxed away, billionaires they’d likely to be more inclined to spend it on political influence.
But the main reason why this ‘billionaire influence’ argument is bogus is that wealthy people have a terrible track record in ‘buying’ elections. Trump won despite being outspent first by Republican rivals and then by Hillary Clinton. Just recently, the influence of Amazon’s money (combined with a credible threat to move operations out of the city) wasn’t enough to secure majority support on the Seattle city council (the consensus seems to be their contributions may have actually backfired). Zuckerberg is one of the richest billionaires in the world and was thinking of running for president — how’s that going? Tom Steyer and now Michael Bloomberg have actually thrown their hats into the ring — again, how’s that working out? Tom Steyer has been spending 5 times more than the next closest candidate, and is still stuck at <1% support. Saturating the TV and radio airwaves with ads doesn’t work. Steyer could spend his entire fortune 10 times over and still not come close to securing the Democratic nomination.
LK Beland
Nov 20 2019 at 10:13am
Summers mostly refers to political influence, no?
On the other hand, wealth confers a lot of decision-making power in non-political contexts as well. Simply put, being the owner puts you in charge.
The Left has long made an argument that this concentration of power can be detrimental to society in several circumstances. The Right makes a good counter-arguement that past performance is a predictor of future performance. Obviously, Warren/Sanders share the former view, in addition to likely favoring immediate relatively equal consumption over unequal investment.
SamChevre
Nov 20 2019 at 11:57am
“A wealthy person could be influential and avoid tax by starting a foundation.”
That points to the one change that would get me to support this: it should apply to non-profit endowments as if the non-profit were an individual.
Floccina
Nov 19 2019 at 1:27pm
Would a 6% billionaire wealth tax lead to:
Billionaires for 20%/year inflation.
Floccina
Nov 19 2019 at 2:28pm
One of my pet peeves is mutual funds quoting expenses at the percent of the total investment rather than a percent of say average return over the last 10 years.
So why not call Warren’s 6% wealth tax a 100% + tax on wealth yields or something like that? What good is owning an investment with a negative return?
Gordon
Nov 19 2019 at 5:18pm
If more of the real output of the economy would be consumed by the wealthy due to a wealth tax, wouldn’t this reduce the real average income? Also, wouldn’t the decline in savings and investments push up real interest rates? I would also think that in cases where the wealth being taxed is in the form of commercial and residential real estate, tenants of those buildings would be hit with higher rents. Yes, the wealth tax is bad because of the disincentives it creates for saving and investment. But I think the key to stopping it is making the average person aware of the negative consequences for them.
Gordon
Nov 19 2019 at 5:19pm
Oops… I should have said real median income not real average income.
Mark Bahner
Nov 20 2019 at 12:39pm
If the taxes proposed by Warren or Sanders ever get implemented, it will be interesting to see how many billionaires simply leave the U.S. and become citizens of other countries. If I was a leader of another country, I think I’d try to make sure as many U.S. billionaires move to my country as possible.
How important is a physical presence in a particular location in this day of electronic communication?
Thomas Sewell
Nov 20 2019 at 11:42pm
They don’t even have to always physically leave. Their wealth just leaves instead, turned into business/assets in other countries. Billionaires can afford significant numbers of smart tax lawyers and accountants to prevent you from taking that much wealth from them.
As a side-effect of that dodging, they also stop funding payroll taxes, income taxes for other people, property taxes, etc… in the jurisdiction they depart their wealth from. That net loss of tax revenue is the main reason the vast majority of the European countries which tried out a (smaller than Warren’s) wealth tax for a few years repealed it. Their sentiments toward wealth hadn’t changed, but they were tired of losing tax money and rich people from their countries..
But in the United States, we’re apparently not to consider looking at the experience of other countries with the same policies being proposed here…
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