Why Wealth Taxes Could Be A Crony Capitalist’s Best Friend

by Reihan Salam

Recently, Jim Manzi addressed Thomas Piketty’s argument that an 80 percent top marginal income-tax on incomes above $500,00 or $1 million would have no negative impact on economic impact, and indeed that it might have a beneficial impact. Piketty rests his argument on the notion that much of the surge in top incomes can be attributed to the bargaining power of top executives. Essentially, Piketty maintains that top executives use their leverage to stack their corporate boards with allies; compliant boards then allow these executives to seize more income from the large business enterprises they manage. Because this activity adds no economic value, the government can, by raising top marginal tax rates, discourage this damaging extractive behavior without reducing economic output. Manzi goes on to explain why he believes Piketty’s stylized “bargaining power model” is unsound:

I don’t believe that his asserted finding is credible, for three reasons. First, there just aren’t enough top managers of relevant companies to account for most of the growing incomes at the top. Second, executives of public companies represent a shrinking share of top incomes. And third, Piketty’s “bargaining power model” for executive compensation in public companies is extremely naïve.

Not surprisingly, I think Manzi gets the better of the argument. Moreover, as Wojciech Kopczuk and Allison Schrager recently argued in Foreign Affairs, the policy prescription Piketty sees as the antidote to extreme wealth concentration, a progressive wealth tax, might actually make matters worse:

A recent comprehensive study of best taxation practices, headed by the economics Nobel Prize­–winner James Mirrlees, explicitly favored taxing the income wealth generates — capital income — instead of wealth itself. This is because a tax on wealth automatically preferences the well positioned wealthy relative to others — and not just because the well-positioned wealthy can set up offshore tax havens.

Imagine that wealth earns a five percent nominal return. A 20 percent tax on income, then, would collect about the same amount of revenue as a one percent tax on wealth. But suppose you earn above the market rate, as wealthier people often do, because of their investment talents or ability to take advantage of opportunities not available to others. The wealth tax is forgiving –- it will tax these extraordinary returns at only one percent –- while a capital income tax would continue to tax them at 20 percent. Disguising labor earnings as capital income, for example, by relying on carried interest, compensation using equity stakes, or certain types of stock options would lead to a similar distortion. In a sense, taxing wealth rather than income gives a subsidy to anyone who earns above market returns either through skills, luck, or privileged market access. In other words, it does just the opposite of what champions of wealth taxation desire.

For now, there is limited evidence that wealth inequality has changed or that we are in a new gilded age. But even if we do get there someday, the proposed cure, taxing wealth, will make the disease worse. [Emphasis added]

That is, the bargaining power of the wealthiest, most well-connected individuals might pay even bigger dividends under a tax regime that includes a progressive wealth tax. 

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.