Wealth is hard to measure and easy to hide.
Wealth is hard to measure and easy to hide.
C alls for a wealth tax are rising across North America. Bernie Sanders and Elizabeth Warren each endorsed such a tax when running for the Democratic nomination. Its political attraction plays on the populist fantasy that taxes can painlessly be shifted to rich people and corporations. The temptation to adopt a wealth tax will grow in the aftermath of record budget deficits resulting from the pandemic-induced recession.
The political receptivity to a wealth tax is reinforced by a growing intellectual hostility to wealth inequality, most evident in Thomas Piketty’s Capital in the Twenty-First Century. The French economist argues that inequality will widen indefinitely because the return on wealth assets exceeds the growth of income from production.
However, the case for a wealth tax rests on questionable or unfounded assumptions. For one, it is unclear that inequality is even widening. Different ways of estimating wealth yield conflicting results, leading one expert to observe, “Overall, the existing evidence on what happened to the concentration of wealth in the last few decades is not conclusive.” Credit Suisse’s Global Wealth Databook shows the top decile’s share was little changed between 2000 and 2017, although the very wealthiest fared better.
Widely publicized annual, and, more recently, daily, lists of individual wealth contribute to the assumption that wealth is easy to measure and tax. The reality is more complicated.
Donald Trump personifies the difficulties of estimating wealth. Despite extensive public scrutiny of the president, estimates of his wealth vary widely, from his own boast of more than $10 billion to Forbes’s estimate of $4.5 billion and Bloomberg’s $2.9 billion. The dispersion reflects the difficulty of judging which assets to include, how to value those assets, and how to calculate liabilities (people often forget wealth is assets net of liabilities, one reason a property tax is not a true wealth tax). Trump himself appears to conflate income with revenues, overlooking the expense of operating his various assets and not deducting loans and mortgages, especially properties where he is part owner.
Compiling wealth estimates is complicated. By definition, it is easiest to price widely held assets such as housing, stocks, and bonds, but these are mostly exempt from wealth taxes (many stocks and bonds are held in pension accounts). Wealth taxes fall mostly on illiquid assets, including private equity holdings, small businesses, and works of art, which therefore are hard to price. This quandary in estimating wealth is almost impossible to resolve.
Proponents argue that wealth taxes generate substantial net revenues: Sanders claimed his version would yield $4 trillion over a decade, while Warren’s promised $500 billion. However, Europe’s experiment with wealth taxes yielded little revenue. The dearth of revenue reflects the exemption of most housing and pension savings, keeping the tax rate low to forestall capital from leaving the country, and households acting to minimize their taxes. As a result, wealth taxes raised only 1.0 percent of GDP in Spain and Switzerland, 0.4 percent in Norway, and 0.2 percent in France in 2017, not enough to significantly affect either government finances or wealth distribution. As a result, most European nations abandoned wealth taxes years ago.
Wealth taxes are costly to administer for several reasons. The easiest taxes to collect involve transactions where one of the parties has an incentive to honestly report the details to the government. Most of our tax system functions “automatically” because this incentive exists; employers report income paid to employees because it is a deductible business expense. Problems in taxation arise when the incentive to be transparent weakens. Transfer pricing of cross-border transactions within a firm is problematic because firms adjust prices to minimize taxes. Small business and sales taxes incentivize customers to pay cash and save on taxes.
A wealth tax is rife with administrative problems because it creates the incentive to minimize reported wealth. Asking people to evaluate their own worth invites underreporting. Having outside assessors do the job is expensive and leads to disputes over the valuation of illiquid assets.
Besides, taxpayers can easily circumvent a wealth tax. Canada’s former Prime Minister Jean Chretien warned that “there is nothing more nervous than a million dollars — it moves very fast, and it doesn’t speak any language.” High taxes to pay for the First World War created Switzerland’s tax-evasion industry. The ease of moving money across borders has since increased and is growing with the proliferation of technologies such as cryptocurrencies.
Compounding the mobility of capital is the willingness of people to move to avoid or minimize taxes. One study of estate taxes found that 21.4 percent of the 400 richest Americans moved from states levying an estate tax to a state without one, while only 1.2 percent did the reverse. As a result, $80.7 billion in wealth avoided estate taxes in 2010. States without an estate tax benefited from income taxes on high-net-worth people moving in.
A wealth tax also distorts economic incentives, encouraging consumption while penalizing the savings and investments that foster higher long-term growth. This is especially true when wealth taxes are layered on top of taxes on the capital income that wealth generates.
A wealth tax presumes that changes in wealth are driven only by economic factors. In reality, demographics play an increasing role in wealth dynamics. Older people inevitably have higher wealth because they had longer to accumulate assets. As our aging population inflates the number of wealthy people, taxing the wealthy can really mean taxing the elderly.
Instituting a wealth tax means fiscal policy contradicts monetary policy. Asset prices and therefore wealth soared after the Great Financial Crisis when central banks around the world slashed interest rates and adopted Quantitative Easing. Low interest rates boost prices by stimulating demand for assets such as stocks and housing. Quantitative easing reinforced this with direct central-bank purchases to bid up asset prices.
Central banks hoped rising asset prices and wealth would stimulate spending. A wealth tax would depress demand and the price of assets. Without passing judgment on monetary policy, a wealth tax contradicts the intended effect of these policies. If wealth inequality is regarded as pernicious for society, central banks should stop pursuing policies that increase wealth and inequality in the first place.
The goal of taxing wealth is unclear. Its design, level, and even necessity depends on what proponents hope to achieve. Is the goal maximizing government revenue? Reducing inequality? Punishing the rich because some wealth was acquired in a dubious manner? Preventing wealth from corrupting democracy? The answer to these questions partly depends on how one perceives wealth.
Economists and the general public have conflicting views of wealth, which helps frame how it should be taxed. One view is that wealth is the stock of past accumulated savings, resulting in an economy dominated by Ricardo’s parasitic landowners where wealth is passive and often unearned. Taxing such wealth has few negative economic effects and may help reduce the dominance of past savings that led Piketty to claim “the past devours the future.”
A competing view of wealth looks more to the future than the past. From this perspective, wealth is a claim on future output arising from investments in machines, houses, and other assets, and results from profits that are the proper and socially useful reward that allows capital to be accumulated. The epitome of this view are the billionaires spawned by high-tech companies, not the owners of large estates. Since wealth is deployed in investments that benefit the economy, it should not be taxed. Instead governments should claim some of the capital income that wealth generates, thereby minimizing the negative impact on investment and growth.
Adopting a wealth tax based on dubious assumptions and narratives about inequality would be harmful to economic growth, raise few revenues, have little impact on inequality, and contradict the conduct of monetary policy. A wealth tax penalizes savings and encourages consumption, even frivolous spending, over investment. It says society prizes redistribution ahead of growth and equity over efficiency, the wrong signals to send when a decade of sub-par growth was capped by the worst economic downturn since the Great Depression.