The Agenda

Thomas Piketty’s Wealth Tax Proposal Has Huge Problems

EDITOR’S NOTE: I recently had the good fortune to meet James Wetzler, who until December of last year served as a director in the New York City office of Deloitte Tax LLP. From 1988 to 1994, Mr. Wetzler served as Commissioner of Taxation and Finance of New York State, having been appointed to that position by Governor Mario M. Cuomo. And from 1973 to 1984, he served on the staff of the Joint Committee of Taxation. There are very few people who understand the ins and outs of taxation in the United States as well as Mr. Wetzler, and so I’m delighted that he has agreed to share some of his thoughts on economist Thomas Piketty’s important new book, Capital in the Twenty-First Century. Rather than address the analytical core of the book, Mr. Wetzler delves into some of the practical questions raised by the book’s central policy prescription — a progressive wealth tax that would be harmonized across the advanced countries by international agreement.

There’s a lot to like in Thomas Piketty’s Capital in the Twenty-First Century. He and his colleagues have collected and refined a vast amount of data on income, wealth and inequality in various countries over several centuries, and Piketty can explain long-term trends in wealth inequality with a simple relationship between the rate of return on investment (after taxes) and the rate of economic growth. In a nutshell, when the rate of return is high, top wealth-holders can maintain their desired lifestyles and still be able to save; when economic growth is slow, they don’t have to do much saving in order for their wealth to grow faster than the economy so that inequality grows. Most strikingly, Piketty interprets the trend towards greater equality in most of the twentieth century, which many viewed as a new normal, as an aberration arising from exceptionally high economic growth after World War Two and exceptionally low rates of return between 1914 and 1945 on account of war and depression. What is normal, in his view, is the increase in inequality since 1980. While stopping short of making an actual forecast, he concludes that, absent aggressive policy intervention, the Western world appears to be headed towards a plutocratic dystopia characterized by wealth inequality approaching that of ancien régime France.

His policy intervention of choice is a progressive tax on personal wealth levied by all advanced countries.

What are we to make of Piketty’s wealth tax proposal? Is it realistic? Or should policy entrepreneurs concerned about inequality focus instead on increasing the progressivity of the existing array of taxes? Several issues arise:

(1) Who would bear the economic burden of a wealth tax? In Piketty’s model, where top wealth-holders satiate themselves with consumption and save the rest of their disposable income, the super-rich would finance their tax payments by selling assets. Unless government uses the revenue from the wealth tax to augment national savings, such as by repaying national debt or providing savings incentives to the non-wealthy, some of the wealth tax burden will be shifted from the wealthy taxpayers to workers: the asset sales by the rich will lead to a reduction in investment, lower productivity and, over a period of time, lower wages. The world has little experience with this type of taxation and little evidence on which to base predictions on how taxpayers will respond.

(2) Piketty’s proposal is directed largely to Europeans, and they will want to know whether the United States would participate in an international effort to impose a wealth tax. The answer is almost certainly not. The U.S. Constitution prohibits direct taxation by the federal government unless the tax burden is apportioned among the states on the basis of their population. (The Sixteenth Amendment exempted the personal income tax from this requirement.) Apportionment is generally viewed as a non-starter because it means higher tax rates on taxpayers in states with lower per capita tax bases, and a constitutional amendment hardly seems likely in any foreseeable political environment. Chief Justice Roberts’ opinion in the Affordable Care Act case makes it quite clear that a wealth tax (unlike the individual mandate) would be a direct tax subject to the apportionment requirement.

(3) For cross-border investment, a wealth tax could be imposed either on the basis of where the owner is resident or where the wealth is located. Unless all countries that are attractive residences for wealthy people impose such a tax, a residence based wealth tax with rates high enough to have a meaningful impact on inequality is vulnerable to out-migration by wealthy taxpayers. Failure of the U.S. to impose a wealth tax may well rule out Europe’s use of the residence basis unless the U.S. is prepared to make its tax system unattractive to wealthy in-migrants in other ways. Furthermore, in any multilateral negotiation over a common tax scheme, countries that are recipients of in-bound investment are unlikely to agree to cede their ability to tax it to the countries where the investors live. Location-based wealth taxation, however, is difficult to apply to intangible assets or to impose on a progressive basis, and it must address complexities associated with the fact that so much wealth is owned by corporations and other legal entities with dispersed ownership. These are all problems with existing income taxes, and there is no reason to believe they would be less problematical under a wealth tax.

None of these problems are necessarily unsolvable and workarounds may exist; however, they’re not easy, and my advice to people concerned about inequality is to focus on making better use of such existing tax instruments as the personal income and wealth transfer taxes rather than to pursue a wealth tax.


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