[Noah Smith] Wealth tax better than most alternatives

By Bloomberg
  • Published : Feb 6, 2019 - 16:51
  • Updated : Feb 6, 2019 - 16:51

Close on the heels of Rep. Alexandria Ocasio-Cortez’s proposal to tax top income at 70 percent, Sen. Elizabeth Warren, D-Mass., has released her own big idea -- a tax of 2 percent a year on all wealth above $50 million, rising to 3 percent for those fortunes of more than $1 billion. The proposal, which would affect about 75,000 of the country’s wealthiest people, also comes with a set of measures designed to reduce avoidance and evasion.

The motivation for taxing wealth directly undoubtedly comes from the observation that the most prosperous Americans own a larger share than they used to.

Warren’s plan to tax some portion of this wealth has much to recommend it. Even though the number of people affected would be smaller than the crowd at some college football games, the revenue raised from the tax would be substantial -- economists who study inequality estimate that Warren’s plan would raise about $275 billion a year, almost four times as much as the most optimistic estimates for Ocasio-Cortez’s income tax.

Additionally, wealth taxes will probably seem fairer to many people than income taxes. Instead of taxing only future income, they tax the accumulated income of the past -- in other words, the existing rich can’t avoid the tax by being grandfathered in. A substantial fraction of the wealthiest Americans inherited their money instead of creating a business or earning a high salary; Americans are unlikely to shed a tear for heirs forced to give up a larger slice of their unearned fortunes. Even rich people themselves might be relieved not to have to worry as much about spoiled heirs - research shows that wealthy individuals who give most of their money away tend to be happier.

Finally, many Americans already pay wealth taxes, in the form of property taxes on their homes. Since the affluent tend to hold more of their wealth in stocks rather than in real estate, taxing those assets seems only fair. For all of these reasons, wealth taxes are likely to be a political hit. Polls already show strong support for taxes on the prosperous, and wealth taxes seem likely to be even more popular if anything.

What about economic harms? Even more than top-bracket income taxes, wealth taxes seem unlikely to substantially discourage entrepreneurship or risk-taking. As Paul Krugman put it: “How much would entrepreneurs be deterred by the prospect that, if their big ideas pan out, they’d have to pay additional taxes on their second $50 million?”

Wealth taxes could even increase the nation’s productivity. Many wealthy people don’t invest their fortunes particularly efficiently, earning mediocre returns on their assets. Economists Daphne Chen, Fatih Guvenen, Gueorgui Kambourov, Burhan Kuruscu and Sergio Ocampo-Diaz have suggested that wealth taxation could help to liberate this unproductive capital for more productive uses. Guvenen suggests using the tax to offset cuts in corporate taxes; although progressives seem unlikely to want to use it for this purpose, it’s hard not to notice that Warren’s tax plus US President Donald Trump’s recent corporate tax cut would end up implementing Guvenen’s idea almost exactly.

Rich people can afford to hire expensive accountants and lawyers to hide their income offshore, or keep it in assets whose value compounds while generating little income. By adding a second layer of taxation, wealth taxes would make hiding from the taxman more difficult.

So wealth taxes have a wide array of advantages. Still, there are downsides. Because much wealth isn’t traded in a liquid market, valuations have to be estimated from models opening the door for both unfairness and for avoidance. A whole cottage industry might spring up around undervaluing assets for the purpose of dodging taxes. There’s also the possibility of capital flight -- wealthy people moving their money out of the country, straining the economy. It was partly because of capital flight that some European countries, such as Sweden, got rid of their own wealth taxes in the 1990s and 2000s.

Finally, a wealth tax may be legally very difficult to implement in the US. The constitution forbids so-called direct taxation of property by the federal government -- note that property taxes aren’t federal -- except for certain rare exceptions. So Warren’s plan might require a constitutional amendment.

If these difficulties prove insurmountable, Warren and other egalitarian tax crusaders might consider an alternative -- an inheritance tax, which would close many of the loopholes that now riddle the US estate tax. Taxing all income from inheritances -- including trusts, foundations, gifts, estates, and any other kind of family transfers -- at a very high rate would yield a result similar to a small annual wealth tax, only its constitutionality would be less in doubt. And it would focus the tax on the rich people whose fortunes Americans are most likely to think of as being undeserved.

But whether it’s Warren’s plan or an alternative, a wealth tax seems like good idea for the modern US. One way or another, it seems as if higher taxes are coming, and this tax seems better than most.

Noah Smith
Noah Smith is a Bloomberg Opinion columnist. -- Ed.