Monday, October 27, 2014

Would Piketty's Wealth Tax Help America Strike It Rich?

Economist Thomas Piketty has caused all sorts of hullabaloo with his book Le Capital au XXIe Siècle (Capital in the 21st Century) because his thesis states that because the rate of return on capital is greater than the rate of economic growth in the long run (r > g), this results in such an unhealthy concentration of wealth that it creates societal instability. Its depth and usage of data have gained the attention of those who want to bring income inequality to the forefront of political issues. I do not want to get into the economic nitty-gritty of r > g right now (also see here, here, and here) or even discuss the extent to which wealth inequality is an issue. I would like to go after his idea of a wealth tax.

Piketty's proposal is relatively simple. In addition to taxing the income of the richest citizens, tax their wealth, as well, in order to better reflect the vertical equity of the rich. A wealth tax is essentially a tax on the returns on capital. Piketty suggested multiple rate schedules (see technical index of his book here), but one in particular that he would implement is a 1 percent tax for wealth totaling €1-3M  and a 2 percent tax for anything exceeding €5M. The collected tax revenue could be distributed to those in need, thereby remedying some of the maldistribution. Considering how high the Social Security or income tax rates are, 1-2 percent sound reasonably low in comparison to what the rich are already paying. What harm could a wealth tax cause?

According to the Tax Foundation, quite a bit. The Tax Foundation published a study just a few days ago (Schuyler, 2014) using an economic model in attempts to measure the economic impacts of such a tax. Their main results included reducing employment by nearly 900 thousand, reduce wages, and have the GDP take a nosedive of $1T, all to simply collect a few extra billion dollars in tax revenue. We can go after the flaws that the model almost certainly has, and we could even go after the fact that the leanings of the Tax Foundation are contrarian to those of Piketty. I don't find the latter to be productive, but regardless, why would such a tax be so problematic?

Forget the fact that even Piketty himself calls the idea of a global wealth tax "utopian," mainly because trying to collect that tax on a global level without a global taxing authority is essentially impossible at this time. Even if we attempted that a wealth tax on the national level, it would still be problematic. The closest thing America has right now is the estate tax, which is only collected on inheritances. This is not simply a matter of asking whether the rich in this country "pay their fair share" or if the rich are being whopped with a form of double taxation because a wealth tax is a surtax on income. If we went went Piketty's suggestion of starting the tax at the equivalent of $260,000, it would hit a lot of middle-class Americans because it's not unreasonable to assume that they have that much in wealth. This would also disproportionately affect seniors who are trying to save up for retirement and have finally reached the wealth tax minimum. Even with a higher tax minimum, you still run into these issues, just at a smaller magnitude. As we see with the Tax Foundation study, a wealth tax would reduce wealth inequality, but it would also increase poverty. There is also the matter of liquidating illiquid assets for the purposes of paying the tax, which would further jam up taxpayers. If you need a small list of countries that have abandoned the wealth tax, here's one: Austria, Denmark, Germany, Finland, Luxembourg, and most notably, Sweden. Taxation has two primary goals: 1) tax revenue collection, and 2) disincentivizing behavior. What are we disincentivizing here? Wealth. Since it's easier than ever for jobs and capital to cross borders in our increasingly globalized world, the last thing America needs to do is further punish wealth creation.

Let's say that the Pikettys of the world didn't care that the wealth tax would increase poverty because wealth equality is the prime goal. Can you imagine trying to administer this tax? In order to measure one's wealth, the government has to be able to make an itemized list of every asset and every bit of capital an individual has. That would include housing, land, stocks, bonds, cash, cars, jewelry and antiques, retirement savings, the list goes on. If you think administering a value-added tax is problematic because its multiple stages increases the likelihood of tax evasion, imagine how much of an intrusive nightmare it would be to account for every last piece of wealth in one's possession. And this is not mere theory: this has been an issue in the past (Seim, 2014Pichet, 2007). It is easier to value bonds and stocks, but have fun trying to put a price on other assets! This inventory check would not be a one-time endeavor, either. It would have to be done on an annual basis, and I don't see the government capable of doing it, especially given how it currently administers current redistributive programs. Amazing how Piketty thinks that too much concentrated power in the private sector is so problematic, but when it comes to government, they are somehow immune. Go figure. Let's not forget that the Constitution (Article I, Section 9, Clause 4) prohibits direct taxation, which means that either the Supreme Court would have to rule in favor of its constitutionality or the relatively more likely occurrence of Congress passing an amendment for a wealth tax, which I don't see happening anytime soon. Valuation, administration, and collection: a trifecta that kills the wealth tax's possibilities of having any practical benefit or application.

Much like I brought up last Friday, we don't need to go after the ever-abstract concept of income inequality in hopes to redistribute wealth "more fairly." Why are we so focused on outcome when we should be focused on institutions, incentives, and processes? We need a way to encourage entrepreneurship and stimulate economic growth, and a wealth tax is simply not the way to go.

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