Democrats running in the U.S. presidential election primaries have not been short of radical policy proposals. These range from the introduction of national health insurance (“Medicare for All”) to the payment of a universal basic income for all adults (the “Freedom Dividend”).
One hotly debated idea, championed by Elizabeth Warren and Bernie Sanders, is introducing a “wealth tax” aimed at the richest citizens. The details of the plans from the two presidential hopefuls are different, but the basic idea is the same: The U.S. suffers from excessive inequality, and a wealth tax would reduce these disparities and raise revenue to be spent on health care, infrastructure and education.
Two recent debates at a conference at the Peterson Institute for International Economics offered a cautionary tale against wealth taxes. On the one side there were Emmanuel Saez and Gabriel Zucman, two economists at the University of California at Berkeley who have just published a book, “The Triumph of Injustice,” and are advising Warren on her tax plan. On the other, economists including Larry Summers and Gregory Mankiw of Harvard University who have scrutinized and criticized their work.
Overall, Saez and Zucman failed to make a convincing case for their proposal. Their eye-catching claim that the very richest now pay less tax as a proportion of their income than the poor is based on highly dubious assumptions. A wealth tax also suffers from a string of substantial practical and theoretical problems not shared by other ideas to reduce inequality, such as raising capital gains taxes or closing estate-tax loopholes. As Summers put it during the debate: “For progressives, to use their energy on a proposal that has a more than 50% chance of being struck down by the Supreme Court, little chance of passing through Congress and whose revenue-raising potential is very much in doubt, is to potentially sacrifice immense opportunities.”
The problem with the analysis offered by the Berkeley economists starts with their stunning finding that was recently advertised in a widely-shared column in the New York Times. Saez and Zucman claim that in 2018, the top 400 earners faced a lower effective tax rate, measured as a share of pre-tax income, than everyone else. This finding is only based on an estimate, since the actual data for 2018 are not yet available. Moreover, as noted by Wojciech Kopczuk, an economist at Columbia University, the result hinges on making some extreme assumptions on the incidence of taxation and the measurement of pre-tax income. As Kopczuk noted, their calculation is presented as a “fact” when it is not.
Of course, one can still believe that the rich should pay much higher taxes regardless of what exactly happened to their tax rate. Any policy-maker can legitimately prefer greater redistribution. The tax burden in the U.S. is significantly lower than in most other OECD countries. There is a good case to be made that the U.S. should increase revenues and spend more on education and infrastructure. The question, however, is which taxes are best suited for this aim.
Zucman believes that wealth taxes have several advantages. They allow one to overcome what he identified as the “Warren Buffet problem”, after the billionaire founder of Berkshire Hathaway, who once famously said he pays a lower tax rate than his secretary. Buffett’s annual income flows mainly from him selling a small proportion of his shares, on which he pays a capital gains tax. Capital gains taxes don’t take into account the enormousness of Buffett’s wealth, which would be taxed under Sanders’s and Warren’s plans. Moreover, unlike an estate tax, a wealth tax allows the state to obtain revenue immediately, rather than waiting until the death of a billionaire. Saez and Zucman believe that Warren’s plan — which would tax fortunes over $50 million at 2% annually, and those over $1 billion at 3% — would raise $2.75 trillion over the course of 10 years.
However, there are reasons to be skeptical of this number. For starters, you would expect billionaires to make different choices when faced with a wealth tax. They could donate much of their money to a charity, for example, or decide to spend more of it; a wealth tax could then end up encouraging lavish consumption. Mankiw outlined the paradox that a wealth tax would spare a wasteful top manager who spends all his income annually, while hitting a frugal one who saves a lot and perhaps invests in successful start-ups. Finally, a wealth tax is a form of double taxation, because the money was often taxed when it was earned, and because it would recur every year. (An estate tax, sometimes also called a form of double taxation, is at least levied only once.) As such, one wonders to what extent it is as fair as its proponents suggest.
There are also important practical problems: Billionaires’ wealth often stems from private companies. Private valuations of unlisted companies can often be spectacularly wrong. Zucman suggested that billionaire owners of private firms should be given the option of paying the wealth tax based on an estimated value or payment of shares. But the idea that the state would over time acquire significant holdings of some private companies is also problematic, as it would amount to — at least temporary and partial — nationalization.
There are other ways to make taxation in the U.S. more progressive: Summers proposed increasing the capital gains tax and getting rid of the exemption whereby capital gains escape taxation at death. One could close other loopholes around estate taxes, and perhaps raise them. If the goal is helping the poor rather than whacking the rich, one could also imagine greater transfers to those at the very bottom of the income scale funded through other, more conventional taxes, such as the corporate income tax.
A wealth tax may sound good to some progressives, but once you think about the details, its limitations become obvious. There are smarter ways to make America fair again.
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Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.