Wednesday, February 26, 2020

A Better Wealth and Taxes

CATO has put out a much-improved version of my "Wealth and Taxes" series on wealth inequality and the wealth tax. Html here and pdf here. Many thanks to Chris Edwards and the CATO staff for editing and formatting it, and getting it out in this nice format. 


Alan Reynolds wrote with interesting comments. Among others,
the $18+ trillion now invested in retirement, education and health savings accounts has gradually made middle-income investment income more and more invisible in tax returns as time moved on.   Exemption of $500,000 of capital gains on home sales further reduced the IRS-reported capital income of all but the top 1%.
...the Saez-Zucman methodology is sure to show the rich having a larger and larger share of taxable income from capital, and therefore of wealth based on that taxable income, because income from the savings of middle-income taxpayers has become increasingly unreported. 
Bottom line:
Because tax laws exempted a rising share of investment income (and residential capital gains) of the bottom 95%, the visible portion left showing for the top 1% must appear as a rising share (of a meaningless total). 
I still like my 2006 WSJ title: "The Top 1% of WHAT?"  Pre-tax, pre-transfer income reported on individual income tax returns was never meaningful, and capital income on those tax returns is incomparable over time. 


  1. The income tax is a terrible way to apply taxes. First of all, it tends to be a tax on productive behavior, not quite as bad as wage taxes but pretty close.

    Secondly, there are gigantic fog zones such as the concept of adjusted gross income and the simple non-reporting of income because it is offshore.

    Income taxes have become a domestic and international shell game Gong Show.

    Still, I cannot abide by the idea that income stratification can continue forever without some sort of political consequences. The American voters are getting ready to put a socialist or a populist in the White House.

    What we are seeing may only be the first chapter of voter response to excessive income stratification and soaring rents.

    The United States should move to a system of national sales taxes, property taxes, fuel taxes, and import taxes. Cut military outlays in half and phase out the VA.

    Search tax reform is highly unlikely, due in no small part to the entrenched interests that have evolved around the current tax system. And as for the elimination of property zoning that will happen in a better and future world.

    Ergo, get ready for Trump or Sanders in the White House and possibly worse to come.

  2. Investment income of the bottom 95% which is mostly in IRA's, 401s, and 457's is not tax free, only tax deferred. When you reach my age you are forced to take a portion out of the account each year and pay taxes on 100% of the withdrawal.

  3. Very nice article. It's great that this topic is finally being examined.

    You ask "why care about inequality?" Here's the economic reason: Because utility from wealth is convex, then the maximum utility from a fixed amount of wealth will be realized (in the cross section) when there is NO volatility or noise in the cross-section.

    So, if wealth in the US is X, the distribution of that wealth will have maximum utility when distributed equally to each person. That's basically the socialist/communist argument in a nutshell, and it is valid.

    The capitalist argument is that wealth is NOT FIXED. By providing for the possibility of inequality as a function of helping others, we can grow national wealth. And, that the growth of national wealth from zero (which is what happens if you actually just distributed everything equally) is definitely worth it.

    Thus, optimal policy that maximizes utility of wealth over the long run is simply the integral of utility from wealth at every point. Given that at every point utility from wealth is maximized by equal distribution, but that will have negative implications regarding the size of wealth, any optimal policy must balance these two dynamics.

    That's the "why we should care about inequality".

    1. You are making a lot of assumptions, many of which are not true. Even allowing your hypothesis, it assumes utility from a marginal dollar of wealth is equal for every person. But we have hundreds of millions or even perhaps billions of observations where this is not true. Many people have the ability to earn far greater income and accumulate far more wealth than they do. But, they choose not to because of other factors affecting their utility. Those who value wealth more highly tend to be the ones who create more wealth.

  4. "Economists have no professional expertise to object to
    redistribution or argue for it."

    That may be the tradition, but it's not really true. Economists can take the moral sentiments and translate them into equations that clarify the logic of what's going on.

    People intuitively understand this idea that wealth concentration is "bad." Economic concepts can explain this:
    - The idea that there is a utility from wealth function.
    - That the utility from wealth declines.
    - How a sum of f(x) is not the same as f(sum of x).
    - that the f(sum(x)) > sum(f(x)) when there's any variance in x, when were talking about a function with a declining marginal value.

    This idea of looking at variance of wealth in the cross-section is something that may be novel to economics, but it's hiding in plain sight.

  5. You have no data for the “don’t tax rates of return” conjecture.

    In fact, the globally widespread use of property taxes to fund municipalities is exactly that. It works for municipalities wealth and poor alike, with great success.

    Before writing taxes on assets off, go and figure out why it works so well in practice.

  6. "People react to a tax on rates of return by saving less and consuming more."

    Why do you care about that? The government should not be deciding how people should save. Especially because in the long run, all savings turn into consumption, the long run total amount of savings is 0. Similarly, we cannot consume greater than our income over time. So over a long time, the amount of savings and the amount of consumption will be equal over both regimes.

    If that's so, we should collect taxes in the way that bothers people the least. That is certainly not income taxes.

  7. "A tax on rates of return taxes when you consume, not your
    overall level of consumption."

    If we're targeting the dollars least cared about, then "when I consume" is exactly what we want to do, actually. Because I don't need the money NOW, that implies that i don't care about it as much as money that I actually do need now.

    Taxing dollars that I'll only need in the distant future is actually a great way to make sure that we never tax funds that are needed now for emergencies, child care, food, or whatever.

  8. "Put another way, the wealth tax—like a rate of return tax—
    taxes money that has already been taxed."

    Yes, but that's OK. Should municipal property tax be a one-time payment? Is it a problem that your house is taxed more than once?

    No, because your payment on your house roughly corresponds with your use of municipal services and municipal protection of your property rights. Which is something that increases in value with time.

  9. "A substantial wealth tax would be a neon sign to the
    wealthy: Don’t save your wealth, consume it now! Take a private jet on a round-the-world tour!"

    That's how wealth inequality is reduced, actually. The only way to reduce inequality without forced redistribution is by encouraging the wealthy to consume more.

  10. "A progressive wealth tax, like the progressive income tax,
    strongly discourages risk taking."

    This is true. But the distortion effects are greater from a 35% income tax than from a 6% wealth tax, so the wealth tax actually wins here too.

  11. "The proposed wealth tax would tax away the incentive to
    get rich."

    What's worse than taxing away the INCENTIVE to get rich is taxing away the ABILITY to get rich. Income tax taxes away the ABILITY to save, and we see this by looking at the huge percent of the population with no savings.

    In any case, this statement is actually wrong. Wealth taxes tax away the incentive to STAY rich, not to GET rich. Wealth taxes would encourage you to get rich, but then spend the money. That's actually very good.

    Income taxes mean you're not going to get rich, so you're going to stay poor and not spend any money, ie: save whatever little you have.

  12. and taxed at ordinary income tax rates, not the more favorable capital tax rates.

  13. Reynolds's observation about the non-reported capital income of the middle class is very astute. Interestingly, some people worry that tax-sheltered investment accounts are giveaways to the well off. However, if the contribution limits are tuned well to target most of the tax benefits to the non-wealthy, then we would indeed expect to see the wealthy's share of *taxable* investment income grow.

  14. I'm of the opinion that tax laws are structured in such a way to incentivize people to risk capital to start and run a business. Without access to these deductions, the incentive to start and run a business would be severely diluted. Now, it makes rational economic sense to take advantage of deductions as much as possible - this goes for businesses and individuals. The big difference is that businesses have access to more deductions. And, at the end of the day, people own businesses, which can help generate wealth, which then, hopefully, gets redeployed out into the larger economy. Wealth is ultimately used, or should be.


Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.