Columbia University public finance economist Wojciech Kopczuk, who is also editor-in-chief of the Journal of Public Economics, arguably the top journal in public finance, has a first-rate critique of a proposal by Emmanuel Saez and Gabriel Zucman for taxing wealth. Saez and Zucman are professors of economics at University of California, Berkeley.
I’m working my way through the paper and found one statement up front that non-economist readers might find implausible but that is correct. Kopczuk writes:
An individual with this year’s stock of wealth W earning the return of r could be next year (assuming away any consumption) subject to a tax that is imposed on either (1+r)W or rW — a wealth or a capital income tax. It is immediate to see that absent any other considerations, a tax of t on wealth is revenue-equivalent to a tax of τ=(1+r)t/r imposed on capital income rW. This links the two bases and provides a straightforward comparison of the burden that a wealth tax would impose on capital income. If you consider a safe rate of return of, say, 3%, a 3% wealth tax is a 103% tax on the corresponding capital income and a 6% tax rate is a 206% tax. Obviously, even though wealth tax rates appear nominally small, they are in fact very heavy taxes on the corresponding streams of income.
Really? A 3% tax on wealth amounts to a 103% tax on capital income? Yes, it really does. It probably isn’t “immediate to see,” as Kopczuk writes. But it’s true.
My point here is to make his point clear by filling in the missing math.
If someone starts the year with wealth W and earns a rate of return of r on that wealth, at the end of the year she will have a wealth of (1+r)W. [Why do I say “she?” Because the tax that Saez, Zucman, and Senator Warren advocate is on the wealthy and the wealthy are disproportionately old, and the old are disproportionately female.]
So the tax will be t(1+r)W, where t is the tax rate on wealth.
But t(1+r)W = t(1/r +1)rW.
So the tax rate of t on W amounts to a tax rate of t(1/r +1) on rW
But notice that rW is the return on capital. QED.
Now plug in some plausible numbers.
Kopczuk starts with a 3% tax on wealth.
So the tax rate on income from wealth = 0.03(1/0.03 + 1) = 1 + 0.03 = 1.03. So indeed a 3% tax on wealth is a 103% tax on the income from wealth.
Start with Elizabeth Warren’s 2% tax on wealth. The tax rate on income from wealth, therefore, = 0.02(1/0.03 +1) = 0.687. That amounts to a 68.7 percent tax on the income from wealth.
READER COMMENTS
Matthias Görgens
Nov 22 2019 at 8:03pm
The conclusion is that a wealth tax would most likely raise the pre-tax returns to most capital.
Vivian Darkbloom
Nov 23 2019 at 1:17am
The Netherlands has an interesting form of wealth tax. The taxable base is derived by starting from most savings and investment assets, then subtracting liabilities associated with those assets. This amount is multiplied by a fictional (annual) return on investment and then subject to a tax at the rate of 30 percent. For the 2019 tax year the taxable tiers are for assets €30,000-€71,650, €71,650-989,736 and over €989,000. Effective rates rise progressively for each successive band and are re-calculated annually as a percentage of the estimated average annual national return. For 2019 the rates are 1.935%, 4.451% and 5.60% Is this a tax on (fictional) income or is a progressive tax on wealth? Anyone can play the semantics game; but, substantively, in 2019 it is the equivalent to a progressive .5805 to 1.68 percent annual tax on assessable wealth.
This system was first adopted in the 1990’s and was the brainchild of then Finance Minister Willem Vermeend. The important thing to keep in mind is that with respect to assets subject to the tax, this replaced the tax on actual income and capital gains. Thus, most dividends, interest and capital gains are not taxed directly.
The system seems to have worked fairly well so far. It addresses the issue of deferral and seems, in my view, contary to a system that taxes actual “income”, to “reward” assets that are invested productively and “punish” those that are not.
I would not be strongly opposed to a wealth tax such as this. One main difference with the Warren proposal is that it does not pile on a wealth tax on top of the existing income tax (or even increase the latter at the same time as Warren proposes to do).
The complexity of the Dutch system is primarily in deciding which assets are subject to the tax. Most closely held business assets (greater than 5 percent ownership of sharess) are exempt, for example, and continue to be subject to a more normal income tax scheme (with deferral, of course).
Thaomas
Nov 23 2019 at 7:36am
As far as I can understand the desire to tax “wealth” grows out of discontent with the special treatment of “capital” income and real estate income relative to other forms of income. This gives rise to the famous Warren Buffet problem of the seeming unfairness of Mr Buffet having an average tax rate lower than that of his secretary and more generally that those with high incomes are not paying their fiar share of the costs of running the government.
The special treatment of “capital” and real estate income in turn I think grows out of a vague sense of consumption rater than income as being the more appropriate tax base because others benefit from a person’s non-consumption and because taxing all income equally “distorts” the choice between current and future consumption. [The special rate for capital gains is in response to the problem of not indexing capital gains and not averaging the tax rate on gains over the holding period.]
If one thinks that the addition of a wealth tax makes the whole system a closer approximation to a proper progressive consumption tax, one might favor a wealth tax as a second best policy.
Personally I’d prefer to try making changes to the income tax
system to push it closer to a consumption tax: higher nominal rates on personal income, no business taxes, imputation of business profits to shareholders, indexing and averaging of capital gains and deductions for saving/reinvestment of income with rates set to eliminate the structural deficit.
Todd Ramsey
Nov 23 2019 at 10:40am
AFAIK, Warren does not eliminate the capital gains tax, further increasing the marginal tax rate on capital income.
Furthermore:
“Note: Elizabeth originally proposed a wealth tax of 2% on wealth between $50 million and $1 billion, and a 3% tax on wealth above $1 billion. On November 1, 2019, Elizabeth proposed an additional 3% surtax on wealth over $1 billion – bringing the total annual rate to 6% on every dollar over $1 billion – which generates an additional $1 trillion in revenue.” https://elizabethwarren.com/plans/ultra-millionaire-tax
Apparently she does not believe the new tax will have any incentive effects.
Daniel
Nov 23 2019 at 10:56am
Dr. Kopczuk has a great paper full of compelling reasons on why we might prefer more “vanilla” taxation schemes than a wealth tax, but the “an X% wealth tax is actually a Y% capital income tax” line isn’t one of them. It’s important to note that the same revenue can be achieved from a similar same tax base but very different collection mechanism, which is one of the good points of the paper, but translating things around to make scarier numbers isn’t helpful.
Dr. Sumner provides a simple example for this: https://www.econlib.org/income-tax-rates-are-a-misleading-indicator/
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