In the last couple of days, I’ve been going through old exams and problem sets for my economics courses that I taught from the mid-1980s until a couple of years ago. I found a problem I put on a problem set that readers might find interesting.
Here’s the background, and it’s background I gave the students. In 1999, Donald Trump proposed a one-time tax on Americans’ wealth. His proposed tax rate would have been 14.25 percent and it would have been on individuals and trusts worth $10 million or more.
Shortly after, Bruce Bartlett, then a senior fellow with the National Center for Policy Analysis, wrote an op/ed in the Wall Street Journal analyzing Trump’s proposal. Here’s the part of his op/ed that I asked my students about:
Regardless of the rate imposed, a plan like Mr. Trump’s would lead to an enormous amount of income shifting. Presumably, someone with assets of $9,999,999.99 would pay nothing, while someone with $10 million would pay $1.425 million. That means that anyone with assets between $10 million and $11.425 million would have an enormous incentive to consume or simply give away $1.425 million.
Here’s the question I asked:
Is he [Bartlett] correct? Explain why or why not. [HINT: think carefully on the margin.
Take a shot, but, as Bryan Caplan likes to say, show your work.
READER COMMENTS
Mike Hammock
Dec 18 2019 at 8:02pm
Why would someone with, say, $11 million (which is between $10 million and $11.425 million) choose to give away $1.425 million?
Jonathan S
Dec 18 2019 at 8:28pm
You are correct that a person with $11 million wealth wouldn’t want to consume and/or give away $1.425 million. This person would have an incentive to consume and/or give away $1,000,001 to get below the $10 million threshold. If they didn’t consume or give anything away the resultant wealth would be $11 million * (1-0.1425) = $9,432,500.
The last sentence would be better if phrased: “That means that anyone with assets between $10 million and $11.662 million would have an enormous incentive to consume or simply give away up to $1.662 million. There becomes less of an incentive to consume and/or give away the closer one’s income increases to $11.662 million.“
Oscar Cunningham
Dec 19 2019 at 4:30am
Even if you had $12 million you might decide that quickly consuming $2 million was better than paying $1.71 million in tax. You get $2 million worth of consumption at only $0.29 million cost. Of course you’ll be getting less value from that consumption than you usually would, because you’re forced to do it more quickly than you would have liked. But for any given ratio of employability of quick consumption against enjoyability of long term consumption we can calculate a maximum wealth at which it would be worthwhile to spend down to $10 million immediately, and that maximum will be greater than or equal to $11.662 million with equality reached in the case where fast consumption is completely worthless.
Oscar Cunningham
Dec 19 2019 at 5:01am
The word “employability” is here a typo for “enjoyability”.
David Henderson
Dec 19 2019 at 8:29am
Well done, Jonathan S.
Phil H
Dec 18 2019 at 10:01pm
Wouldn’t a tax like this normally be levied on *that part of the estate exceeding 10M*? So the guy with the $11M estate would actually be liable for $140k?
What you might get is a bunch of selling. A person with $20M in real estate would have to pay $1.4M, and they may well not have that in cash, so you would get a boost in liquidity for high-value fixed assets.
robc
Dec 18 2019 at 10:10pm
The current federal beer excise tax is $3.50/bbl on the first 60000 bbls and $16 after that as long as you brew under 2MM bbls. If you brew over 2MM it is a flat $16/bbl on the first 6MM and $18 above that.
So the marginal tax on the 2,000,001st bbl is $750,016.
When both Sam Adams and Yuengling reached that point in their growth, they paused for a few years just under 2MM then jumped well past it. No point in squeaking over the line.
Its the exact same issue.
David Henderson
Dec 19 2019 at 8:30am
Nice analysis. I didn’t know that about the beer tax.
MG
Dec 19 2019 at 5:15am
I am assuming that the proposal does not refer to marginal wealth (unlike Phil H’s caveat). I think Prof Henderson is going to be in Jonathan S’s camp who shows that unless the wealth tax is 100+% there is always a residual dollar to save by giving away, consume, etc. But I think Mr Barlett was referring to income shifting within the control of an individual, say by creating more and more trusts, (which are separate legal entities) like what people did back when income taxes climbed into the 90%. Also, giving away to you family ahead of schedule, prepaying expenses. all could be done and not reduce utility (much).
Vivian Darkbloom
Dec 19 2019 at 7:57am
Three problems (at least) with the op-ed:
First, as others have noted, Trump propod a one-time tax of 14.25 percent on wealth exceeding $10 million. The proposal was clear that the tax was only on each dollar of wealth exceeding that threshold.
https://www.businessinsider.fr/us/donald-trump-wealth-tax-from-1999-more-severe-elizabeth-warren-2019-10
Second, as others have also noted, the comment on wealth “between” $10 million and $11.425 million is non-sensical and at best ambiguous. A person with exactly $11.425 million might have an increased incentive to give away or consume up to $1.425 million to exclude that amount otherwise subject to the wealth tax.
Third, the focus on “income shifting” is puzzling. This was a proposed wealth tax! There would be a greater incentive to *shift wealth* by either real or artificial means. The comment about income only makes sense to the extent that the income producing asset would not be counted as wealth in the hands of the potential income recipient (for example, pension assets might be exempt, but a distribution from that pension treated as “income” might also increase wealth for purposed of the tax since the asset would then be outside the exempt solution). And, the specific example given in the op-ed has nothing to do with “shifting income”. It had to do with shifting consumption through timing and by shifting wealth through gifts. If there were an incentive it would likely be to shift non-income producing wealth. The proposal suggested that income tax breaks would somewhat offset the wealth tax collected.
David Seltzer
Dec 21 2019 at 4:02pm
As an investor, Why would I acquire an additional increase in wealth between $10 Million and $11 million if my tax bill is $1.425 million? The marginal rate on the next million is 142.5%.
David Henderson
Dec 22 2019 at 11:18am
And the marginal tax rate on the dollar that takes you from $9,999,999 to $1,000,000 is 142.5 million percent.
Dylan
Dec 22 2019 at 4:24pm
David,
Why are you ignoring the fact that the proposal was clearly only a tax on the wealth above $10m, as multiple other commenters have noted, with Vivian including a link?
David Henderson
Dec 22 2019 at 5:06pm
I’m not ignoring it. Vivian’s mistaken.
Go to the link she provided. Then click on the link to the 1999 CNN article. Here’s the relevant part:
Note what it doesn’t say. It doesn’t say “on the amount of wealth over $10 million.”
It’s entirely conceivable that Trump meant to advocate taxing only the portion of wealth over $10 million. But I had my students analyze what he advocated rather than asking them to be mind readers. With everything you know about Trump, are you surprised that he would be so careless?
Dylan
Dec 23 2019 at 2:04pm
Thanks for the reply and the link to the 1999. I certainly wouldn’t be surprised that Trump would be that careless in making a proposal, however, I would be very, very surprised to have anything like that version of it ever make it into law, for the reasons that are mentioned.
I understand that this could be a learning opportunity for undergrads, because that kind of thinking isn’t always obvious. But it still feels a bit disingenuous to suggest that this was some kind of real policy proposal and that the tax would be on absolute wealth instead of just the marginal wealth above the threshold. (Mind you, I think both types of wealth tax are a very bad idea, I just think that it is better to criticize the versions that actually have a chance of becoming legislation versus the even worse version that doesn’t)
Vivian Darkbloom
Dec 23 2019 at 2:30pm
No, Vivian is not “mistaken”. The language is the CNN article is ambiguous. The article that I cited is more clear, here:
“Trump proposed a one-off 14.25% tax on parts of households’ net worth exceeding $10 million.”
Nota bene the word “exceeding”. Unfortunately, one cannot take literally the poor phrasing used in news articles, particularly on technical subjects. If, however, the news articles were to be treated as statutory language, I’m pretty certain that the courts would interpret this in the way to avoid an absurd result (absurd for the reasons mentioned in several comments). See, e.g., Green v. Bock Laundry Machine Co., 490 U.S. 504 (1989). See, also, Einer Elhauge. Statutory Default Rules: How to Interpret Unclear Legislation. Harvard University Press (2008), p. 148
Happy Holidays. Viv
David Henderson
Dec 23 2019 at 11:53pm
Dylan,
My purpose wasn’t to have them criticize; it was to have them analyze.
Incidentally, as far as things having chances of becoming law, there really are small parts of the tax code that have such provisions. For example, on Schedule C income, for years if you made $399, you had to pay no self-employment tax. If you made $400, you did–0n the whole $400.
And I don’t appreciate, by the way, your accusation of disingenuousness. I don’t make such accusations against you. I expect the same assumption of good faith.
Dylan
Dec 24 2019 at 8:29am
David,
My apologies. I truly meant no disrespect with the disingenuous coment (you will notice that I tried to lighten it by saying “felt” and a “bit,” both of which I meant). I used that term, because I was trying to avoid the “straw man” argument, but perhaps that is a better phrasing.
I have no quarrel with you putting a question like this on a test, especially at the time when this might have been in the news. However, posting the same question here, where the audience can be expected to be pretty familiar already with marginal thinking, doesn’t seem to offer the same analytical benefit. And (to me) it came off as a criticism of a half thought out campaign proposal from 20 years ago, by a man that had no shot at the presidency (at least at the time!). Then, to top it off, the critical analysis was taking an ambiguous proposal and assuming the unlikeliest implementation of it (that being a wealth tax on the entire wealth, once an arbitrary threshold is reached).
I know that parts of the tax code still do suffer from these kinds of threshold jumps, but, as far as I know, most are now fairly small in terms of the dollar value of the tax, even if the marginal rate is high. My understanding was that the tax code used to have a lot more of this, but that the most egregious examples have been removed? Much of that due to the Regan-era tax reform bills?
David Henderson
Dec 24 2019 at 9:43am
I accept your apology.
Actually, I disagree with you that the audience is “pretty familiar already with marginal thinking.” Some are; some aren’t. There’s a whole range.
Comments are closed.