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Taxing Wealth: A Pro-Growth Policy Option

Kudos to Tyler Cowen for stimulating public debate on an important policy option.  Now if someone will just move away from the popular distortions and dysfunctional politics to confront the merits or flaws of the issue, we might be on the verge of an important debate.  

It started with Tyler Cowen’s piece in the NY times on 7/20/13, Wealth Taxes: A Future Battleground, in which Mr. Cohen opined that, “The next major struggle — in economic terms at least — will be over whether taxes on personal wealth should rise — and by how much.”  He foresees that, “Like the bank robber Willie Sutton, revenue-hungry governments will go ‘where the money is’.”  

On 7/22, Dean Baker at the Center for Economic and Policy Research weighed in with Tyler Cowen Is Worried About Wealth Taxes, dismissing the concept by suggesting “If we give people a large incentive to hide their wealth, it is reasonable to assume that they will.”  He went on to say “we need not worry about taxing wealth if we reverse the policies that have redistributed so much income upward over the last three decades´.  

On 7/24 James Kwak, blogging at The Baseline Scenario, penned Wealth Taxes? Don’t Hold Your Breath, in which he suggested in passing that we should have that debate, but failed to take up the substance of any reason why, choosing instead to bemoan the politics of power and money and cynically concluding “the reality is that for decades people who want to cut taxes have either held the reins of power or been able to veto policies they oppose. Since they are backed by the wealthy, of course they have set about reducing taxes on wealth at every opportunity.”  

Also on 7/24, Joseph Thorndike of the Tax History Project offered Wealth Taxes to Cure Inequality? How About Tax Reform Instead published on the Huffington Post.  He argues that history favors “more tepid reforms” and dismisses wealth taxes as “a full-throated campaign to soak the rich with some sort of new levy on wealth.”  The most pointed observation in his article was its title which suggests that a structural shift to incorporate a tax on wealth wouldn’t even qualify as reform.  

Unfortunately, as suggested by the extracted quotes (I don’t think I’ve misrepresented them, but I encourage you to examine the articles yourselves) there are no advocates of wealth taxes engaging in this mini-debate.  Indeed, there is precious little discussion of the merits or flaws of a direct tax on wealth appearing in any of these articles.  Cowen subtly equates wealth taxes to robbery.  Thorndike characterizes the very topic as a populist revolt aimed at soaking the rich.  Baker apparently believes regulating the nuts and bolts of economic activity would be more effective than directly attacking the preferences embedded in tax policy.  And Kwak implies he believes wealth taxes are a good idea, but is evidently so discouraged by the political obstacles he deems it futile to even share his rationale or logic toward the substance of the concept.  

While I thank Mr. Cowen for raising the topic, unless someone steps forward as an advocate to address the merits I think the battle he foresees will be neither long nor particularly interesting.  So let me take a shot at reframing the issue.  

I perceive our tax and monetary policies have been jointly responsible for destabilizing our economy.  I further perceive that structural tax reform, specifically replacing investment income taxes with an annual wealth tax (to tax the investment potential of capital at a constant rate) has the potential to correct the flaws of current policy.  

First, I suggest we subordinate the subjective debate over what is fair and address tax policy as preeminently a matter of efficiency.  Though even my own initial examination of the concept of wealth taxes was triggered by the question of equity: “How is it fair that Warren Buffett and Mitt Romney and their billionaire peers pay marginal tax rates half as high as their less fortunate fellow citizens?”, the far more important question is what policies will lead most reliably to a thriving sustainable economy and society.  

Second, the single most significant policy contributing to the ever-increasing concentration of income and wealth is the preferential tax treatment wealth holders now receive; of which the most damaging element is the way it subsidizes unproductive capital and distorts Adam Smith’s famous Invisible Hand.  Thus, I must respectfully disagree with Mr. Baker and Mr. Thorndike; reform should start by addressing the flaws of existing structure.  

If the ever-increasing concentration of income and wealth was the path to a thriving sustainable economy and society, I would join the multitude of conservative economists, shrug my shoulders, and accept that “a rising tide floats all boats.”  But paraphrasing a quip by Warren Buffett, our rising tide has been floating the yachts and threatening to drown the multitudes.  The measure of tax policy should be whether it effectively supports our society and economy.  Current policies do not.  Our tax (and monetary) policies have made tax avoidance and valuation manipulation far more profitable than productive enterprise.  We have under-mined our productive economy.  There is no reason to be surprised that we are creating serial asset bubbles instead of jobs.  

The primary objective around which we all should rally is not redistribution of wealth, or elimination of inequality, but revitalization and stabilization of our economy.  It is within that framework that I believe we need to evaluate our existing tax structure, and examine alternatives.  It is within that framework that I advocate a carefully crafted shift back toward property taxes, the long-term historic norm of taxation, as a pro-growth policy option.  

I am a capitalist.  I believe that the productive deployment of capital is the driver of economic growth and prosperity.   One key measure of the efficiency of our tax policies is do they promote the efficient productive deployment of capital.  I posit that our present policies do not.  By sheltering unproductive capital from taxation, we effectively subsidize and encourage unproductive holdings.  As a result, we are misallocating our collective resources.  

A simple truism common among economists is “when you tax something more heavily, you get less of it.”  It is the rationale behind so-called “sin taxes”, cigarettes, gasoline, carbon; if you want to discourage something you tax it.  

So what is the relative burden of our tax structure today?  We tax labor at the highest rates.   We tax investment income at reduced rates.  We shelter unproductive capital from any direct tax assessment whatsoever.  Sheltering illiquid and unproductive assets from taxation may be an effective way to inflate their value, but it is not an effective way to encourage productive investments, which as a capitalist I perceive to hold an exceptionally important societal benefit.    

The rationale for preferential treatment of investment income is that savings are presumed to stimulate increased productive economic activity.  But objective analysis of the effect of current policies clearly suggests we are failing to achieve that goal.  It is not savings that provide benefit, it is productive investment – and structural tax shelters for low-profit and unproductive capital areinadvertently diverting resources away from productive allocations.  

Mr. Kwak is right.  We should be having a debate about taxing wealth, but the point of that debate should be the economic efficiencies of structural reform, not class warfare.  We should not approach wealth taxes as an add-on revenue grab with redistributional intent.  A wealth tax should be considered as the cornerstone of comprehensive tax reform aimed at eliminating the misincentives and distortions embedded in current policies.  

A properly structured wealth tax integrated with repeal of current investment income taxes, reform of tax expenditures, and a reduction in the top marginal tax rate on earned income would stimulate consumer spending by increasing disposable income for the middle class masses while simultaneously encouraging capital to migrate toward more productive allocations.  

Near the end of his article Mr. Cowen suggests that “It doesn’t seem fair to the holders of that wealth to suddenly pay additional taxes on assets that they thought were in the clear.”  Undoubtedly he is correct, hedge fund managers and billionaires who have become accustomed to receiving preferential tax treatment probably will perceive removal of those preferences as “unfair.”  But fair really is in the eye of the beholder.  

The concept of equal treatment is fundamental to both democracy and capitalism; and “fairness” is an emotionally charged perspective that is difficult to subordinate.  Yet fairness is so subjective debating it doesn’t often seem to lead to a meeting of the minds.  I perceive reduced tax rates and perpetual tax deferrals offered to a select class of citizens to be grievously unfair.  But the holders of wealth to whom Mr. Cowen refers have anointed themselves as beneficent “job creators,” and I have no doubt that their perception of fair is different from my own.  We are unlikely to close that gap by debating the issue.  

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Thus, I suggest the more productive framework for evaluating and debating taxes and economic policy should be efficiency.  Advocates of the status quo should be challenged to defend the efficiency of existing policies.  Likewise, advocates of change would do well to look beyond class warfare arguments and the search for incremental revenue and examine the potential benefits of removing investment distortions from the tax code.   I hope Mr. Cowen is correct.  I hope an even-handed and efficient tax on wealth does become a topic of serious conversation and debate.  If my perceptions about the potential benefits of structural tax reform are wrong, I welcome substantive rebuttal.  If they are right, they deserve critical public evaluation and debate.  

1If we can’t agree on even that point I suspect I am going to have difficulty influencing your opinion. But if you think I’m wrong there, I invite and urge you to explain your opposing position.

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