By Zachary Hayward
The world is currently in the grip of a pandemic and globalized capitalism is facing a crisis of confidence. Unlike the financial problems of 2008, the pandemic has laid bare stark differences, not just in the financial system, but in how societal wealth inequality affects our health. The IMF has suggested that pandemics tend to increase inequality in the areas affected by them (Ostry Furceri 2020) as the poor face higher comorbidities and risk. It is more important than ever to consider how extremes of wealth should be controlled. I argue that a wealth taxes are critically important for allocative efficiency in the post-pandemic economy.
But with the failure of the Warren and Sanders campaigns in the USA it is not likely that the policy merits of wealth taxes will enter the political zeitgeist. However, the question remains, are there reasons to tax wealth and if so, how can it be made to work successfully? Academics like Thomas Piketty have written at length about using wealth taxes to control inequality (Piketty 2014), and even more recently the National Bureau for Economic Research released a working paper on the efficiency benefits of a tax on wealth (Guvenen et al. 2019). Although, they come to different conclusions about the level and purpose of taxation required. This implies that we should at least think seriously about how such a policy can be made to work. And it seems unlikely that any policy proposal can avoid requiring a higher degree of international cooperation than is currently possible.
Tax Time in Paris
The European experience has been one of low revenues and high levels of avoidance (Smith 2019). And proposals for similar taxes in the United States have been met with serious opposition (Sullivan 2020). The main challenges appear to be along the lines of how easily such a tax can be avoided, whether it would raise the revenue promised by politicians, and whether there would be perverse investment incentives. I argue that the solution to these problems is the Common Ownership Self-Assessed Tax (COST) program argued for by Glen Weyl and Eric Posner in their 2018 book Radical Markets. However, it does require adjustments as it is likely not feasible in the extreme form posited by them. This is where more work needs to be done – assess if a restricted program would present the same tradeoff between investment and allocative efficiency.
In 2019, a New York Times article spelled out a common objection to wealth taxes. It argued that due to the prevalence of unlisted assets, it was next to impossible to accurately value the holdings of the super-wealthy. That it would be akin to differential taxation to take market values for listed securities and then allow tax services to value private assets. Another article in Bloomberg was highly critical of wealth taxes in France (Smith 2019), citing evidence that wealthy citizens simply left the country and that it was not able to raise significant revenue.
In this discussion, we will leave aside the amount of wealth in tax havens that cannot be attributed to any individual. However, the evidence suggests this is not insignificant and places the lower bound estimate at approximately 8% of global wealth (Ingles 2016). Here we will confine our discussion mostly to the most interesting arguments, that of efficiency and valuation. Guvenen et al. argue in their 2019 NBER working paper, that when heterogenous returns on capital is explored in an Overlapping Generations (OLG) model, there is good reason to believe that taxes on capital can enhance allocative efficiency. This differs from the existing literature which suggested that that there should instead only be taxation of capital income (Conesa 2009). However, this is down to the key assumption of differences in returns. Once this is considered, the tax on capital income appears to be distortionary in a way a tax on capital is not (Guvenen et al. 2019).
There is good reason to believe that heterogenous returns exist. This argument is most cogently presented by Piketty in Capital in the 21st Century, where he uses university endowment fund data to show evidence of differential returns with respect to wealth. However, the reasoning behind this assumption can easily be seen when comparing entrepreneurs to the so called “idle rich”. That is, a tax on capital income places a higher burden on the entrepreneur who is earning a large return on capital, than the already wealthy person who invests purely in treasuries and lives off the sheer size of their fortune. This generates inefficiencies, because the opportunity cost of the safe, low return investment is potentially higher growth due to increased productive investment. Perhaps wealth needs help to trickle down.
The paper goes on to find that an effective tax on wealth of between 2%-3% would yield a significant improvement of allocative efficiency expressed as TFP by about 4.6% (Guvenen et al. 2019). The second important question is how this should be collected. Currently, tax services like the IRS are forced to engage in costly litigation to determine the value of assets. In France they have complicated valuation procedures and conventions that end up valuing different assets in different ways (Ingles 2016). Not only is this distortionary with respect to investment but it also presents ample opportunity for tax minimization.
There are several potential solutions. Gabriel Zucman argues that wealth taxes such as the Warren proposal would work efficiently. However, it should be noted a key difference between the USA and other countries, is that taxation is based on citizenship rather than just residency. This is important to keep in mind as it seems to deal with many of the capital flight objections. However, there remains the problem of valuing unlisted wealth. I argue that the COST proposed by Weyl and Posner in their 2017 book Radical Markets, is the best solution (Posner Weyl 2018).
Their proposal rests on a radical redefinition of property rights, particularly those towards capital. In their paper Property is Only Another Name for Monopoly, they set out the foundations for their policy. Their view is that private property rights as they currently exist reduce allocative efficiency in market economies. They suggest that one method of producing non-distortionary tax revenue and addressing this inefficiency would require asking individuals to declare the value of their assets and then to levy a tax based on this value (Posner Weyl 2017). However, the values they place on the assets would be made publicly available and should some other party offer to purchase the assets at the listed price, they would be bound by law to accept and transfer the asset.
The major difference between the COST in the Weyl and Posner paper and the what is being argued for here, is that no such tax would be levied on wealth up to a threshold. The purpose here is to deal with the allocative inefficiency of highly concentrated wealth and not that of ordinary citizens. The main reason for this is that it would be more politically viable to suggest that private firms might scour records looking for undervalued assets of the very wealthy. This seems less likely to put highly personal assets at risk. And second, it seems like this model would give less arbitrary power to those who were already wealthy, even if this system were already procedurally fair.
This proposal has several useful properties. First, it gives good incentives for the wealthy to provide accurate valuations of their assets (in fact, if the tax rate is relatively small it would cause them to overvalue assets) and therefore allows for more efficient taxation processes. Second, it improves allocative efficiency by taking the burden of tax off the productive entrepreneur and placing it on those with relatively unproductive wealth. While this in itself may seem like it does a relatively poor job of controlling inequality, I would argue that the purpose of a wealth tax is to encourage productive investment, something that the current set of incentives fails to do. Controlling inequality should be a secondary goal here since this policy is best suited to improving allocative efficiency. The tax base would essentially be fixed by choosing the threshold value of assets. However, everyone will have to set the value of their assets in this way. This is not really a problem since if there is a 0% tax rate below the threshold everyone not affected by the tax would value their assets at the threshold. There would effectively be no policy change for them. For example, the Warren campaign suggested a two-bracket system with the first threshold set at $50 million USD. However, the exact level of the threshold could be set to maximise allocative efficiency.
The main objection to a COST, is the effect on investment incentives. However, Weyl and Posner can prove mathematically that at low levels of taxation (2%-3%) the deadweight loss of sub-optimal taxation is relatively small compared to the effects of allocative efficiency. While the pandemic rages on, radical approaches to economic policy will become increasingly necessary to spur the recovery. We should not baulk at measures that upset the existing order of wealth and property rights. A wealth tax is an effective way of improving allocative efficiency without reducing investment. And the COST proposal reduces the resources required for enforcement while also improving allocative efficiency.
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SMITH, N. 2019. France Tried Soaking the Rich. It Didn’t Go Well. [Online]. Available: https://www.bloomberg.com/opinion/articles/2019-11-14/france-s-wealth-tax-should-be-a-warning-for-warren-and-sanders
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