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The Impoverished Wealth Tax

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The Impoverished Wealth Tax

It fails as a revenue generator and as a tool to deliver fairness. March 10, 2021
Politics and law
Economy, finance, and budgets

On Monday, a group of Democratic lawmakers led by Senator Elizabeth Warren introduced the Ultra-Millionaire Tax Act, a bill that would levy a 2 percent annual tax on individual assets worth more than $50 million and a 3 percent tax on assets worth more than $1 billion. In her announcement, Warren noted the popularity of wealth taxes, as polls show that Americans tend to support the idea. But the apparent popularity of the wealth tax is no reason to adopt it. Aside from its many technical problems—posing administrative difficulties, discouraging investment, creating incentives to move assets abroad, distorting the efficient allocation of capital, and encouraging tax evasion—Warren’s proposal both relies on and reinforces dangerous assumptions about the nature of income inequality in the U.S.

Because wealth taxes consistently fail to generate revenue, many of the countries that implement them swiftly abandon the experiment. Twelve European states had wealth taxes in 1990; only three have them today. Consider the experience of France, where, in economist Eric Pichet’s estimation, the tax cost the government almost twice as much money as it collected while generating a paltry 1.6 percent of total revenues. Emmanuel Macron’s government repealed the tax in 2017, estimating that it caused “some 10,000 people with 35 billion euros worth of assets” to leave “in the past 15 years.”

Proponents reply that even if the wealth tax is ineffective at raising revenue, it is justified on the basis of fairness. As Warren argued, income inequality is a problem in the U.S., the pandemic made it worse, and ameliorating it is an end in itself, hence the need for her bill.

The argument fails on several fronts. As skeptical economists have noted, wealth taxes are unlikely to solve the putative problem of economic inequality on their own—and may even worsen it by reducing wealth creation and creating an incentive to keep companies private. In any case, the level of inequality in the U.S. tends to be overstated. As Phil Gramm and John F. Early point out, the U.S. Census Bureau does not count taxes as lost income or fiscal transfers to the poor as earned income, overlooking $1.9 trillion in annual transfers from the rich to the poor. In a 2019 paper, economists Gerald Auten and David Splinter found, after making technical adjustments to inequality data, that the U.S. Gini coefficient has increased only slightly in the past several decades.

Even if inequality were as severe as advertised and a wealth tax were an effective tool to reduce it, such a policy would not necessarily advance fairness. In a free society, inequality is not the unjust product of a rigged system: it results from differences in individual skills, capabilities, and work habits. In a paper for the National Bureau of Economic Research, the authors find that “most top earners are working rich: they derive most of their income from human capital, not physical or financial capital.” According to economists Steven Kaplan and Joshua Rauh, the share of those who are self-made on the Forbes 400, a list of the nation’s wealthiest individuals, rose from 40 percent in 1982 to 69 percent by 2011. And America’s richest are not a static group: just 21 people from the 1982 Forbes list were on the 2019 list.

Complaints about inequality tend to overlook this dynamism. Talk of a “middle-class squeeze” notes, for example, that income growth has slowed for the median American. But data also show that members of the middle class have moved up; indeed, both middle-class and poor Americans got richer in the past several decades. Between 1979 and 2015, the bottom 20 percent of Americans witnessed an 80 percent increase in their incomes, while the share of households with real income over $100,000 rose from just 8 percent 50 years ago to nearly 30 percent in 2017.

The main problem with income inequality is the perception of income inequality. If our view of reality is pessimistic and incomplete, we might unduly worsen our own real-world circumstances by, say, adopting a wealth tax. Populists exploit the widespread perception that inequality is a dire threat to people’s well-being. But contrary to what they claim, capitalism is not broken—at least, not until their unreasonable policy proposals become reality.

Photo by Chip Somodevilla/Getty Images


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