Taxing the rich

Why has the ‘tax the rich’ movement reemerged to take hold at this point in time?

The first question you need to answer before anything else is what exactly does ‘tax the rich’ mean? Taxing the rich can mean at least three things: taxing high-income earners, taxing capital income because most of the income of the super-rich comes from capital income, or taxing the stock of wealth directly. The most recent proposals by Bernie Sanders and Elizabeth Warren specifically targeted taxing wealth. There’s an economic distinction between these three different forms of taxes, what they might imply both for equity considerations, and how efficient they are in terms of generating tax revenue. 

For all three forms of taxation, an evaluation needs to consider the efficiency properties of the tax but also whether it actually can be implemented in practice. Currently we tax labor income, and we tax capital income, but we do not tax wealth directly in the United States, abstracting from a limited estate tax, which is a form of wealth tax.

If the government wants to tax the stock of wealth, then it has to base this tax on an accurate measure of wealth. The U.S. government does not currently collect data on wealth. To implement a wealth tax, the government would have to get into the business of collecting comprehensive information on the wealth of its citizens. This would be great for researchers like me to have good data on the distribution of household wealth in the United States. For instance, Norway has a wealth tax, and there’s a ton of research based on the data that have been generated. But measuring wealth accurately in the United States is not going to be easy.

If America was going to tax the wealthy in some way, what would make the most sense in your opinion?

There’s an active economic academic debate about that. On one side, there’s people like Thomas Piketty, who’s sort of a champion of the left, and Emmanuel Saez of Berkeley advocating for a wealth tax directly, as far as I can tell. They laid out their proposal in a recent Brookings paper, and their discussant Wojciech Kopczuk critiqued this proposal. I would be perfectly on board with the fact that you want to raise additional tax revenues from people at the very top of the wealth distribution to finance much-needed infrastructure investment, which has been too low for a long time in this country, in my view. The question to me is, Is the wealth tax the most efficient way to do so? I think it would be very hard to implement. You have to effectively measure wealth. A lot of the wealth that we are talking about is in the form of private business wealth, and therefore there’s not a readily available market value for this form of wealth on which a wealth tax might be based. If you then impose a wealth tax on this form of wealth, the owners of these businesses might take all kinds of actions to artificially lower the value of this form of wealth.

Another issue is that a tax of wealth, if unilaterally imposed by one country, might lead to wealth migrating to other countries that do not tax wealth, or tax it at lower levels. If I was the government of Luxembourg or Switzerland, or in general a relatively small country with borders that are open to international capital flows, I would be very worried about this concern since it might be fairly easy to relocate wealth, especially financial or business wealth, across borders. In the U.S., I’m not sure of how big the wealth tax would have to be such that wealthy, successful entrepreneurs in the United States would relocate to, say, Mexico to avoid the tax.

Overall, I therefore think the wealth tax is perhaps not the most efficient way to raise tax revenue or to achieve redistribution because wealth is hard to measure, because of concerns about people moving their wealth elsewhere, or because of shifting economic activities to lower the value of the forms of wealth that are to be taxed.

Despite the public will and talking points of politicians, why does there never seem to be any progress on this topic?

Major tax reforms are extremely rare. If you think about big tax reforms that have been enacted, there were the Reagan tax reforms some 35 years ago, then the Bush tax reforms that were partially reversed during the Obama administration. Overall, big tax reforms are rare because once you have a status quo, there’s people who benefit from that status quo who’ll try to block the initiative to implement something new. This seems to be especially effective for tax changes at the top of the income or wealth distribution.

From my perspective, I think it would be more promising to reform the income tax code that we already have because that is not a fundamental departure from how we do things now. If you really want a wealth tax, you have to set up infrastructure to measure things we aren’t currently measuring, which would take time. At that point, it would be clear to wealthy individuals what would be coming and would have enough time to react to that by potentially moving the wealth out of the country.

So, if I were to tax the rich more, I’d try to do it within the framework of the current income tax. There are two key elements I would highlight. The first is addressing tax loopholes in the current tax system to make sure that the tax rate people at the top of the income distribution actually pay are closer to their statutory counterpart, and second, to consider raising the top marginal tax rates on income, meaning both capital as well as labor income, to try to generate the extra tax revenue for the infrastructure investment programs that are currently being discussed. 

Of course, income tax reforms will also have behavioral consequences. If you raise the top marginal rate, people might work less, people might invest less in their businesses since they get to keep a smaller share of their profits. That’s all certainly possible. The question is how strong that response will be, and I think it depends on the group of people. Take LeBron James. Would he stop playing basketball as hard, would he focus less on winning, if we taxed his income at a higher marginal rate, say 50%? I don’t necessarily think so. However, if you think about a private business, say a law firm or a medical practice, would they take additional clients if they know that the extra income from that client would be taxed at a higher rate? That’s less clear to me.

One attractive feature with this proposal is that it would simply change tax rate within the tax system already in place and thus would be straightforward to implement. It would not change the type of information the IRS would have to collect from taxpayers. In my judgment, and given what I know about the behavioral responses of the private sector to changes in marginal tax rates, this could generate substantial additional tax revenues without harming the economy too much. That would be my way to go, and I have advocated for such a tax reform in work with Fabian Kindermann about to be published in the American Economic Journal: Macroeconomics.

What’s the most important thing for people to understand about this topic?

This idea of taxing the rich more has been popular for at least the last 15 years and without much action. Rather than focusing on the most grandiose ideas, in my own judgment, I think it would be good to just get started on this by reforming the current income tax code. But taking a broader perspective, my own somewhat cynical view is that there might be a sizable infrastructure spending bill, which I think is a good thing, and in fact long overdue, but that when it comes to the difficult question of how to pay for it, Washington will kick the can down the road. The outcome will be a massive increase in the government debt which is already pretty large as a share of gross domestic income.

I’m very concerned about intergenerational justice in this regard. To me it seems that the entire debate is about the conflict between the rich and the poor now, but what about future generations that we are leaving with a massive amount of bills to pay in a world where the population is not growing as fast anymore and productivity growth has slowed considerably? The future tax burden is going to be quite substantial for future generations. That is what I would be concerned about.

Intergenerational redistribution and justice are things that I would like to see discussed much more openly in this context, as opposed to always just focusing on inequality within the generations currently alive. How about future generations? The biggest potential injustice I see is leaving our kids with a rotten, overheated planet and a lot of government debt to pay for the spending programs discussed now. My first priority would be to insure that taxes are indeed raised to finance the infrastructure spending plans and to maximize the share of spending that is in fact an investment into an infrastructure for the future.