Wealth and Income Taxes on the Rich-Becker

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The Occupy Wall Street movement has not expressed clear goals, but it does want higher taxes on the “rich”. President Obama agreed in his State of the Union address, and proposed that the rich-in his case, anyone with an annual income of at least $1 million- pay no less than 30% of their income in federal taxes. Others have proposed to add annual taxes on household wealth, in addition to taxes on income. The fact is that Obama’s tax goal is already being met by the complicated American tax code, while even a small wealth tax would discourage savings and create other problems.

According to a 2010 study by the Congressional Budget Office, the effective federal tax rate on the top 1 percent of households has already been about 30%. This might seem to be a misprint since very wealthy persons like Warren Buffet and Mitt Romney report that they pay only about 15% of their income in taxes. However, much of their incomes come from investments that are first taxed at the corporate tax rate of 35%, and then the after-corporate tax income is taxed again when paid out as corporate dividends, or when capital gains are realized.

According to the same CBO study, federal taxes on the middle classes comprise on average only about 15% of their incomes, This disparity in tax rates indicates that the American tax system is already quite progressive when corporate income taxes are combined with personal income and capital gains taxes. To be sure, it is inefficient to have such high tax rates on corporate incomes. Eliminating the corporate income tax, and then taxing personal incomes, capital gains, and dividends at the same rate would go a long way to both simplifying the tax code and to improving its efficiency.

Better still would be to scrap entirely the income tax, and substitute a consumption (i.e. sales or value added) tax instead (see the more extended discussion of a general consumption tax in my post on 8/29/11). Even if consumption of the poor were taxed at lower rates, the current bloated level of federal spending could be financed with a consumption tax on the great majority of households of no more than 25%. The effective tax rate does not have to be high because a generally flat consumption tax would be far more efficient, in particular, it would be more encouraging to investments, than the present complicated personal and corporate income tax system.

An income tax is an indirect tax on wealth because it lowers the value of the assets that produced the taxable income. Nevertheless, support has recently emerged for a direct tax on wealth to go along with taxes on incomes. Some forms of wealth are already directly taxed, such as property taxes levied by most local governments, and taxes on estates of deceased individuals. Henry George in his book Progress and Poverty (1879) made a famous proposal for a wealth tax in the form of a 100% tax on increases in the value of land. This single tax, he believed, could replace all other taxes. George argued that a land tax was a good tax because, so he claimed erroneously, the value of land did not depend on what landowners did, but rather depended only on forces like population growth that were beyond their control.

Current proposals for a wealth tax go beyond taxes on particular assets, like land or housing, and envisage a much broader tax that includes financial wealth, like stocks and bonds. I only say “broader” since a viable wealth tax would still exclude wealth in the form of human capital, the most important form of capital in modern economies, and the source of wage and salary incomes. Since the richest one percent of households on average get about half their incomes from wages and salaries (the remaining 99% get almost all their income from human capital), much of the true wealth of the rich would escape a wealth tax.

Another major problem with even a small tax rate on wealth is that it implies a very high tax rate on savings. Consider a constant 2 percent tax on wealth, and suppose that a household saves $10,000 out of its income to raise its future wealth. A one year 5% return on these savings would increase its before tax wealth next period by  $10,500. Since a 2 % wealth tax on $10,500 would leave an after-tax value of just $10, 290, such a wealth tax would reduce the after-tax return form 5% to only 3%, a 40% reduction.

So what seems like a small tax on wealth of only 2% is the equivalent of an income tax on savings of 40%. Presumably, this would discourage savings and increase consumption, whereas sustained higher long-term growth in GDP requires greater, not lesser, savings. As I mentioned earlier, the discouragement to savings of an income (or wealth) tax is a major reason why consumption taxes are better.

Wealth taxes have several other serious problems in addition to their negative effects on savings. It is almost impossible to value accurately many sources of tangible wealth, such as the value of privately owned businesses, so that an actual wealth tax would be rather narrow. Moreover, forms of wealth that can be most easily valued because they have good asset markets, such as stocks and bonds, can be moved across countries, and hidden through complex arrangements of assets.

Therefore, I conclude that a general tax on wealth is undesirable because it is both inefficient and ineffective. A feasible wealth tax is dominated by consumption taxes, including even progressive consumption taxes, and by inclusive income taxes.

Comments

[Blaise]

It's debatable that the corporate tax should be added to income tax to assess the true tax rate of wealthy people. It can be argued that the cost of the corporate tax is internalized by firms and, that to bear this cost, firms are willing to pay lower wages, charge higher prices and pay a lower returns to its stakeholder. Therefore, it's not clear that the entire cost of the corporate tax is supported by stakeholders and that its rate should be added to the income tax of wealthy people.

[freelance writing]

A one year 5% return on these savings would increase its before tax wealth next period by $10,500. Since a 2 % wealth tax on $10,500 i think this is not big money and what are the problem to pay them?

[Mike Hunter]

It's funny how conservatives argue that corporate income taxes fall on workers or consumers, and not wealthy owners of capital when there's public support for raising the corporate tax rate. But as soon as we talk about raising the top marginal tax rate, economic conservatives instantly start arguing that the wealthy already bear a higher tax burden; because they have to pay corporate tax rates. You can't have it both ways.

Income inequality has been increasing in this country for a long time. Raise the tax rate on those making over $500,000 a year, and transfer that money to those making under $50,000 in the form of a tax credit. How you collect that money from those at the very top is of no concern to me. All other things being equal rather they government does it in the most economically effective way possible.

Lastly becker mentions tax evasion which is illegal. There's a simple answer for that. Increase the penalties for tax evasion and the enforcement budget for the IRS, then go after tax evaders ruthlessly.

[Rajiv Shastri]

It's not about the rich v/s the not so rich. It's about wage earners v/s the rest, regardless of their level of income. Wages or salaries are taxed in full while all other sources of income are taxed on the savings, or profits, they generate. Even income drawn by an individual entrepreneur is taxed on the amount left after all expenses associated with earning that income have been deducted. Business and corporations pay tax only on the excess of income over expenditure, which can be called either savings or profits. Existing tax regimes tax business savings (typically a small fraction of total revenues) but tax individual revenues in entirety, claiming that to do anything different will discourage savings. Well, if a tax on savings hasn't discouraged corporate savings, why would it discourage individual savings?

And the best regime would be one without personal income tax and not one without corporate tax; the one option not discussed in this post. I wonder why?

[A Facebook User]

Above, you mention the proposals by Henry George to raise all public revenue from a tax on "increases in the value of land." That particular argument was made by John Stuart Mill rather than Henry George. George argued that rent (i.e., the annual potential rental value of land in all its forms, not simply surface values) rightfully belongs to the community -- that rent is, in effect, a common fund, up to that point allowed under law to be privatized. This privatization of rent forced government to look to other assets and other activities in order to raise the revenue for public goods and services. Economic theory is clear that a 100% tax on rent would virtually eliminate a selling price for locations because there would be no imputed or actual income stream to be capitalized by market forces into a selling price.

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[lvtfan]

I encourage Mr. Becker to read the book he misdescribes, "Progress and Poverty." He wrote, "Henry George in his book Progress and Poverty (1879) made a famous proposal for a wealth tax in the form of a 100% tax on increases in the value of land. This single tax, he believed, could replace all other taxes. George argued that a land tax was a good tax because, so he claimed erroneously, the value of land did not depend on what landowners did, but rather depended only on forces like population growth that were beyond their control."

First, George did not propose a 100% tax on INCREASES in the value of land. Rather, he proposed a most-or-all tax on the annual rental value of the raw land -- the land before the owner-provided improvements.

Second, George's claim was not erroneous. The landowner doesn't cause the value of his land to rise; it is the presence and activity and investment of the community as a whole which does that, and relates in part to what nature provides which people value -- fine views, harbors, rivers, good climate, etc.

George was not the first to propose that land value was a right, just, rational and perhaps sufficient source for natural public revenue, but he made the case better than most.

If you don't know George, you might read "An Introduction to Henry George" at http://wealthandwant.com/docs/CarterW_intro.html (The URL comes from the subtitle to "Progress and Poverty," which was the #2 bestseller 1880 to 1900, second only to the Bible.

And if Milton Friedman's observations suit your fancy, you might look into what he said about Land Value Taxation, in 1978 and in an interview in the San Jose Mercury a few weeks before he died. He called it the "least bad tax." It appears that he didn't originate that phrase; that it might have come from Lowell Harriss at an NTA meeting some years earlier.

[TANSTAAFL]

Welcome back, Prof. Becker, and a happy new year. A broad based consumption tax makes a lot of sense for the reasons you give. But the devil is in the details and, thus, the tax base would hinge on how one defines "consumption." If a person transfers an asset to a newly formed corporation in exchange for an ownership interest, without any money or other liquid assets changing hands, is that "consumption"? What are the arguments for and against subjecting the exchange to the consumption tax? How do those arguments differ -- if at all -- from the tax policy debates that followed the ratification of the 16th Amendment nearly a century ago, leading to the federal tax code we know today?

In other words, we've spent a century arguing about the definition of "income" for purposes of the federal income tax. Is it realistic to expect that the definition of "consumption," for purposes of a nationwide consumption tax, would be any less contentious? Were Congress to enact a consumption tax, it would not be long before the Supreme Court issued another opinion akin to Gregory v. Helvering (that is, taxation follows substance, not form).

[Takenomics.wordpress.com]

Like almost all who presume to offer criticisms of Henry George's arguments, Professor Becker has evidently not read the book he erroneously describes, nor the arguments he erroneously purports to refute. George did not propose a 100% tax on increases in land value. That was John Stuart Mill -- not coincidentally one of the most brilliant and penetrating minds that ever lived. George's proposal was a 100% tax on the unimproved rental value of land, to recover that publicly created value for public purposes and benefit rather than giving it away to idle private landowners in return for nothing.

Prof. Becker also erroneously claims that land value depends on what landowners do. That claim is objectively false. The landowner qua landowner, by definition, does not contribute anything whatever to the unimproved value of his or any other land, which would be just the same if he were comatose, or had never existed. The only way landowners AS PERSONS increase the value of land is in other economic capacities: as investors providing capital improvements, as vendors providing consumption opportunities, as entrepreneurs providing employment opportunities (N.B.: a landowner who rents land to a productive user is not providing an employment opportunity, but merely charging the producer for an employment opportunity that was already there, and would otherwise have been available for free), etc. But these activities do not increase the unimproved value of the land whereon they are undertaken, and the people who perform such activities increase land value by exactly the same amount whether they own any land or not, so it is objectively false (and highly misleading) to claim that a landowner who happens also to do any of those things is increasing land value in his capacity as landowner.

Land value arises from the services and infrastructure government provides, the opportunities and amenities the community provides, and the physical qualities nature provides. I suggest that Prof. Becker will search that list in vain for anything the landowner provides.

It is worth noting that while mainstream neoclassical economics has industriously ignored, dismissed, derided and (invariably) mischaracterized Henry George's arguments for recovery of publicly created land value for public purposes and benefit, it has never managed actually to refute them -- certainly Prof. Becker has not. Nor will he, or anyone else, ever be doing so.

[Colonel Mustard]

Income inequality. We have it just like other nations have it because there are too many damn people. That's it. In America it's getting worse because many Americans feel entitled to a comfortable living. They elect politicians who reinforce their envy & laziness. Unless a rich person has earned his $ by some illegal monopoly then don't demonize him.

This "tax the rich" smoke screen is misleading. America has a lot of nonproductive people. In addition we have too many unskilled and underskilled workers that we don't need. It is no the duty of the rich to provide jobs or give away $.

[Bill]

This is a misleading post.

The way you get to your claim of an effective rate of 30 percent is to add corporate taxes to divined income. First, my ownership of foreign stock is not double taxed. Second, everyone is double taxed, effectively with that argument, not just the rich, if you have anything, including a pension, so that relatively is the same. Finally, if you argue that corp tax incidence falls on consumers and stock owners, fine, then foreign stockholders of US corps or foreign consumers of US goods are paying US taxes.

On top of it, though, you are completely wrong on US taxes for the top one percent. If you go IRS data, in 2001 the top .1 of one percent paid 28% of adjusted gross income in taxes, whereas in 2007 they only paid 21 percent. This was due to the cap gains and dividend tax chanes, along with the other cuts.

[Benjamin Skinner]

I think calling "tax the rich" a smoke screen is a good way putting it. Most people who say that aren't wealthy, struggle financially, and don't know what they're saying.

[Pradeep Despandee]

I have thus been advising my wealthy overseas clients (many of whom worked hard for their money, and many of whom while barely richer than the average American, are considered well healed in their respective countries) to start pulling their investments out of the US in the mid-long term. These people, who represent the emerging economic juggernaut of three billion people rising in the increasingly important developing world, have better things to do than lose their hard earned wealth at the altar of American class warfare. They can find that investment environment and associated mediocre growth prospects in many other places in the world. There is nothing keeping them in American investments. If Americans are seeking the same reduced effort shortcuts to prosperity as the Europeans, they will meet the same fate.

Occupy protesters may indeed find themselves living in an environment of flatter outcome in a couple of decades. But they will also find that their per capita relative prosperity compared to the world average will have declined from 6x world average to 3x or some lower multiple. The top American 1,2,5,10% will be mostly gone, but Americans as a whole would have descended from their current top 10% worldwide to 30% 40% etc. The American middle class will no longer be amongst the privileged humans of this planet.

We are now finally living in a very mobile (i.e. much freer) world, and while true mobility is still available to only a small part of the world’s population, this is only the beginning. Productive people will find shelter somewhere in the world, one way or another. If the voters of western democracies cannot keep the pitchforks in the storage bin, the shelter may eventually be provided by a host of competing authoritarian regimes -- and that would be a sad outcome,… though not as sad as it would have been in the past. After all, in our newly mobile world, even dictatorships are starting -- and will increasingly have to -- compete to attract and retain productive people by offering them attractive environments (e.g. Singapore, Dubai and a few others now, but the circle will expand).

As one can easily see when looking from above the myopic day to day noise of an increasingly politicized America (in central planning, everything eventually becomes politics, and this is a new phenomenon for America):

The newly awakening three billion people emerging world juggernaut, has neither the desire nor the patience to wait and see how the western world’s experiment with the flat effort/reward curves of mandatory collectivism ends. They already know — they have already experienced the outcome.

[Brian]

Good posts,
but what a lame website. I post, it says it posted and then it does not. No moderation, no message nothing. Just deception....

[Takenomics]

Colonel Mustard claims, "America has a lot of nonproductive people." It does indeed. But the nonproductive rich cost the country an order of magnitude more than the nonproductive poor.

[Kassandra]

"America has a lot of nonproductive people." - they must also know what's the reason behind this.

[Tax Relief]

Where did Jack go?

[TANSTAAFL]

Maybe Jack fell prey to the emerging world juggernaut described above. Hope not.

[lee]

thank you for your information!

[Jack]

Colonel Mustard? of the Clue game? Could you use these graphs to square up the "case" you're attempting to pawn?

http://lanekenworthy.net/2008/03/09/the-best-inequality-graph/

It strikes me a a bit odd that we've so many "unproductive" people and yet average $45,000 of GDP per man/woman and child with but half that number even in the labor market and 20% either under or unemployed.

Without favoring a flat GINI curve it is worth observing that, on average, that would work out to something over $150,00 of income per family of four.

[Jack]

Tans and Tax... thanks for inquiring about me. Not sure if its climate change related but having one of the coldest and snowiest winters in Anch or Fbks history has kept us busier than usual.

Pradeep sez: "But they will also find that their per capita relative prosperity compared to the world average will have declined from 6x world average to 3x or some lower multiple."

Yes! after spending a fine year in Korea replete with a free wardrobe all of the same color, few things have pleased me more than to see those, formerly poor, but hardworking folk gain so much against out standard of living here in the US and wish the same for those billions of Chinese and Indians and those of Africa as well.

I see no threat to their energies being harnessed, (at long last) in a productive manner.......... though it does make more crucial our rapid transition to solar energy.

Your first sentences has me really curious as to what sort of advice you're offering your rich clientele of average income? I suppose I'd want to warn any, and especially those having "worked hard" that American stocks may be vastly overvalued. In part because there is just SO much damn money sloshing around with no place else to go that "investors" will buy astronomical P/Es. The second, is of course that in out DEMAND starved economy there is little justification for high P/E's when E's are likely to be hard to come by.

For a while it looked as though there was considerable political risk as well. What IF one of these guys got in who really believe that a combo of ladling out benefits to the already rich and that of cutting the programs and projects that employ working folk WERE to get in w/o getting rid of enough silly 'baggers for Congress to block another round of fantasy "trickle down" and take advantage of tragic levels of unemployment to further pound down the wages of most consumers, and speed the race to the bottom and the demand starved downward spiral that will reverberate around the world?

Lately, though, I've become confident that the President will mount a well financed, educational campaign strong enough to save us, and the world from having our fate sealed by a few retirees and Cuban ex-pats down in Florida.

[Ron Toczek]

"An income tax is an indirect tax on wealth because it lowers the value of the assets that produced the taxable income."

This is a terribly misleading statement. I can think of at least three interpretations, two of which refute it.

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