Tax the Riches
I have a question for people who know more economics than I do.
Right now, if I understand the state of debate about the Fed, there are two camps.
One camp holds that the Fed can do a variety of things – such as purchasing debt of somewhat longer maturity than T-bills – that are metaphorized as “dropping money from helicopters” in order to reduce the value of money, which should stimulate demand, and help pull us out from what might otherwise be a double-dip recession.
The other camp holds that the Fed really shouldn’t do these sorts of things at all except in a Titanic-scale emergency because of the risk to the ultimate credibility of the currency – that you’ll overshoot the desired outcome of “inflation expectations go up” and go directly to “the Fed’s gone mad – let’s put all our money in gold (or Euros, or whatever looks like a better store of value than dollars that are being dropped from helicopters).”
(Interestingly, Paul Krugman, in his 1998 article on Japan argues that it is only the expectation of precisely this kind of irresponsibility that could possibly make unconventional monetary policy work:
If this stylized analysis bears any resemblance to the real problem facing Japan, the policy implications are radical. Structural reforms that raise the long-run growth rate (or relax non-price credit constraints) might alleviate the problem; so might deficit-financed government spending. But the simplest way out of the slump is to give the economy the inflationary expectations it needs. This means that the central bank must make a credible commitment to engage in what would in other contexts be regarded as irresponsible monetary policy – that is, convince the private sector that it will not reverse its current monetary expansion when prices begin to rise!
Put that in your rotor and smoke it, helicopter Ben.)
In any event, the alternative to action by the Fed is action by the Treasury – increase borrowing and put the money into the economy via either government spending or tax cuts. We all know the political constraints on this kind of action, and I rather think it’s subject to the same kind of criticism – if the Treasury issues a whole bunch of 10-year debt, that should push up the yield on government bonds, which should stimulate more private savings to take advantage of the yields, and that rise in private savings should offset the stimulative effect of the tax cuts, so there isn’t any point. Japan’s public debt has grown positively brobdignagian since the early 1990s, but it’s all financed by domestic savings and has therefore traded off with dwindling private sector demand; hence it’s done precious little to stimulate growth. Again, the only way to make this work is to reduce confidence that the government will pay back the bonds in good coin – in other words, to behave truly irresponsibly.
So now we come to my question.
Our goal is to increase the output of the economy, either increasing aggregate demand for goods and services relative to demand for money (the demand side approach), or encouraging the deployment of “dead” money in productive investment (the supply side approach).
Wouldn’t a meaningful wealth tax do both?
A tax on wealth (financial assets and real property) is functionally equivalent to a rise in inflation (that’s why inflation is also described as a tax on savings). Money currently earning a nominal zero percent per year in a savings account would now earn negative two percent per year because of the tax. Spending on assets that naturally depreciate (cars, toasters, trips to Florida) would look more attractive than watching one’s money evaporate through taxes. So would taking risk on a productive investment that might yield a big return but might go bust – just as when inflation expectations rise people shift out of safe short-term bonds and into riskier assets, to “stay ahead of inflation.”
Take the money from the tax and spend it on public works, or reduce other taxes to offset, or just rebate it. Because the wealth tax persists, there’d be a good reason why people would not just save the rebates – again, to stay ahead of inflation.
It feels to me like if, instead of taxes on wages and income, we had a wealth tax and a value-added tax, you’d have a readily available policy lever for increasing or decreasing the velocity of money as desired. Just raise the wealth tax and cut the VAT whenever we look like we’re dipping towards deflation, and do the opposite whenever inflation rears its ugly head.
What am I missing? Isn’t this a pretty straightforward and “fiscally responsible” way around the “zero bound” problem of manipulating nominal rates?
(Alternatively, as Larry Niven once proposed, we could mint nuclear waste. That would certainly be a disincentive to hoard cash!)
You are of course making the case for Veblen’s single tax. 100 years later.
— raylward · Jul 14, 10:26 PM · #
Old is the new new.
— Noah Millman · Jul 14, 10:33 PM · #
I am recoiling in horror at the thought of what the Republicans would say if someone proposed, “say we taxed wealth…,” no matter how sensible the actual plan.
— Come Back Zinc! · Jul 14, 11:15 PM · #
I disagree that the object is to create wealth. The object is to reduce the government portion of GDP to a more reasonable level. If we get that by creating wealth or by destroying wealth is not so important as reducing the govt portion of GDP. Whether it’s done through inflation or deflation, through higher taxes or lower taxes, through spending or saving, is not the most important thing. The most important thing is reducing the govt portion of GDP.
— The Reticulator · Jul 15, 03:26 AM · #
disagree that the object is to create wealth. The object is to reduce the government portion of GDP to a more reasonable level. If we get that by creating wealth or by destroying wealth is not so important as reducing the govt portion of GDP. Whether it’s done through inflation or deflation, through higher taxes or lower taxes, through spending or saving, is not the most important thing. The most important thing is reducing the govt portion of GDP.
— gucci handbags · Jul 15, 06:10 AM · #
Let us suppose that we have a situation where a large portion of a person’s wealth is tied up in financial assets. Stocks, say. The price of a stock fluctuates every second of every day, so when do we assess the value of it? What if the value falls dramatically after it is assessed? What about this hypothetical having to sell a large amount of stock well below market value just to drum up enough cash to satisfy the bill?
What if a wealth tax causes the global tax dynamic to change to where brain drain starts to work against the US instead of for it? Do we believe that those who create large amounts of wealth can’t move to Australia? Or Ireland? Or another relatively low tax first world nation?
What about capital flight occurring if this tax on wealth changes returns to capital downward in the US while it stays that same everywhere else in the world? The trend in corporate tax rates is downward, and with good reason. I feel like a wealth tax would, functionally, be the equivalent of an increase in the Effective tax rate on businesses, and I don’t feel that would result in particularly good outcomes.
I guess that my point could be summed up this way. This post assumes that the choice is between hoarding cash and investing/consuming, but for a lot of the wealthy there exists the third option of moving somewhere else.
That, at least, is the immediate issue I see.
— Alex Hoopes · Jul 15, 06:48 AM · #
If your proposal goes through I’ll end up buying another Birken handbag.
— Tony Comstock · Jul 15, 02:37 PM · #
I think you’re onto something. You pay the VAT on the fraction of your income that you consume, and (over time) the wealth tax on the fraction that you save. (Plus the wealth tax also picks up inherited wealth.) Both the VAT and the property tax are somewhat easier to enforce and harder to evade than the income tax which relies largely on self-reporting. Financial assets also have records, although as Alex mentions the timing issues may be tricky.
You may be able to get around Alex’s concern about international issues if the wealth tax applies to US residents as opposed to assets located in the US or traded on US exchanges.
A disadvantage would be that the wealth tax base could fluctuate wildly from year to year, although the VAT base (if appropriately broad) would be more stable than the current income tax.
— sacman701 · Jul 15, 08:03 PM · #
Alex: yes, a number of European countries have abandoned their wealth taxes for precisely this reason. Another concern is that it is extremely expensive to administer – the corporate income tax has a huge dead loss associated with it, and the dead loss of a wealth tax is probably higher.
What I was really curious to know was whether I got the economic argument right, though – that a wealth tax would be functionally equivalent to a mandated increase in inflation, and therefore there is a clear policy lever for tackling the problem of the zero interest rate bound, whatever its other side effects.
And, I’ll note, that expectations of higher inflation generally lead wealth to leave a currency. Don’t know if a wealth tax would be materially better or worse on that score. If you levied the tax on net assets held in any jurisdiction, it’d probably be better – to escape rising inflation, you just invest abroad, but to escape the wealth tax you’d actually have to renounce your American citizenship, like you have to do if you want to avoid paying American income tax, which is a pretty high bar.
— Noah Millman · Jul 16, 02:31 PM · #
I think you’re correct that an increase in the wealth tax would act like an increase in expected inflation with respect to a household’s decision to save v. consume, or a firm’s decision to spend/borrow v. sit on its cash. I suspect the effect on saving behavior from changing the wealth tax rate would be fairly small if people expect the rate change to be temporary. I think changing the VAT (which would necessarily have a much higher rate than the wealth tax) would have a bigger effect on consumption in the short term.
— sacman701 · Jul 16, 08:03 PM · #