Do We Really Need a Wealth Tax?

 

Our dire fiscal and economic problems are crying out for a bold solution.  We need to simultaneously stimulate our economy to grow faster and create more jobs, raise sufficient tax revenue to pay for our growing spending commitments, and address a widening inequality gap which threatens to undermine the basic principles of a free and just society.  How are we going to accomplish all of these tasks at the same time?
It seems to me that the best way is to thoroughly reform our income tax system based on the following principles:

  • Lower tax rates on marginal income to encourage more investment and entrepreneurship.  Such changes can be made revenue neutral by eliminating deductions, loopholes and other tax preferences.  This would apply to corporations as well as individuals.
  • Establish a new low percentage (1% – 2%) wealth tax with a relatively high personal exemption ($5 million – $10 million).  This would bring in approximately $200 billion per year to be used for reducing the deficit.  Equally as important it would be a visible sign that the wealthy are making a significant contribution towards solving our fiscal problem.  This will make it more acceptable to lower marginal tax rates on income in order to boost economic growth.

Fiscal conservatives often oppose any increase in tax revenue because, they think, it is likely to be used for new spending rather than for lowering the deficit.  One way to overcome this concern is to pass a Balanced Budget Amendment to the Constitution. This would make it much harder to increase spending.  The problem is that it will be very hard for Congress to pass such an amendment and have it ratified by ¾ of the states.
But something has to be done.  The longer we wait and the more debt we build up, the more painful it will be to extract ourselves when the next crisis occurs as it surely will.

Truth and Myth about Inequality

 

Two of my favorite columnists are the Brooking Institution’s William Galston, a social economist who has a weekly column in the Wall Street Journal and the economics journalist Robert Samuelson who writes for the Washington Post.  
Most people agree that income inequality in the U.S. is steadily getting worse.  Mr. Galston make a good case (see my last post) that it is primarily caused by the large gap between the rising productivity of American workers and the stagnant level of their pay which has developed since 1973.  He thinks that we need a fundamentally new social contract which links worker compensation to productivity.  This, of course, is a tall order and it is not at all clear how such a new order would be achieved.
CaptureMr. Samuelson has a different perspective: “Myth-making about Economic Inequality”.  For example:

  • The poor are not poor because the rich are rich
  • Most of the poor will not benefit from an increase in the minimum wage because only 6% of the 46 million poor people have full time jobs
  • All income groups have gained in the past three decades, even though the top 1% has gained the most (see the above chart from the CBO, December 2013)
  • Widening economic inequality did not cause the Great Recession

These two perspectives on inequality are quite different but not contradictory.  Basically what Mr. Samuelson is saying is that we have to be careful in how we address this problem or we’ll just make it worse.  Raising taxes on the rich is unlikely to help and might hurt if it slows down the economy.  Raising the minimum wage will only raise a fairly small number of people out of poverty and may cause a lot of unemployment along the way.
My solution: focus on boosting the economy to create more jobs in the short run (tax reform, immigration reform, trade expansion) and improved educational outcomes for the long run (early childhood education, increasing high school graduation rates, better career education).
But I agree with Mr. Galston that it is imperative to lessen income inequality, one way or another.  Otherwise as a society we’ll have big trouble on our hands.

More on Inequality: What Does the Data Mean?

In yesterday’s Wall Street Journal, the economist Robert Grady addresses “Obama’s Misguided Obsession With Inequality”.  The basic problem is that an important Congressional Budget Office report in 2011, “ Trends in the Distribution of Household Income Between 1979 and 2007”, is easy to misrepresent and misinterpret.  Here are three basic pieces of data from the CBO report:
Capture3CaptureCapture1The first chart shows that yes, between 1979 and 2007 the rich did indeed get richer relative to the rest of the population.  The second chart shows, however, that median household income increased by 62% during this same time period.  And the third chart shows that all five income groups made substantial gains at the same time.
As Mr. Grady says, “Here is the bottom line.  In periods of high economic growth, such as the 1980s and 1990s, the vast majority of Americans gain and have the opportunity to gain.  In periods of slow growth, such as the past four and a half years since the recession officially ended, poor people and the middle class are hurt the most, and opportunity is curbed. … The point is this: If the goal is to deliver higher incomes and a better standard of living for the majority of Americans, then generating economic growth – not income inequality or the redistribution of wealth – is the defining challenge of our time.”
So then, what is the best way to address income inequality?  Should we concentrate on raising taxes on the rich and increasing spending on social programs like we have done in the last five years?  Or should we rather concentrate on speeding up economic growth, as Mr. Grady says, in order to create more jobs and more opportunities for advancement?
Compare the enormous growth in the period from 1979 to 2007 with the stagnation of the past five years.  Isn’t it obvious which is the better way to proceed?

Can We Solve Our Fiscal Problems by Taxing the Rich? II. Robert Reich’s View

 

One of America’s foremost liberal writers, Robert Reich, a Professor of Public Policy at UC Berkeley, argues in his latest book, “Beyond Outrage”, that “America’s economy and democracy are working for the benefit of ever-fewer privileged and powerful people.”  He presents “a plan for action for everyone who cares about the future of America.”  Mr. Reich’s tax policy:

  • Raise the tax rate on the rich to what it was before 1981

“Sixty years ago Americans earning over $1 million in today’s dollars paid 55.2 percent of it in income taxes, after taking all deductions and credits.  If they were taxed at that rate now, they’d be paying at least $80 billion more annually.”

  • Put a two percent surtax on the wealth of the richest one-half of one percent

“The richest on-half of one percent of Americans, each with over $7.2 million of assets, own 28 percent of the nation’s total wealth.  Given this almost unprecedented concentration, and considering what the nation needs to do to rebuild our schools and infrastructure, as well as tame the budget deficit, a surtax is warranted.  It would generate another $70 billion a year.”

  • Put a one-half of one percent tax on all financial transactions

“This would bring in more than $25 billion per year.”

These new tax provisions would together raise tax revenue by $175 billion per year.  But our deficit this fiscal year, ending September 30, 2013, is about $700 billion.  In a few years, without significant changes in either discretionary or entitlement spending, annual deficits will be back up over a trillion dollars per year and climbing.  Mr. Reich’s steep taxes on wealth and wealth creation are not enough to seriously tame deficit spending, let alone end it.
Let’s be honest and admit that some new tax revenue is probably going to be necessary in the future if we are ever going to be able to eliminate the deficit.  But it makes no sense to start out with a tax increase which will be strongly opposed anyway.  It is far more sensible to first wring out the hundreds of billions of dollars in wasteful federal spending which now exists.  After this is done there likely will still be a big deficit.  Then, and only then, would it be appropriate to generate significant new revenue by raising taxes.

Can We Solve Our Fiscal Problems by Taxing the Rich? I. The Third Way

“I enjoy your blogs and always look forward to the next one.”
“I am amazed when listening to my liberal friends, who could care less about any of the arguments you are making. Their basic belief is that any deficit can be solved in short order by simply raising taxes on the rich. One of these friends just bought a home in Palm Springs and came back declaring, ” Jerry Brown solved the financial problem in California. He raised taxes on the rich and the deficit is gone. California no longer has a financial problem.” He then went on to say that with 40 million people, California will set a good example for the country. After listening to this, I think you should address the issue of why simply increasing taxes will never work. I would start with Simpson Bowles and then go on to more recent findings. I think this argument has to be made over and over again. There are precious few Democrats who think we have a serious or fundamental financial problem that cannot be solved by simply raising taxes on the rich. I believe Obama is leading the charge.”

One response to this argument is provided by the President, Jon Cowan, and the Senior Vice President for Policy, Jim Kessler, of the Third Way, a center-left think tank, in a June 2013 memo, “The Four Fiscal Fantasies” .

  • Fantasy #1: Taxing the rich solves our problems.

Mr. Cowan and Mr. Kessler look at a plan that “completely soaks the rich.”  They stipulate that the top tax rate increases ten points to 49.6%.  They impose the Buffett Rule requiring all millionaires to pay at least 30% in taxes (after deductions).  They raise the estate tax to allow a $3.5 million exemption with a 45% rate.  “If we leave entitlements on auto-pilot in this scenario, our deficit in 2030 will be close to a stunning $1.3 trillion in 2013 inflation-adjusted dollars.”
The authors then show that to keep our finances even roughly in check, a middle income family with a $65,000 income, for example, would have to pay several thousand dollars a year in new taxes.
Conclusion:  We cannot keep entitlements on auto-pilot.  Something has to give!