Some Theory of Wealth Taxation

Mirlees is the basis for a lot of how economists think about taxation (he won a Nobel Prize for this body of work in 1996). Famously, while he was a supporter of the Labour Party in the UK, and generally what we would now call progressive, he believed his own results on taxes. Namely that most forms of corporate or capital taxation were a bad idea, and that rates are best kept at zero.

Of course, that doesn’t work politically in most places.

Kocherlakota published an article in 2003 in Econometrica expanding on Mirlees work. It’s one of the basic theoretical papers in taxation.

He set up a model with the following features:

• Agents have skills that determine their income.
• Agents can save, and can finance consumption out of wealth if needed.
• Skills evolve through time with persistence, sometimes getting worse; but you’re self-insured to the extent that you saved something.
• The government is interested in providing a social safety net to the income-poor by taxing the wealth-rich, and redistributing the proceeds as income to the needy.

In this framework, what would the optimal wealth tax look like? The answer is anything but what politicians commonly propose.

• The expected tax rate that an agent expects now on the wealth they may have in the future … should be zero.
• The gross amount of total tax revenue collected on wealth … should always be zero.
• But, the actual tax rate that an agent should face on their wealth once they accumulate it … should be decreasing in their consumption.
• The dispersion of tax rates on wealth between the wealth-rich and wealth-poor should be bigger if the government is bigger.

If you told that to anyone in D.C. (or any other capital) they’d think you were nuts. It means the wealthy should be subsidized, and the not-so-wealthy should be taxed. Further, that should be accentuated when the government is bigger (as they pretty much all have done over the last century).

Economists anger people by pointing out unintended consequences. And there’s a doozy in the framework established by that first set of bullet points (which honestly seemed pretty plausible when you first read it, right?).

It turns out that the dominating effect comes from people who are wealthy now, and who suffer a negative skill shock in the future, so their income drops. Their optimal choice is to … stop working completely … collect the government’s welfare support … and keep their nest egg relatively untouched.

Does this sound like any seniors you know? Wealth rich, income poor, choosing not to work because they have relatively more aches and pains than other seniors, and receiving checks from the government?

Before you complain, let’s look at how an optimal wealth tax might differ from the one’s we have or might have. Current wealth taxes (and those proposed) simply take a percentage of wealth. What Kocherlakota is saying is that you can and should take a fraction of wealth, provided that you adjust that for current income; you take more from someone with low income because they might be a slacker, and you take less from those with high income because you know they’re probably supporting the government more with the high income taxes they pay.

Do note that we already do something like this in certain situations. For example, many welfare programs have asset tests. No one likes this, but in practice this is what is happening when an old person with a home needs to go into a nursing home, and the government requires that the home be sold and the proceeds used up before they’ll start covering the cost of the nursing home. In short, if you self-insured, the wealth tax rate should function to make sure that you use your self-insurance when it’s needed.

The paper is not required. It appeared in Econometrica, which is one of the toughest journals. And the author, Narayana Kocherlakota, has been a top macro theorist at theory-heavy schools for most of his career. By all means check it out, but don’t make yourself feel bad just because you’d need years of math and theory classes to get it all (when all boiled down, the model is 58 equations and 58 unknowns).

Some Politics of Wealth Taxation

Taxing wealth seems to be on the policy table in this U.S. election cycle. This is arguably the most serious move in this direction in about 70 years.

Of course, we already do have some forms of wealth taxation. Owners of real estate pay property taxes. Estate taxes claim a portion of large inheritances. And capital gains on assets are taxed when the gains are realized at sale.

The proposals this year, made by candidates Sanders and Warren, are far broader. They are analogous to property taxes, in that they will be paid on some guess of value (since the value of an asset is only an estimate until it actually changes hands). However, the base for the taxes is widened to most assets. There is some question about tangible vs intangible assets: stocks owned will be a lot easier to value than say, a copyright or patent.

Wealth taxes have been tried in a number of places, primarily in western Europe. And the history of the last few decades has been that they’ve been slowly dissassembled as impractical, unworkable, and not capable of raising that much revenue.

Nonetheless there is a strong impetus for such taxes, largely driven by the research of Piketty, Saez, and Zucman. I don’t care to discuss those much in this post; suffice to say they have documented a large increase in the portion of wealth held by the richest people, across countries, going back about 40 years. Their worry is that societies did a good thing in reducing the portion of wealth held by the rich in the decades prior to that, and that the rich are using the political process to turn the tide in the other direction, and perhaps to re-cement their new gains into permanence. That is a separate issue from whether or not a tax on such gains is feasible.

For this post, I bring your attention to a recent paper by Glennerster entitled “Why was a wealth tax for the UK abandoned?: lessons for the policy process and tackling wealth inequality”. He discusses the UK experience in the 1970’s.

A couple notes about politics are in order. First, the UK has a parliamentary system. This would be analogous to a U.S. system if the Speaker of the House (Nancy Pelosi) was President, the Senate was far weaker, and the judicial system was not co-equal to the other branches. Second, the two largest political parties in the UK are more extreme than those in the U.S. The Conservative party is fairly close to the Republican party here, but the Labour party there is left of our Democratic party.

The backstory is that the Labour Party had contemplated a wealth tax for a long time. Through the 20th century, they had been disappointed with the revenue collected with high rates through an estate tax. Beginning in the 1950’s they started to discuss taxing wealth before death rather than at death. This came to a head in 1974 when the Labour Party included a wealth tax in the platform it used to successfully win the general election. Now they were in a position to enact the tax rather than crow about one, and that’s when the problems began.

Initial public complaints came from farmers, city-dwellers who owned country houses, and private art collections. This was followed by worries about international flights of capital (basically, the rich moving elsewhere). To some extent this was already happening in the UK, which required a bailout from the IMF in 1976 to stabilize the value of the pound.

N.B. The article does not mention this, but that was a topic of some interest in the U.K. in the 1970’s. This was the period when many rock musicians (e.g., members of The Beatles, The Rolling Stones, and Pink Floyd, David Bowie, the entire bands Jethro Tull and Bad Company, Tom Jones, Cat Stevens, Rod Stewart), movie stars (e.g., Roger Moore and Michael Caine), and television personalities (e.g. David Frost, and members of the Monty Python troupe) decamped (primarily to the U.S. and France) to avoid high income tax rates.

Ultimately the wealth tax proposal was not even brought to a vote. It died in committee meetings of presumable supporters. What went wrong? Glennerster quotes Denis Healey’s memoirs and synthesizes (Healey was analogous to Secretary of the Treasury in the UK during the 1970’s):

Denis Healey’s own reflective conclusion was that it was a mistake. ‘Another lesson was that you should never commit yourself in Opposition to new taxes unless you have a very good idea how they will operate in practice. We had committed ourselves to a Wealth Tax: but in five years I found it impossible to draft one which would yield enough revenue to be worth the administrative cost and political hassle.’ (Healey 1989, p404) It seems clear that the Labour Party never considered in any detail the administrative costs and practical complications involved in assessing individuals’ wealth on a regular basis. It was enough to say, as Labour Party Research Department papers did, that other countries levied such taxes so it must be possible. The several thousand civil servants needed, depending on the valuation level at which the tax began, the numerous regional offices required and the process of regular valuation that might fall on individuals came as a surprise to the politicians and, indeed, to the Treasury when it got to think about the question properly. [emphasis added]

…

One lesson to be drawn from the 1974 experience is that the administrative detail in taxation matters a lot. The idea still lacks detailed study. The second lesson is that tax changes that are likely to affect major sections of the population and the wider economy have to be widely debated before, rather than after, any party reaches power.

This is rather an amazing conclusion for the U.S. going into the 2020 election. As we saw in 2016, the unusual thing about U.S. presidential elections is the extent to which they can bring groups into the White House with little or no policy experience. The huge distinction is that in the UK almost everyone brought into power had policy experience, and not only could they not pull it off, but they abandoned the idea as unworkable.

Via Marginal Revolution.

Some Politics of Wealth Taxation

Taxing wealth seems to be on the policy table in this U.S. election cycle. This is arguably the most serious move in this direction in about 70 years.

Of course, we already do have some forms of wealth taxation. Owners of real estate pay property taxes. Estate taxes claim a portion of large inheritances. And capital gains on assets are taxed when the gains are realized at sale.

The proposals this year, made by candidates Sanders and Warren, are far broader. They are analogous to property taxes, in that they will be paid on some guess of value (since the value of an asset is only an estimate until it actually changes hands). However, the base for the taxes is widened to most assets. There is some question about tangible vs intangible assets: stocks owned will be a lot easier to value than say, a copyright or patent.

Wealth taxes have been tried in a number of places, primarily in western Europe. And the history of the last few decades has been that they’ve been slowly dissassembled as impractical, unworkable, and not capable of raising that much revenue.

Nonetheless there is a strong impetus for such taxes, largely driven by the research of Piketty, Saez, and Zucman. I don’t care to discuss those much in this post; suffice to say they have documented a large increase in the portion of wealth held by the richest people, across countries, going back about 40 years. Their worry is that societies did a good thing in reducing the portion of wealth held by the rich in the decades prior to that, and that the rich are using the political process to turn the tide in the other direction, and perhaps to re-cement their new gains into permanence. That is a separate issue from whether or not a tax on such gains is feasible.

For this post, I bring your attention to a recent paper by Glennerster entitled “Why was a wealth tax for the UK abandoned?: lessons for the policy process and tackling wealth inequality”. He discusses the UK experience in the 1970’s.

A couple notes about politics are in order. First, the UK has a parliamentary system. This would be analogous to a U.S. system if the Speaker of the House (Nancy Pelosi) was President, the Senate was far weaker, and the judicial system was not co-equal to the other branches. Second, the two largest political parties in the UK are more extreme than those in the U.S. The Conservative party is fairly close to the Republican party here, but the Labour party there is left of our Democratic party.

The backstory is that the Labour Party had contemplated a wealth tax for a long time. Through the 20th century, they had been disappointed with the revenue collected with high rates through an estate tax. Beginning in the 1950’s they started to discuss taxing wealth before death rather than at death. This came to a head in 1974 when the Labour Party included a wealth tax in the platform it used to successfully win the general election. Now they were in a position to enact the tax rather than crow about one, and that’s when the problems began.

Initial public complaints came from farmers, city-dwellers who owned country houses, and private art collections. This was followed by worries about international flights of capital (basically, the rich moving elsewhere). To some extent this was already happening in the UK, which required a bailout from the IMF in 1976 to stabilize the value of the pound.

N.B. The article does not mention this, but that was a topic of some interest in the U.K. in the 1970’s. This was the period when many rock musicians (e.g., members of The Beatles, The Rolling Stones, and Pink Floyd, David Bowie, the entire bands Jethro Tull and Bad Company, Tom Jones, Cat Stevens, Rod Stewart), movie stars (e.g., Roger Moore and Michael Caine), and television personalities (e.g. David Frost, and members of the Monty Python troupe) decamped (primarily to the U.S. and France) to avoid high income tax rates.

Ultimately the wealth tax proposal was not even brought to a vote. It died in committee meetings of presumable supporters. What went wrong? Glennerster quotes Denis Healey’s memoirs and synthesizes (Healey was analogous to Secretary of the Treasury in the UK during the 1970’s):

Denis Healey’s own reflective conclusion was that it was a mistake. ‘Another lesson was that you should never commit yourself in Opposition to new taxes unless you have a very good idea how they will operate in practice. We had committed ourselves to a Wealth Tax: but in five years I found it impossible to draft one which would yield enough revenue to be worth the administrative cost and political hassle.’ (Healey 1989, p404) It seems clear that the Labour Party never considered in any detail the administrative costs and practical complications involved in assessing individuals’ wealth on a regular basis. It was enough to say, as Labour Party Research Department papers did, that other countries levied such taxes so it must be possible. The several thousand civil servants needed, depending on the valuation level at which the tax began, the numerous regional offices required and the process of regular valuation that might fall on individuals came as a surprise to the politicians and, indeed, to the Treasury when it got to think about the question properly. [emphasis added]

…

One lesson to be drawn from the 1974 experience is that the administrative detail in taxation matters a lot. The idea still lacks detailed study. The second lesson is that tax changes that are likely to affect major sections of the population and the wider economy have to be widely debated before, rather than after, any party reaches power.

This is rather an amazing conclusion for the U.S. going into the 2020 election. As we saw in 2016, the unusual thing about U.S. presidential elections is the extent to which they can bring groups into the White House with little or no policy experience. The huge distinction is that in the UK almost everyone brought into power had policy experience, and not only could they not pull it off, but they abandoned the idea as unworkable.

Because People Lie, and Some Believe Them

This has been going on in richer, developed, countries for about a century (and it is a macro issue if there ever was one):

It is happening globally, on net. The focus on burning and clearing in South America, Africa, and southeast Asia is not a bad thing, but it is rarely tempered by this simple fact.

And do note that may people will complain about the quality of the recovering trees and forests. That is not tempered by any evidence that it is worse than what poor people are taking away in the tropics.

FWIW: The area that I grew up in the far outer suburbs of Buffalo, NY, is now almost completely forested. It was farms a century ago. My first apartment was an old farm house, where the farm had been taken over by trees decades before. My second apartment was a new building on a property that had been a farm, and which had returned to woodland. They later cleared much of that, put in a subdivision … and planted a ton more trees.

This infographic is from BeautifulNewsDaily which maintains links to all the source data used. And I don’t think anyone would call it a Republican-oriented site.

Extreme Poverty Diminishing

From BeautifulNewsDaily:

Essentially all of this took place in countries with predominantly capitalist economies. Then again … macroeconomists have been noting that for decades.

BTW: “diminishing”. that is, going towards zero, is a better choice of words than “decreasing”, which is going towards negative infinity.