A consumption tax is a wealth tax - InvestingChannel

A consumption tax is a wealth tax

Josh Barro recently discussed a study which polled Americans on attitudes toward wealth:

Indeed, while the top quintile of Americans hold about 84% of national balance sheet wealth, survey respondents believe the figure is just 59% and would prefer a figure of 32%. The authors use the paper to argue for more redistributive policies — or rather, for the insertion of these public preferences into policy debates.

All that study shows is that Americans aren’t very good at math.  If every single American made an identical income at the same age, then wealth would still be more unequal than 32% in the top quintile.  Even if saving propensities were also identical, 18 year-olds typically have far less wealth than 55 year olds who are married and have kids.  And does anyone seriously believe Americans favor paying brain surgeons an identical salary to a clerk at Walmart?  Let’s get serious. Anyone who favors inserting that sort of “public preferences” into the policy debate needs to have his head examined. This is the sort of things that gives economists a bad reputation.  It may be a great study, but come on, use some common sense!

Ezra Klein recently suggested that the highly unequal levels of wealth (which by the way Josh Barro shows occurs in other developed countries as well), is leading to interest in a wealth tax:

So then, here’s what you should know about wealth inequality in the United States: It’s worse than Americans want it to be, much worse than they think it is, and it’s increased over the last few decades. Which is one reason that there’s been more talk of a wealth tax lately.

Matt Yglesias responds as follows:

If you want to think about taxing wealth more heavily, it’s probably worth trying to draw some distinctions. The old argument going back to David Ricardo and Henry George that you should tax land wealth very heavily seems quite sound to me. Levying heavy tax rates on valuable land (whether it’s valuable because it’s in San Francisco or valuable because it has oil in it) does not create any bad incentives. These days, a lot of wealth consists of patents that could be taxed more heavily but should probably just be abolished. But in terms of general taxation of financial assets, the basic concept of taxing estates rather than a steady drip-drip-drip of wealth taxes seems like a reasonably sound idea. We’ve reduced estate taxes a lot over the past 15 years, which seems like a very strange policy response to growing income inequality and some evidence of capital-biased technological change.

I partly agree with Yglesias—a land tax is sensible.  And I agree with his earlier calls for a progressive consumption tax.  But I strongly disagree with the inheritance tax.  Ironically, Matt has a picture of a mega-yacht on the top of his post calling for an inheritance tax.  But an inheritance tax specifically exempts services provided by mega-yachts, and instead taxes only the wealth of thrifty old guys who leave all their fortune to others!  Do we really want to tax the sort of old man or woman who puts all their wealth back into investments at a higher rate than we tax those hedonists who splurge on wine, women, and song? That seems morally grotesque, indeed I’d tax people on the basis of how many resources they consume, or take out of society, not what they produce.

Most people regard consumption as being much more equal than income, which is then much more equal than wealth.  But this is a cognitive illusion, as wealth is basically the present value of future expected consumption (for yourself, plus those you donate to.)  What causes this confusion? It’s partly life cycle effects and consumption smoothing, which I’ve already discussed.  It’s also partly due to the fact that the rich tend to have lots of easily measured wealth (financial assets) whereas the poor and middle class rely more on (difficult to measure) human capital as a form of wealth.

I can already anticipate commenters insisting that wealth is bad for other reasons—it gives people too much political power, for instance. Maybe, but it’s a pipe dream to think we can measurably reduce that problem via progressive policies.  Even the Nordic countries have very unequal wealth.

We need a mixture of the following, in this order:

1.  Taxes on externalities (carbon, but not cigarettes.)

2.  Taxes on land (by acreage, not value, with the tax rate varying by zip code.)

3.  Progressive consumption taxes.  These could include

a.  VAT with poverty level consumption exempted.  Progressive taxes on housing services (i.e. progressive property taxes.)

b.  Progressive payroll taxes—treating capital income that people earn from their own firm as wages, unless they can show otherwise.

c.  Negative taxes on low wage jobs (EITC.)

Do that, and you can pretty much adopt a radical libertarian policy in most other areas (with a few exceptions.)

PS.  Evan Soltas has some good arguments against wealth taxes.