Editor’s Note: Orphe Divounguy is chief economist at the Illinois Policy Institute. Hilary Gowins is vice president of communications at the Illinois Policy Institute. The opinions expressed in this commentary are their own.
Democratic presidential candidate Elizabeth Warren wants a wealth tax. She says she needs it to fund massive new government spending ventures that include clean energy, affordable housing, Social Security benefits, universal childcare, increased spending on public schools, student debt cancellation, free college and Medicare for All. She also believes a wealth tax is needed because rising income inequality generally has a negative effect on the economy.
She’s half right.
Rising income inequality is indeed a problem for economic growth. But taxing wealth could exacerbate the problem, not fix it. That’s because the bulk of the wealth Warren is counting on to pay the bills is not sitting under a mattress. Instead, America’s wealthiest men and women often invest in new business capital, resulting in innovation and jobs that American consumers and workers largely benefit from.
Warren wants to enact a tax of 2% per year on household wealth above $50 million, with an additional 1% levy on wealth above $1 billion. Since most of the estimated wealth of billionaires is invested in companies that innovate and create jobs, Warren’s wealth tax could — if it successfully seizes a large amount of assets from the world’s best allocators of capital — lead to less investment, ultimately harming workers and consumers.
Economist Larry Summers, the former US Treasury Secretary who advised presidents Barack Obama and Bill Clinton, has stated publicly — and repeatedly — that one of the many reasons wealth taxes fail is due to much higher tax avoidance and tax evasion than the 15% estimated by Warren’s economic advisers. They had estimated that the super-wealthy already tend to understate their wealth to avoid taxes by roughly 15%, but as numerous economists, including Summers, pointed out, the rate of tax avoidance would be much higher since tax avoidance is an increasing function of the tax rate. That means that at higher tax rates, tax avoidance would also increase.
But more importantly, there’s also a question of how a wealth tax would affect economic growth.
The economy grows when people put money back into it. It grows even faster when capital flows freely into great ideas and new projects. America continues to lead the world in patent filings because of the investments of wealthy American investors.
Has a wealth tax ever been an effective means of promoting economic growth? France — a country that had a wealth tax until 2017 — proves that the tax is a massive risk.
Eric Pichet, a professor of economics, estimated the costs of the wealth tax in France: Capital flight amounted to over $200 billion, an annual fiscal shortfall of almost $7 billion — or about twice the revenue it generated — as well as a reduction in GDP growth of $3.5 billion per year. It’s estimated that France’s wealth tax led to the exodus of 10,000 millionaires in 2015 alone. President Emmanuel Macron ended the country’s wealth tax in 2017 because of the havoc it wreaked on the French economy.
Sure, some ultra-rich Americans made their money by inheriting it. But most billionaires are self-made. They worked hard and invested. They’re not hoarders — they’re actually infusing massive amounts of money into the American economy and creating jobs. A wealth tax could drastically reduce those investments.
We have to consider what we, as a country, want our public policy to encourage. We shouldn’t be taxing ownership, industriousness and hard work. As a country, we should shift away from taxing income and we should never discourage investment and ownership. There is no surer way out of poverty and up the economic ladder than via the accumulation of human and physical capital.
There is a better model — taxing consumption, not income or wealth. Laurence Kotlikoff, a leading economist at Boston University, suggests taxes should not penalize investments that make good-paying jobs a reality. Instead of taxing wealth, Kotlikoff wants to tax how much the rich consume; income-in minus investment-out equals consumption. Under this plan, billionaire investors would pay lower taxes than billionaires who spend lavishly on private jets and mega yachts. Under Kotlikoff’s plan, only consumption in excess of $100,000 would be taxed at rates that rise from 0% to 30%.
Taxing consumption makes sense for many reasons. For one thing, it encourages new investments. These new investments would make workers more productive, improve living standards and grow the economy.
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A consumption tax is easier to enforce, too. A wealth tax includes everything you own, such as money in the bank, along with property and everything in it, such as expensive paintings for example, making the tax base difficult to estimate.
Currently, the US tax code favors different types of income over others, creating loopholes that have exacerbated the gap between the rich and the poor. Shifting away from an income tax toward a consumption tax would simplify our federal tax code while making sure it doesn’t contribute to rising income inequality. Eliminating progressive income taxes in favor of taxing consumption on a cash-flow basis, is fair, easy to enforce and would help sustain higher rates of economic growth and it would be less costly to enforce and nearly impossible for the rich to evade, as the IRS already tracks income and investments. Consumption is whatever is left over, so it can easily be taxed.
Democratic presidential candidate Andrew Yang, a lawyer and entrepreneur from upstate New York, has pointed out that other countries such as France, Sweden, Germany and Denmark have all adopted a wealth tax, only to repeal the policy shortly afterward.
“If we can’t learn from the failed experiences of other countries, what can we learn from?” Yang asked on stage at the Oct. 15 Democratic presidential debate.
Yang’s right. We don’t have to repeat public policy failures. We can learn from others’ mistakes and simplify the federal tax code to slow the growth in income inequality and continue to improve the nation’s economy, attracting more workers to good paying jobs.