Dishonest Pimping for a Global Wealth-Tax Cartel

Everything you need to know about wealth taxation can be summarized in two sentences.

• The biggest problem with most tax systems is the pervasive tax bias against income that is saved and invested, which discourages the accumulation of capital that helps to finance future growth.
• Wealth taxes would dramatically increase the tax bias against saving and investment and easily could result in implicit marginal tax rates on capital of more than 100 percent.

Unfortunately, economic arguments don’t matter to the class-warfare crowd. They mistakenly think the economy is a fixed pie, so if Jeff Bezos and Elon Musk have a lot of money, then the rest of us have less money.

This is empirically nonsensical.

Or perhaps they simply resent people who are very successful. There’s certainly a good amount of evidence that folks on the left have a hate-and-envy mentality.

I don’t know Prof. Gabriel Zucman’s motives, but he’s a big advocate of a global wealth tax. Here are some passages from his recent column in the New York Times.

…the ultrawealthy consistently avoid paying their fair share in taxes. …Why do the world’s most fortunate people pay among the least in taxes, relative to the amount of money they make? The simple answer is that while most of us live off our salaries, tycoons like Jeff Bezos live off their wealth. In 2019, when Mr. Bezos was still Amazon’s chief executive, he took home an annual salary of just $81,840. But he owns roughly 10 percent of the company, which made a profit of $30 billion in 2023. …Unless Mr. Bezos, Warren Buffett or Elon Musk sell their stock, their taxable income is relatively minuscule. …There is a way to make tax dodging less attractive: a global minimum tax. …The idea is simple. Let’s agree that billionaires should pay income taxes equivalent to a small portion — say, 2 percent — of their wealth each year. …the proposal would allow countries to collect an estimated $250 billion in additional tax revenue per year, which is even more than what the global minimum tax on corporations is expected to add.

There are many problems with Zucman’s analysis.

One concern is that it’s a bad idea to finance bigger government, which is a goal of the class-warfare crowd.

Another problem is that Zucman never acknowledges or addresses the disincentive effect of higher taxes on saving and investment.

Here are some excerpts from the Wall Street Journal‘s editorial on the topic.

In our new socialist age, the demand to tax and redistribute income is insatiable. The latest brainstorm arrives in a proposal by four countries in the G-20 group of nations to impose a 2% wealth tax on the world’s billionaires. …As you might expect, this would principally be a tax raid on Americans, who are the most numerous billionaires. It would also be taxation without representation, since it would be a body of global elites attempting to impose a tax without having passed Congress. …Once a global wealth tax is in place, you can be sure that billionaires won’t be the last target. …the G-20 is becoming a vehicle for the world’s left-wing governments to gang up on the U.S. …For this crowd, taxing American billionaires to redistribute income around the world is all too imaginable.

By the way, Zucman’s problem is not merely bad economics.

He also uses misleading numbers. Phil Magness of the Independent Institute exposes his dodgy manipulations in a thread on Twitter (now called X).

There are dozens of tweets in his thread, but here’s his summary if you don’t have time to read everything.

P.S. Another French economist, Thomas Piketty, also uses dodgy numbers while pushing for class-warfare taxes. Seems to be a pattern on the left (as illustrated by one of Biden’s tweets that was based on make-believe numbers).

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Trudeau’s Class-Warfare Tax Policy Is Bad News for Canada

The tax bias against saving and investment is a major problem in the United States and many other nations.

According to the latest-available data from the Tax Foundation, the worst of the worst is Canada.

So how does Canada’s dilettante Prime Minister respond?

By proposing a big increase in the capital gains tax.

I’m not joking. Even though Canada already has a punitive capital gains tax, Justin Trudeau wants a big increase.

Here are some excerpts from a report in the National Post by Olivia Rumbell, which focuses on how the higher tax is prodding some people to sell homes before the tax is implemented.

The new capital gains tax proposed in the Liberal budget has led to speculation that there might be a flood of cottages entering the market or a push for earlier closing dates as sellers try to avoid a hefty tax bill. “I am seeing an increase in people wanting to list their properties now that this is going into effect,” said Beth Groom, a broker and owner of Cape Breton Realty. The capital gains tax, if it comes into effect, would tax profits on capital gains of more than $250,000 at almost 67 per cent, up from the prior rate of 50 per cent. It would result in an increased tax bill on capital gains for some sellers. …Groom speculated that if she was working for the buyer, she’d put in an offer for a certain amount, closing prior to the June 25 date when the capital gains tax will come into effect, communicating clearly so that the seller knows if they close before that day, they may save money.

For what it’s worth, I’m not overly worried about the impact on homeowners (though it’s unfair for them to be hit by an extra layer of tax).

What matters a lot for long-run prosperity is innovation and business investment. And Trudeau’s class-warfare grab for money is going to discourage those things.

Given the Tax Foundation’s comprehensive formula, I don’t know what it will do to the overall tax rate on capital income, but it definitely will move in the wrong direction.

Why is Trudeau pushing bad policy?

Given that a previous class-warfare tax hike backfired, he should have learned.

But given his approach to fiscal policy, we shouldn’t be surprised.

P.S. His views on monetary policy may be even worse.

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Why Is Someone at AEI Proposing a Massive Tax Increase to Finance Ever-Growing Government, Part I?

Serious and responsible people (in other words, not Trump or Biden) know that Social Security has a massive long-run problem.

A fast-growing number of seniors are expecting future benefits but only a slow-growing number of workers will be paying into the system.

But even if this demographic problem didn’t exist, there is the underlying flaw of a retirement system based on tax-and-spend (or debt-and-spend) rather than wealth accumulation.

The solution is obvious.

We need to shift to a system based on personal retirement accounts.

The transition to a modern system will be expensive, to be sure, but not nearly as costly as the $60 trillion-plus burden of propping up the current system.

But some people prefer the more-expensive option.

Andrew Biggs of the American Enterprise Institute and Alicia Munnell of Boston College want to divert a massive amount of money from the private sector to the government, and they want to do it by double-taxing the money Americans have in retirement accounts.

Here are excerpts from their new report.

The U.S. Treasury estimates that the tax preference for employer-sponsored retirement plans and IRAs reduced federal income taxes by about $185-$189 billion in 2020, equal to about 0.9 percent of gross domestic product. …it actually offers policymakers an opportunity to strengthen the nation’s retirement income system. Revenues saved from repealing the retirement saving tax preferences could be reallocated to address the majority of Social Security’s long-term funding gap. …an opportunity to use taxpayer resources more productively. …the case is strong for eliminating the current tax expenditures on retirement plans, and using the increase in tax revenues to address Social Security’s long-term financing shortfall. …Tax expenditures for employer-sponsored retirement plans are expensive – costing about $185 billion in 2020. … reducing tax expenditures for retirement plans could be an effective way to help address other pressing demands on the federal budget, such as Social Security’s financing shortfall.

By the way, it is no exaggeration to say the authors “want to divert a massive amount of money” to politicians over the next decade. Based on the Congressional Budget Office’s latest 10-year forecast, 0.9 percent of GDP is about $3 trillion.

It’s not just that the authors want to prop up a system that needs reform.

They also want to undo provisions in the tax code (IRAs and 401(k)s) that allow people to protect themselves against two layers of tax on income that is saved and invested.

It’s also laughable that the report states that a huge tax increase will “use taxpayer resources more productively.” If higher taxes to fund bigger government was a good idea, Europe’s welfare states would be richer than the United States rather than way behind.

Even the title of the Biggs-Munnell study is offensive. It implies that taxpayers are getting a handout or favor if politicians don’t impose double taxation. At the risk of understatement, being taxed one time rather than two times is not a subsidy.

P.S. The better option is a shift to retirement systems based on private savings, like the ones in Australia, Chile, Switzerland, Hong Kong, Netherlands, the Faroe Islands, Denmark, Israel, and Sweden.

P.P.S. Biggs and Munnell are misguided for wanting a big tax increase to prop up a bankrupt system. That’s the bad news. The worse news is that some people want to expand the bankrupt system. And they are proposing tax increases that arguably would cause even more economic damage.

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A Primer on So-Called Tax Expenditures

At the start of the year, I wrote that so-called tax expenditures  were a “boring but important issue.”

Well, it’s time to once again put readers to sleep.

Let’s start with a definition. A tax expenditure is basically a loophole in the tax code. And these loopholes are called tax expenditures because they are seen as being equivalent to a spending program.

For instance, the crowd in Washington could pass a $100 billion spending program to benefit an interest group, or it could create a special preference in the tax code that is worth $100 billion to the same interest group.

Libertarians don’t view these things as morally equivalent. A spending program takes money from other people and gives those funds to an interest group, whereas a tax loophole simply lets people keep their own money.

But that does not mean tax loopholes are good policy. They are a form of industrial policy in the tax code.

The pro-market view is that loopholes should be eliminated so long as every penny of the revenue is used to lower tax rates (a core premise of tax reform).

This sounds simple and straightforward, but there is a big controversy over the benchmark (or “tax base“) that gets used when measuring loopholes.

• Is is the Haig-Simons tax base, which assumes that there should be double taxation of income that is saved and invested (in effect, taxing income plus changes in net worth)?
• Is is the consumption tax base, which assumes that income should be taxed only one time (thus creating neutrality between current consumption and future consumption)?

Official Washington (primarily the Treasury Department and the Joint Committee on Taxation, but also CBO, GAO, ) uses the Haig-Simons tax base.

And left-leaning groups understandably like the Haig-Simons approach.

Needless to say, pro-market organizations have a different perspective.

Chris Edwards has a new study that reviews the official list of tax expenditures and identifies which ones actually are loopholes.

The Tax Foundation did something similar back in February.

Here’s a table showing how so-called expenditures dramatically shrink when getting rid of tax penalties on business investment and tax penalties on personal savings and investment.

For those who want to finance genuine tax reform, there are genuine loopholes that could be eliminated or curtailed, most notably the fringe benefits exclusion and the muni-bond exemption.

P.S. The fringe benefits exclusion is such bad policy (contributing to third-party payer) that I even wrote something nice about Obamacare.

P.P.S. Our friends on the left genuinely seem to think that the government has an automatic claim to people’s income.

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The Case Against Biden’s Class-Warfare Tax Policy, Part VI

Last week, I wrote about Biden’s proposed budget, focusing on the aggregate increase in the fiscal burden.

Today, let’s take a closer look at his class-warfare tax proposals. Consider this Part VI in a series (Parts I-V can be found here, here, here, here, and here), and we’ll use data from the folks at the Tax Foundation.

We’ll start with this map, which shows each state’s top marginal tax rate on household income if Biden’s budget is enacted.

The main takeaway is that five state would have combined top tax rates of greater than 50 percent if Biden is successful in pushing the top federal rate from 37 percent to 39.6 percent.

At the risk of understatement, that’s not a recipe for robust entrepreneurship.

While it is a very bad idea to have high marginal tax rates, it’s also important to look at whether the government is taxing some types of income more than one time.

That’s already a pervasive problem.

Yet the Tax Foundation shows that Biden wants to make the problem worse. Much worse.

His proposed increase in the corporate tax rate is awful, but his proposal to nearly double the tax burden on capital gains is incomprehensibly foolish.

I guess we should be happy that Biden didn’t propose to also increase the 40 percent rate imposed by the death tax.

But that’s not much solace considering what Biden would do to American competitiveness. Here’s our final visual for today.

As you can see, the president wants to make the US slightly worse than average for personal income taxes, significantly worse than average for the corporate income tax, and absurdly worse than average for taxes on capital gains and dividends.

I’ll close by observing that some of my leftist friends defend these taxes since they target the “evil rich.”

I have a moral disagreement with their view that people should be punished simply because they are successful investors, entrepreneurs, or business owners.

But the bigger problem is that they don’t understand economics. Academic research shows that ordinary workers benefit when top tax rates are low, and there’s even more evidence that workers are hurt when there is punitive double taxation on saving and investment.

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The Case Against Biden’s Class-Warfare Tax Policy, Part V

In 2020 and 2021, I wrote a four-part series (here, here, here, and here) about Biden’s class-warfare tax agenda.

And I also wrote a series of columns about some of his worst ideas.

• Biden wants America to have the developed world’s highest capital gains tax rate.
• Biden wants America to have the developed world’s highest tax burden on business investment.
• Biden wants America to have the developed world’s highest personal income tax rates.

He even proposed taxes that don’t exist anywhere else in the world.

The main purpose of those columns was to explain why it would be economically harmful to impose punitive tax rates on productive behaviors such as work, saving, investment, and entrepreneurship.

Unsurprisingly, Biden still wants all these tax increases, even though Democrats lost control of the House of Representatives.

Today, let’s look at his awful proposal to tax unrealized capital gains (an idea so absurd that no other nation has enacted this destructive levy).

Eric Boehm’s article in Reason debunks Biden’s proposal (the president calls it a billionaire’s tax).

Say what you will about the Biden administration’s approach to tax-the-rich populism: It’s creative. …Taxpayers with net wealth above $100 million would have to pay a minimum effective tax rate of 20 percent on an expanded measure of income that adds unrealized capital gains to more conventional sources of income, like wages, business income, and investment income. …By raising the effective tax rate on capital gains, the proposal would reduce U.S. saving, discourage entrepreneurship, and decrease economic output. …An annual tax on paper gains would be conspicuously complex. The largest administrative problems relate to valuing non-tradable assets like privately held businesses and taxing illiquid taxpayers with large gains on paper but little cash on hand to pay a minimum tax bill. …Given these problems, it’s unsurprising the idea hasn’t caught on around the world.

And the Wall Street Journal has an editorial about this class-warfare scheme.

After the November midterm election, President Biden was asked what he would change in his last two years. “Nothing,” he said, and…he proved it by reproposing…enormous tax increases that he couldn’t get through even a Democratic Congress. Start with a reprise of his “billionaire minimum tax.” …For starters, it isn’t a billionaire tax and it isn’t an income tax. It would apply to households worth more than $100 million in accumulated assets, and its target is wealth. …if your assets rise in value during a year, you will pay taxes on that increase even if you realized no actual gains through a sale. …If your assets fell in value, you would not be able to deduct the full loss from your overall income. Heads the government wins, tails you lose.

The bottom line is that the capital gains tax is an awful levy.

But rather than abolishing the tax to boost American competitiveness, Biden has latched on to an idea to make a bad tax even worse.

And that’s in addition to his other proposals to make the capital gains tax more burdensome!

P.S. I guess we shouldn’t be surprised at bad ideas since the president is infamous for economically illiterate tax tweets.

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Protecting Individual Savings from Double Taxation

While speaking last year in Hawaii on the topic of good tax policy, I explained why it is misguided to impose extra layers of tax on saving and investment.

Regarding the problem of double taxation, I’ve addressed how various features of the tax code need to be fixed.

• Get rid of the capital gains tax
• Get rid of the double tax on dividends
• Get rid of the death tax

Today, we’re going to focus on the fixing the tax treatment of household savings. And the problem that needs fixing is that the federal government taxes you when you earn money and also taxes any interest you earn if you decide to save some of your after-tax income.

As you can see from the chart, this creates a tax wedge.

And that tax wedge distorts people’s decisions and makes them more likely to choose immediate consumption rather than savings (which can be viewed as deferred consumption).

As mentioned in the video, every economic theory recognizes that saving and investment (again, just another way of saying deferred consumption) are critical to future growth and rising living standards. So there are good reasons to fix the tax code.

The good news is that there are two ways to fix this problem.

1. Tax income only one time when it is first earned.
2. Tax income only one time when it is consumed.

In practical terms, the first option treats all savings like a “Roth IRA,”, which means you pay tax the year you earn your income, but the IRS does not get another bit at the apple if you save some of your after-tax income and it earns interest or otherwise grows in value.

The second option treats all savings like a 401(k), which means you are not taxed on any income that you place in a savings vehicle, but you are taxed on any money (including any interest or other returns) that you withdraw from the account.

As shown by Adam Michel of the Heritage Foundation, both of these approaches lead to the same long-run result (and thus are superior to what happens when people save without being protected from double taxation).

The good news is that Americans can protect their savings from double taxation by using either individual retirement accounts (IRAs) or 401(k)s.

The bad news is that those “qualified accounts” are restricted. Only people who are saving for retirement can protect themselves from double taxation.

That needs to change.

Here’s what I wrote back in 2012 and I think it’s reasonably succinct and accurate.

…all saving and investment should be treated the way we currently treat individual retirement accounts. If you have a traditional IRA (or “front-ended” IRA), you get a deduction for any money you put in a retirement account, but then you pay tax on the money – including any earnings – when the money is withdrawn. If you have a Roth IRA (or “back-ended” IRA), you pay tax on your income in the year that it is earned, but if you put the money in a retirement account, there is no additional tax on withdrawals or the subsequent earnings. From an economic perspective, front-ended IRAs and back-ended IRAs generate the same result. Income that is saved and invested is treated the same as income that is immediately consumed. From a present-value perspective, front-ended IRAs and back-ended IRAs produce the same outcome. All that changes is the point at which the government imposes the single layer of tax.

The key takeaways are in the first and last sentences. All savings should be protected from double taxation, not just what you set aside for retirement. And that means government can tax you one time, either when you first earn the income or when you consume the income.

This means we need universal savings accounts, sort of like they have in Canada.

Here’s what Robert Bellafiore of the Tax Foundation wrote about the idea back in 2019.

USAs do not penalize withdrawals on account of their purpose or timing. In contrast, some types of existing savings accounts are not neutral, penalizing people who withdraw their money for anything but approved purposes at approved times. For example, withdrawals from 529 accounts can only be made without penalty if they are used to fund education. If a parent has a 529 account for a child but must make a withdrawal to cover emergency expenses, he or she must pay income taxes on the earnings, plus a 10 percent penalty. Withdrawals from 401(k)s before the age of 59½ incur the same penalty, though there are certain exceptions. USAs’ neutrality would likely boost saving, for two reasons. First, when savings are not hit by multiple layers of taxation, savers can expect a higher return and are therefore likely to save more. Both IRAs and 401(k)s tax savings only once, and studies have estimated that roughly half of 401(k) balances, and roughly a quarter of all IRA contributions, constitute new saving—in other words, dollars that would have been spent are saved instead.

The bottom line is that we need to copy jurisdictions such as Hong Kong and Singapore that have little or no double taxation of any kind.

Especially since we now live in a world where inflation has become an issue, which acts as a hidden tax on saving and investment.

I’ll close with this chart from the OECD. It’s a few years old, so I’m sure some nations have changed their policies, but it gives one a good idea of how savings is treated around the world.

The bottom line is that it’s good to avoid Norway and the United States is unimpressive.

I’m very surprised to see that Argentina and Germany have good policy.

P.S. For some of our friends on the left, policies that protect from double taxation are akin to an entitlement.

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The Boring but Important Issue of “Tax Expenditures”

It’s fun to write about big-picture tax issues such as tax reform (for instance, should we have a flat tax or national sales tax?).

It’s also fun to write about contentious issues such as whether there should be tax increases or whether the tax code should be based on class warfare.

Many tax topics, however, are tedious and boring. But they nonetheless involve important issues.

1. Depreciation vs. expensing for new business investment.
2. International tax rules and the choice of worldwide taxation vs territorial taxation.
3. The debate on consumption-base taxation vs. Haig-Simons taxation.
4. Choosing the right way of treating prior-years business losses.
5. The fight over whether border-adjustable taxation should be part of tax reform.

Building on that list, today we’re going to wade into the boring topic of “tax expenditures.”

For those unfamiliar with the term, tax expenditures are special preferences in the tax code. In other words, tax loopholes.

But here’s the challenge: In order to figure out what’s a loophole, you first need to define a neutral tax system. And that means the debate over tax expenditures is actually a fight over consumption-base taxation vs. Haig-Simons taxation (the third item in the above list).

At the risk of over-simplifying, here’s what both sides believe:

• Proponents of consumption-base tax believe you get a neutral system by taxing all income one time, but only one time (i.e., there should be no discriminatory extra layers of taxation on income that is saved and invested).
• Proponents of Haig-Simons taxation, by contrast, believe that a neutral tax system also requires double taxation of income that is saved and invested (for all intents and purposes, taxing income and changes in net worth).

I’m motivated to write about this topic because the Committee for a Responsible Federal Budget put out a report last year entitled, “Addressing Tax Expenditures Could Raise Substantial Revenue.”

Since I don’t think our fiscal problem of excessive spending can be solved by giving politicians more revenue, I obviously disagree with the folks at CRFB about whether it would be desirable to “raise substantial revenue.”

For what it’s worth, I want to get rid of tax loopholes, but only if we use the revenues to facilitate lower tax rates. Indeed, that’s the goal of reforms such as the flat tax.

But let’s set aside that fight over tax increases and instead look at CRFB’s list of supposed tax expenditures. They rely on the Haig-Simons approach and thus include items (circled in red) that are not actually loopholes.

In a neutral tax system with no double taxation, there is no capital gains tax, no death tax, and no double taxation of dividends. In a neutral tax system, all savings is treated like IRAs and 401(k)s, which means the provisions circled above should be viewed as mitigations of penalties rather than loopholes.

Adam Michel of the Heritage Foundation illustrated the differences between consumption-base and Haig-Smons taxation in a 2019 report.

Here’s his table looking at what’s a loophole under both systems and the bottom part of the visual is where you will see the stark difference in how both systems treat saving and investment.

I’ll close by observing that my friends on the left generally support double taxation because they view such policies as a way of getting rich people to pay more (or as a way of punishing success, regardless of whether more revenue is collected).

I try to remind them that saving and investment is what leads to higher productivity, which means it is the most effective way of boosting wages for those of us who are not rich.

Sadly, it’s not easy to get them to understand that labor and capital are complementary factors of production (apologies for the economic jargon).

P.S. While CRFB uses the wrong definition when measuring tax loopholes, they are not alone. The Joint Committee on Taxation,  the Government Accountability Office, and the Congressional Budget Office make the same mistake. Heck, you even see Republicans foolishly use this flawed benchmark.

P.P.S. Here’s my award for the strangest tax loophole.

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Fiscal Policy, Double Taxation, and (Im)Morality

Since my specialty in economics is fiscal policy, I’m used to wonky (and perhaps boring) debates about topics such as marginal tax rates, Keynesianism, and the Armey-Rahn Curve.

But there’s also a moral component to fiscal policy.

Though immoral might be a better word. That’s because some of our friends on the left actually think that all money belongs to the government.

As such, they think that it is a “subsidy” if we are allowed to keep any of our earnings.

If you think I’m exaggerating, let’s look at some excerpts from a column in the New York Times by Ron Lieber. He starts by equating Biden’s student loan bailout with a provision in the tax code.

For months now, we’ve been in a nationwide debate over whether we should cancel up to $20,000 in student loan debt for tens of millions of people. …But hiding in plain sight is another federal program — 529 college savings plans — that offers the biggest benefits to wealthy families. …With some careful planning, no taxes will come due for most people as long as future generations use the money to pay for college…, graduate school…and any other related educational costs.

Mr. Lieber wants people to think these two policies (the student loan bailout and the tax provision) are both ways of giving benefits to people.

But there’s a big moral difference.

Student loans take money from taxpayers and gives the funds to other people (the real beneficiaries are college administrators rather than students, but that a topic for another day).

By contrast, Section 529 accounts allow people to keep their own money.

Here are some further excerpts from the column.

In 2015, President Obama proposed taxing future earnings in 529 accounts. The blowback from the upper middle class was so severe — and from Democrats and Republicans alike — that he rescinded the plan in the same month that he introduced it. …we did not, as a nation, feel the need to call on The Supremes to weigh in on the legality of maintaining tax-favored savings for millions of people who could afford many college educations anyway. We just canceled the cancellation of their sweet, juicy subsidy without a vote in Congress or a trial. …it is the wealthy who have the best opportunity to extract the largest breaks from the federal government when it comes to saving and paying for college. 

I’m not surprised Obama was on the wrong side, but let’s ignore that and instead focus on Lieber’s assertion that Section 529 accounts are a “sweet, juicy subsidy.”

As already noted, I don’t think it’s right to say it’s a subsidy when people get to keep their own money. That’s reminiscent of the offensive “tax expenditure” term used by some of the people in Washington.

But it is true that some provisions of the tax code create distortions and should be eliminated as part of tax reform.

However, Section 529 accounts are not loopholes. They are simply ways for people to save and invest without being subject to double taxation. Very similar to IRAs and 401(k)s.

And eliminating all forms of double taxation should be a top goal if we want fundamental tax reform.

The bottom line is that folks on the left are wrong about IRAs and 401(k)s and they are wrong about Section 529 accounts.

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Taxing Stock Buybacks: Bad for Workers and Investors

Whenever I discuss the varying types of double taxation on saving and investment (capital gains tax, dividend tax, corporate income tax, death tax, wealth tax, etc), I always emphasize that such levies discourage capital (machinery, tools, technology, etc) which leads to lower levels of productivity.

And lower levels of productivity mean less compensation for workers.

Some of my left-leaning friends dismiss this as “trickle-down economics,” but the relationship between capital and wages is a core component of every economic theory.

Even socialists and Marxists agree that investment is a key to rising wages (though they foolishly think government should be charge of making investments).

I’m providing this background because today’s column explains that politicians made a mistake when they included a tax on “stock buybacks” in the misnamed Inflation Reduction Act.

I’ve written once on this topic, mostly to explain that buybacks should be applauded. They are a way for companies to distribute profits to owners (shareholders) and have the effect of freeing up money for better investment opportunities.

Let’s look at some more recent analysis.

In a column for today’s Wall Street Journal, two Harvard Professors, Jesse Fried and Charles Wang, debunk the anti-buyback hysteria.

A 1% tax on stock buybacks is poised to become law as part of the Inflation Reduction Act just passed by the Senate. This is a victory for critics… But those critics are dead wrong. If anything, American corporations should be repurchasing more stock. Taxing buybacks will increase corporate bloat, lead to higher CEO pay, harm employees and reduce innovation in the economy. …A tax on buybacks will harm shareholders. It creates an incentive for managers to hoard cash, leading to even more corporate bloat and underused stockholder capital. Because CEO pay is tied closely to a firm’s size, this bloating will drive up executive compensation, further hurting investors. …Taxing buybacks will harm employees as well. …Our research shows that 85% of this value flows to employees below the top executive level. Increasing the tax burden will tend to lower equity pay, to the detriment of workers. …A tax that inhibits buybacks will also reduce the capital available to smaller private firms. The cash from shareholder payouts by public companies often flows to private ones, such as those backed by venture capital or private equity. These private firms account for half of nonresidential fixed investment, employ almost 70% of U.S. workers, are responsible for nearly half of business profit, and have been important generators of innovation and job growth. Bottling up cash in public companies will reduce the capital flowing to private ventures—and thus their ability to invest, innovate and hire more workers.

Professor Tyler Cowen of George Mason University makes similar points, in a very succinct manner.

This is flat out a new tax on capital, akin to a tax on dividends. …Are you worried about corporations being too big and monopolistic?  This makes it harder for them to shrink!  Think of it also as a tax on the reallocation of capital to new and growing endeavors.

Catherine Rampell of the Washington Post is far from a libertarian, but even she warned that the hostility to stock buybacks makes no sense.

You’ve probably heard some ranting recently about “stock buybacks,” the term for when a public company repurchases shares of its own stock on the open market. …Why do Democrats hate buybacks so much? …they proposed legislation to ban buybacks. They excoriated companies for returning cash to shareholders… Share buybacks themselves aren’t necessarily bad — particularly when the alternative is wasting investor money… Yelling at companies to stop their buybacks won’t cause them to increase investment… In fact, some policy measures Democrats are considering, ostensibly to discourage firms from returning so much cash to shareholders, would do the opposite.

The only good news to share is that the tax being enacted by Democrats is just 1 percent, so the damage will be somewhat limited (the main economic damage will be because of another provision in the legislation, the tax on “book income“).

Though I suppose we should be aware that a small tax can grow into a big tax (the original 1913 income tax had a top rate of just 7 percent and we all know that the internal revenue code has since morphed into an anti-growth monstrosity).

The bottom line is that the crowd in Washington has made a bad tax system even worse.

P.S. Since we have been discussing how taxes on capital are bad for workers, this is an opportunity to share an old cartoon from the British Liberal Party (meaning “classical liberal,” of course). The obvious message is that labor and capital are complementary factors of production.

And the obvious lesson is that you can’t punish capital without simultaneously punishing labor. Sadly, I’m not holding my breath waiting for Washington to enact sensible tax policy.

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More Evidence against the Capital Gains Tax

The capital gains tax is double taxation, and that’s a bad idea (assuming the goal is faster growth and higher wages).

Let’s consider how it discourages investment. People earn money, pay tax on that money, and then need to decide what to do with the remaining (after-tax) income.

If they save and invest, they can be hit with all sorts of additional taxes. Such as the capital gains tax.

If you want to be wonky, a capital gain occurs when an asset (like shares of stock) climbs in value between when it is purchased and when it is sold.

But stocks rise in value when the market expects a company will generate more income in the future.

Yet that income gets hit by both the corporate income tax and the personal income tax (the infamous double tax on dividends).

So a capital gains tax is a version of triple taxation.

Now that I’ve whined about capital gains taxation, let’s see what happens when a country moves in the right direction.

Professor Terry Moon, from the University of British Columbia, authored a study on the impact of a partial cut in South Korea’s capital gains tax. His abstract succinctly summarizes the results.

This paper assesses the effects of capital gains taxes on investment in the Republic of Korea (hereafter, Korea), where capital gains tax rates vary at the firm level by firm size. Following a reform in 2014, firms with a tax cut increased investment by 34 log points and issued more equity by 9 cents per dollar of lagged revenue, relative to unaffected firms. Additionally, the effects were larger for firms that appeared more cash constrained or went public after the reform. Taken together, these findings are consistent with the “traditional view” predicting that lower payout taxes spur equity-financed investment by increasing marginal returns on investment.

There are several interesting charts and graphs in the study.

But this one is particularly enlightening since we can see big positive results for the firms that were eligible for lower tax rates compared to the ones that still faced higher tax rates.

Richard Rahn wrote about capital gains taxation late last year.

Here are some excerpts from his column in the Washington Times.

Would you vote for a tax that frequently taxes people at an effective rate of 100% or more, misallocates investment, reduces economic growth and job creation, often becomes almost impossible to calculate, and in many cases reduces, rather than increases, revenue for the government? …So-called “capital gains” are price changes most often caused by inflation, which, of course, is caused by incompetent or corrupt governments. …Some countries explicitly allow for the indexing of a capital gain for inflation. Other countries have no capital gains tax at all because they recognize what a destructive tax it is. …The current maximum federal capital gains tax is 23.8%. …“Build Back Better” (BBB) bill would push the top rate to 31.8%…and…citizens of states with high state income tax rates like California, New York, and New Jersey would find themselves paying destructive rates from 43 to 45%.

Needless to say, it is a bad idea to impose a 43 percent-45 percent tax on any type of productive behavior.

But it is downright crazy to impose that type of tax on economic activity (investment) that also gets hit by other forms of tax.

Let’s close with this map from the Tax Foundation. As you can see, some European nations have punitive rates, but countries such as Belgium, Slovakia, Luxembourg, the Czech Republic, and Switzerland wisely have chosen not to impose a capital gains tax..

P.S. For more information, I invite people to watch the video I narrated on the topic. And this editorial from the Wall Street Journal also is a good summary of the issue.

P.P.S. Biden wants America to have the world’s worst capital gains tax. To learn why that’s a bad idea, click here and here.

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Wealth Taxation and Economic Suicide

The people of Chile elected a Bernie Sanders-style leftist last December and one of his crazy ideas is a wealth tax. In a discussion with Axel Kaiser, I explain why this destructive levy is misguided.

A wealth tax would be bad news in Chile. It also would be bad news in the United States.

Indeed, there is no country in the world where it wouldn’t be bad news (including Switzerland).

As I noted in the above video clip, an annual tax on wealth is economically akin to a tax on saving and investment.

And the effective tax rate can be confiscatory. Especially when you consider the impact of other taxes, such as dividend taxes, capital gains taxes, and income taxes (and don’t forget the corporate income tax and death tax!).

The chart shows that the severity of the tax varies depending on the rate of wealth tax and the change in the value of a taxpayer’s assets.

And it only includes the impact of the wealth tax and personal income tax.

Yet even with that limitation, it is still very easy to wind up with effective tax rates of more than 100 percent.

You don’t need to be a wild-eyed supply-sider to conclude this will undermine growth by discouraging people from saving and investing.

Daniel Savickas of the Taxpayer Protection Alliance wrote about this unfair and punitive levy earlier this year.

Here are excerpts from his column for Real Clear Markets.

A wealth tax means it would no longer be worthwhile for many to invest in the economy. People invest with the hopes of making money on that investment and accept they will have to pay a percentage on gains once it’s sold off. However, with repeated taxes in the interim just for holding the stock, many investments cease making financial sense. As a result, many startup companies will end up losing access to capital at a critical time. A wealth tax will end up punishing small businesses more so than the super wealthy. …The economy has taken a beating lately and – given recent inflationary trends – does not seem to be getting a break any time soon. Policymakers should be focusing on how to alleviate those pains. A wealth tax would go after the people who take risks and invest their money in our companies and our jobs. This approach would never be helpful, but is especially harmful at a time like this.

The bottom line is that a wealth tax would be very bad news. It would weaken the United States economy. And it would have an even worse impact on Chile’s economy (particularly when combined with Boric’s other bad policies).

P.S. There’s definitely not a libertarian argument for a wealth tax, and I also have explained why there is not a conservative argument for this invasive levy.

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Lower Taxes on Capital = More Prosperity

Good tax policy should strive to solve the three major problems that plague today’s income tax.

1. Punitive tax rates on productive behavior.
2. Double taxation of saving and investment
3. Corrupt, complex, and inefficient loopholes.

Today, let’s focus on the second item. If the goal is to minimize the economic damage of taxation, both labor and capital should be taxed at the lowest-possible rate.

But, as illustrated by the chart, the internal revenue code imposes widespread “double taxation” on income that is saved and invested.

Actually, it’s more than double taxation. Between the capital gains tax, corporate income tax, double tax on dividends, and death tax, there are multiple layers of tax on income from saving and investment.

So even if statutory tax rates are low, effective tax rates can be very high when you consider how the IRS gets several bites at the apple.

This is why good tax reform plans eliminate the tax bias against capital.

But we don’t want the perfect to be the enemy of the good. Simply lowering tax rates on capital also would be a step in the right direction.

And such an approach would produce meaningful economic benefits, as explained in a new Federal Reserve study by Saroj Bhattarai, Jae Won Lee, Woong Yong Park, and Choongryul Yang.

…capital tax cuts, as expected, have expansionary long-run aggregate effects on the economy. For instance, with a permanent reduction of the capital tax rate from 35% to 21%, output in the new steady state, compared to the initial steady state, is greater by 4.24%… A reduction in the capital tax rate leads to a decrease in the rental rate of capital, raising demand for capital by firms. This stimulates investment and capital accumulation. A larger amount of capital stock, in turn, makes workers more productive, raising wages and hours. Finally, given the increase in the factors of production, output expands.

This is all good news.

But our left-leaning friends might not be happy because some people get richer faster than other people get richer.

This aggregate expansion however, is coupled with worsening…inequality in our model. For instance, skilled wages increase by 4.66% while unskilled wages increases by only 0.56%, driven by capital-skill complementarity.

For what it is worth, I agree with Margaret Thatcher about adopting policies that help all groups enjoy higher living standards.

Here’s a chart for wonky readers. It shows how quickly the economy grows depending on how lower capital taxes are offset.

 

And here’s some of the explanatory text.

The main takeaway if that you get the most growth when you also lower the burden of redistribution spending.

The three financing schemes under consideration…produce different effects on aggregate output because each scheme influences workers’ labor supply decisions differently. …lump-sum transfer cuts…boosts unskilled hours and in turn, contributes to greater aggregate output… In comparison, a rise in the labor or consumption tax rate decreases the effective wage rate (as is well-understood) and additionally, weakens the wealth effect for the unskilled household. These two mechanisms work together to generate a smaller aggregate expansion under the distortionary tax adjustments. …we show that the capital tax cut has different welfare implications for each type of household depending on time horizon and policy adjustments. …The tax reform benefits the skilled households the most when transfers adjust, whereas the unskilled households prefer distortionary financing to avoid a significant reduction in transfer incomes.

The secondary takeaway from this research is that it would be bad for the economy (and bad for both rich people and poor people) if Joe Biden’s class-warfare tax policy was enacted.

But if you read this, this, this, and this, you already knew that.

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Dividend Taxation in Europe and the United States

Modern tax systems tend to have three major deviations from good fiscal policy.

1. High marginal tax rates on productive behavior like work and entrepreneurship.
2. Multiple layers of taxation on income that is saved and invested.
3. Distortionary loopholes that reward inefficiency and promote corruption.

Today, let’s focus on an aspect of item #2.

The Tax Foundation has just released a very interesting map (at least for wonks) showing the total tax rate on dividends in European nations, including both the corporate income tax and the double-tax on dividends.

Because it has a reasonably modest corporate income tax rate, some of you may be surprised that Ireland has the most onerous overall burden on dividends. But that’s because there are high tax rates on personal income and households have to pay those high rates on any dividends they receive (even though companies already paid tax on that income).

It’s less surprising that Denmark is the second worst and France is the third worst.

Meanwhile, Estonia and Latvia have the least-onerous systems thanks to low rates and no double taxation.

But what about the United States?

There’s a different publication from the Tax Foundation that shows the extent – a maximum rate of 47.47 percent – of America’s double taxation.

The bottom line is that the United States would rank #7, between high-tax Belgium and high-tax Germany, if it was included in the above map.

That’s not a very good spot, at least if the goal is more jobs and more competitiveness.

To make matters worse, Joe Biden wants America to be #1 on the list. I’m not joking.

I’ve already written about his plan for a higher corporate tax rate.

But he wants an even-bigger increases in the second layer of tax on dividends.

How much bigger?

Pinar Cebi Wilber of the American Council for Capital Formation shared the unpleasant details in a column last year for the Wall Street Journal.

The Biden administration has released a flurry of tax proposals, including a headline-grabbing tax hike on capital gains that would apply retroactively from April. Dividends would be subject to the same treatment, according to a recently released Treasury Department document. …the proposal would tax qualified dividends—dividends from shares in domestic corporations and certain foreign corporations that are held for at least a specified minimum period of time—at income-tax rates (currently up to 40.8%) rather than the lower capital-gains rates (23.8%).

I also like that the column includes references to some academic research.

A 2005 paper by economists Raj Chetty and Emmanuel Saez looked at the effect of the 2003 dividend tax cuts on dividend payments in the U.S. The authors “find a sharp and widespread surge in dividend distributions following the tax cut,” after a continuous two-decade decrease in distributions. …Princeton’s Adrien Matray and co-author Charles Boissel looked at the issue the other way around. In a 2019 study, they found that an increase in French dividend taxes led to decreased dividend payments. …Another study from 2011, looking at America’s major competitor, reached the same directional conclusion: A 2005 reduction in China’s dividend tax rate led to an increase in dividend payments.

Not that anyone should be surprised by these results. The academic literature clearly shows that it’s not smart to impose high tax rates on productive behavior such as work, saving, investment, and entrepreneurship.

Unless, of course, you want more people dependent on government.

P.S. Biden also wants American to be #1 for capital gains taxation. So at least he is consistent, albeit in a very perverse way.

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There Are Very Good Reasons Why No Nation Has Ever Tried to Tax Unrealized Capital Gains

The Biden economic agenda can be summarized as follows: As much spending as possible, financed by as much taxation as possible, using lots of dishonest budget gimmicks to glue the pieces together.

But it turns out that higher taxes are not very popular, notwithstanding the delusions of Bernie Sanders, AOC, and the rest of the class-warfare crowd.

If the latest reports are accurate, the left has given up on imposing higher corporate tax rates, higher personal tax rates, and making the death tax more onerous.

That’s the good news.

The bad news is that they’ve revived an awful idea to make capital gains taxes more onerous by taxing people on capital gains that only exist on paper.

In a column for the New York Times, Neil Irwin explains how the new scheme would work..

…congressional Democrats..are looking toward a change in the tax code that would reinvent how the government taxes investments… The Wyden plan would require the very wealthy — those with over $1 billion in assets or three straight years of income over $100 million — to pay taxes based on unrealized gains. …It could create some very large tax bills… If a family’s $10 billion net worth rose to $11 billion in a single year, a capital-gains rate of 20 percent would imply a $200 million tax bill.

In other words, families would be taxed on theoretical gains rather than real gains.

Some have said this scheme is similar to a wealth tax, though it’s more accurate to say it’s a tax on changes in wealth.

Similarly bad consequences, with similarly big problems with complexity, but using a different design.

Mr. Irwin’s column also acknowledges some other problems with this proposed levy.

The proposal raises conceptual questions about what counts as income. When Americans buy assets — shares of stock, a piece of real estate, a business — that become more valuable over time, they owe tax only on the appreciation when they sell the asset. …The rationale is that just because something has increased in value doesn’t mean the owner has the cash on hand to pay taxes. Moreover, for those with complex holdings, like interests in multiple privately held companies, it could be onerous to calculate the change in valuations every year, with ambiguous results. …having a cutoff at which the new capital gains system applies could create perverse incentives… “If you have a threshold, you’re giving people a really strong incentive to rearrange their affairs to keep their income and wealth below the threshold,” said Leonard Burman, institute fellow at the Tax Policy Center.

In other words, this plan would be great news for accountants, lawyers, and other people involved with tax planning.

I support the right of people to minimize their taxes, of course, but I wish we had a simple and fair tax system so that there was no need for an entire industry of tax planners.

But I’m digressing. Let’s continue with our analysis of this latest threat to good tax policy.

Henry Olson opines in the Washington Post that it’s a big mistake to impose taxes on unrealized gains.

The Biden administration’s idea to tax billionaires’ unrealized capital gains…would be an unworkable and arguably unconstitutional mess that could harm everyone. …Tesla founder Elon Musk’s net worth rose by $126 billion last year as his company’s stock price soared, but he surely paid almost no tax on that because he never sold the stock. Biden’s plan would tax all of that rise, netting the federal government about $30 billion. Do the same for all the nation’s billionaires, and the feds could pull in loads of cash… If that sounds too good to be true, it’s because it is. …Privately held companies…are notoriously difficult to value. Rare but valuable items are even more difficult to fix an annual price. …Billionaires are precisely the people with the motive and the means to hire the best tax lawyers to fight the Internal Revenue Service at every step of the way, surely subjecting each tax return to excruciatingly long and expensive audits. …Expensive assets can go down in value, too, and billionaires would rightly insist that the IRS account for those reversals of fortune. …Would the IRS have to issue multi-billion dollar refund checks to return the billionaires’ quarterly estimated tax payments from earlier in the year?

These are all excellent points.

Henry also points out that the scheme may be unconstitutional.

The Constitution may not even permit taxation of unrealized gains. The 16th Amendment authorizes taxation of “income,”… Unrealized gains don’t fit under that rubric because the wealth is on paper, not in the hands of the owner to use as she wants.

And he closes with the all-important point that the current plan may target the richest of the rich, but sooner or later the rest of us would be in the crosshairs.

…it will only be a matter of time before lawmakers apply the tax to ordinary Americans. Anyone who owns a house or has a retirement account has unrealized capital gains. Billionaires get all the attention, but the real money is in the hands of the broader public, as the collective value of real estate and mutual funds dwarfs what the nation’s uber-wealthy hold. The government would love to get 25 percent of your 401(k)’s annual rise.

Amen. This is a point I’ve made in the past.

Simply stated, there are not enough rich people to finance European-sized government. Eventually we’ll all be treated like this unfortunate Spaniard.

I’ll close with a few wonky observations about tax policy.

• The government should not impose discriminatory extra layers taxation on income that is saved and invested rather than consumed.
• This means there should be no capital gains tax, much less a tax on unrealized capital gains (or inflationary gains).
• This means there should be no wealth tax, whether levied on annual wealth or imposed on changes in wealth.

P.S. Biden, et al, claim we need higher taxes on the rich because the current system is unfair, yet there’s never any recognition that the United States collects a greater share of revenue from the rich than any other developed nations (not because our tax rates on the rich are higher than average, but rather because our tax rates on lower-income and middle-class taxpayers are much lower than average).

P.P.S. The bottom line is that taxing unrealized capital gains is such a crazy idea that even nations such as France and Greece have never tried to impose such a levy.

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Quantifying the Damage of Biden’s Plan for Higher Taxes on Capital Gains, Part II

Yesterday’s column cited new scholarly research about the negative economic impact of Biden’s plans to increase capital gains taxation.

In today’s column, let’s start with a refresher on why this tax shouldn’t exist.

But if you don’t want to spend a few minutes watching the video, here are the six reasons why the tax shouldn’t exist.

I highlighted the final reason – fairness – because this is not simply an economic argument.

Yes, it’s foolish to penalize jobs and investment, but I also think it’s morally wrong to impose discriminatory tax rates on people who are willing to defer consumption so that all of us can be richer in the long run.

By the way, I should have included “Less Common Sense” as a seventh reason. That’s because the capital gains tax will backfire on Biden and his class-warfare friends.

To be more specific, investors can choose not to sell assets if they think the tax rate is excessive, and this “lock-in effect” is a big reason why higher rates almost surely won’t produce higher revenues.

In a column earlier this year for the Wall Street Journal, former Federal Reserve Governor Lawrence Lindsey explained this “Laffer Curve” effect.

…43.4% is well above the rate that would generate the most revenue for the government. Congress’s Joint Committee on Taxation, which does the official scoring and is no den of supply siders, puts the revenue-maximizing rate at 28%. My work several decades ago puts it about 10 points lower than that. That means President Biden is willing to accept lower revenue as the price of higher tax rates. The implications for his administration’s economic thinking are mind-boggling. Even the revenue-maximizing rate is higher than would be optimal. As tax rates rise, the activity being taxed declines. The loss to the private side of society increases at a geometric rate (proportional to the square of the tax rate) as rates rise. … The Biden administration is blowing up one of the key concepts that has united the economics profession: maximizing social welfare. It now believes in taxation purely as a form of punishment and is even willing to sacrifice revenue to carry it out.

By the way, Biden’s not the first president with this spiteful mindset. Obama also said he wanted to raise the tax rate on capital gains even if the government didn’t get any more revenue.

Democrats used to be far more sensible on this issue. For instance, Bill Clinton signed into a law a cut in the tax rate on capital gains.

And, as noted in this Wall Street Journal editorial on the topic, another Democratic president also had very sensible views.

Even in the economically irrational 1970s the top capital-gains rate never broke 40%… A neutral revenue code would tax all income only once. But the U.S. also taxes business profits when they are earned, and President Biden wants to raise that tax rate by a third (to 28% from 21%). When a business distributes after-tax income in dividends, or an investor sells the shares that have risen in value due to higher earnings, the income is taxed a second time. …The most important reason to tax capital investment at low rates is to encourage saving and investment. …Tax something more and you get less of it. Tax capital income more, and you get less investment, which means less investment to improve worker productivity and thus smaller income gains over time. As a former U.S. President once put it: “The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital from static to more dynamic situations, the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential for growth of the economy.” That wasn’t Ronald Reagan. It was John F. Kennedy.

For what it’s worth, JFK wasn’t just sensible on capital gains taxation. He had a much better overall grasp of tax policy that many of his successors.

Especially the current occupant of the White House. The bottom line is that Biden’s agenda is bad news for American prosperity and American competitiveness.

P.S. If you’re skeptical about my competitiveness assertion, check out this data.

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Quantifying the Damage of Biden’s Plan for Higher Taxes on Capital Gains, Part I

Public finance theory teaches us that the capital gains tax should not exist. Such a levy exacerbates the bias against saving and investment, which reduces innovation, hinders economic growth, and lowers worker compensation.

All of which helps to explain why President Biden’s proposals to increase the tax burden on capital gains are so misguided.

• He wants a radical increase in the tax rate on capital gains – from 23.8 percent to 43.4 percent, the highest burden in the world.
• He wants to impose capital gains tax on assets when people die, even if assets aren’t sold and there are not any actual capital gains.

Thanks to some new research from Professor John Diamond of Rice University, we can now quantify the likely damage if Biden’s proposals get enacted.

Here’s some of what he wrote in his new study.

We use a computable general equilibrium model of the U.S. economy to simulate the economic effects of these policy changes… The model is a dynamic, overlapping generations, computable general equilibrium model of the U.S. economy that focuses on the macroeconomic and transitional effects of tax reforms. …The simulation results in Table 1 show that GDP falls by roughly 0.1 percent 10 years after reform and 0.3 percent 50 years after reform, which implies per household income declines by roughly $310 after 10 years and $1,200 after 50 years. The long run decline in GDP is due to a decline in the capital stock of 1.0 percent and a decline in total hours worked of 0.1 percent. …this would be roughly equivalent to a loss of approximately 209,000 jobs in that year. Real wages decrease initially by 0.2 percent and by 0.6 percent in the long run.

Here is a summary of the probable economic consequences of Biden’s class-warfare scheme.

But the above analysis should probably be considered a best-case scenario.

Why? Because the capital gains tax is not indexed for inflation, which means investors can wind up paying much higher effective tax rates if prices are increasing.

And in a world of Keynesian monetary policy, that’s a very real threat.

So Prof. Diamond also analyzes the impact of inflation.

…capital gains are not adjusted for inflation and thus much of the taxable gains are not reflective of a real increase in wealth. Taxing nominal gains will reduce the after-tax rate of return and lead to less investment, especially in periods of higher inflation. …taxing the nominal value will reduce the real rate of return on investment, and may do so by enough to result in negative rates of return in periods of moderate to high inflation. Lower real rates of return reduce investment, the size of the capital stock, productivity, growth in wage rates, and labor supply. …Accounting for inflation in the model would exacerbate other existing distortions… An increase in the capital gains tax rate or repealing step up of basis will make investments in owner-occupied housing more attractive relative to other corporate and non-corporate investments.

Here’s what happens to the estimates of economic damage in a world with higher inflation?

Assuming the inflation rate is one percentage point higher on average (3.2 percent instead of 2.2 percent) implies that a rough estimate of the capital gains tax rate on nominal plus real returns would be 1.5 times higher than the real increase in the capital gains tax rate used in the standard model with no inflation. Table 2 shows the results of adjusting the capital gains tax rates by a factor of 1.5 to account for the effects of inflation. In this case, GDP falls by roughly 0.1 percent 10 years after reform and 0.4 percent 50 years after reform, which implies per household income declines by roughly $453 after 10 years and $1,700 after 50 years.

Here’s the table showing the additional economic damage. As you can see, the harm is much greater.

I’ll conclude with two comments.

• First, inflation is obviously bad for citizens. But as I wrote more than 10 years ago, it’s profitable for governments.
• Second, even seemingly small differences in economic growth produce big differences in long-run living standards.

P.S. If (already-taxed) corporate profits are distributed to shareholders, there’s a second layer of tax on those dividends. If the money is instead used to expand the business, it presumably will increase the value of shares (a capital gain) because of an expectation of higher future income (which will be double taxed when it occurs).

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Biden’s Awful Plan for a Hybrid Death Tax/Capital Gains Tax

More than 10 years ago, I narrated this video explaining why there should be no capital gains tax.

The economic argument against capital gains taxation is very simple. It is wrong to impose discriminatory taxes on income that is saved and invested.

It’s bad enough that government gets to tax our income one time, but it’s even worse when they get to impose multiple layers of tax on the same dollar.

Unfortunately, nobody told Biden. As part of his class-warfare agenda, he wants to increase the capital gains tax rate from 23.8 percent to 43.4 percent.

Even worse, he wants to expand the capital gains tax so that it functions as an additional form of death tax.

And that tax would be imposed even if assets aren’t sold. In other words, it would a tax on capital gains that only exist on paper (a nutty idea associated with Sens. Ron Wyden and Elizabeth Warren).

I’m not joking. In an article for National Review, Ryan Ellis explains why Biden’s proposal is so misguided.

The Biden administration proposes that on top of the old death tax, which is assessed on estates, the federal government should add a new tax on the deceased’s last 1040 personal-income-tax return. This new, second tax would apply to tens of millions of Americans. …the year someone died, all of their unrealized capital gains (gains on unsold real estate, family farms and businesses, stocks and other investments, artwork, collectibles, etc.) would be subject to taxation as if the assets in question had been sold that year. …In short, what the Biden administration is proposing is to tax the capital gains on a person’s property when they die, even if the assets that account for those gains haven’t actually been sold. …to make matters worse, the administration also supports raising the top tax rate on long-term capital gains from 23.8 percent to 43.4 percent. When state capital-gains-tax rates are factored in, this would make the combined rate at or above 50 percent in many places — the highest capital-gains-tax rate in the world, and the highest in American history.

This sounds bad (and it is bad).

But there’s more bad news.

…that’s not all. After these unrealized, unsold, phantom gains are subject to the new 50 percent double death tax, there is still the matter of the old death tax to deal with. Imagine a 50 percent death tax followed by a 40 percent death tax on what is left, and you get the idea. Karl Marx called for the confiscation of wealth at death, but even he probably never dreamed this big. …Just like the old death tax, the double death tax would be a dream for the estate-planning industry, armies of actuaries and attorneys, and other tax professionals. But for the average American, it would be a nightmare. The death tax we have is bad enough. A second death tax would be a catastrophic mistake.

Hank Adler and Madison Spach also wrote about this topic last month for the Wall Street Journal.

Here’s some of what they wrote.

Mr. Biden’s American Families Plan would subject many estates worth far less than $11.7 million to a punishing new death tax. The plan would raise the total top rate on capital gains, currently 23.8% for most assets, to 40.8%—higher than the 40% maximum estate tax. It would apply the same tax to unrealized capital gains at death… The American Families Plan would result in negative value at death for many long-held leveraged real-estate assets. …Scenarios in which the new death tax would significantly reduce, nearly eliminate or even totally eliminate the net worth of decedents who invested and held real estate for decades wouldn’t be uncommon. …The American Families Plan would discourage long-term investment. That would be particularly true for those with existing wealth who would begin focusing on cash flow rather than long-term investment. The combination of the new death tax plus existing estate tax rates would change risk-reward ratios.

The bottom line is that it is very misguided to impose harsh and discriminatory taxes on capital gains. Especially if the tax occurs simply because a taxpayer dies.

P.S. Keep in mind that there’s no “indexing,” which means investors often are being taxed on gains that merely reflect inflation.

P.P.S. Rather than increasing the tax burden on capital gains, we should copy Belgium, Chile, Costa Rica, Czech Republic, Hungary, Luxembourg, New Zealand, Singapore, Slovenia, Switzerland, and Turkey. What do they have in common? A capital gains tax rate of zero.

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International Comparisons of Capital Tax Burdens

There are three important principles for sensible tax policy.

1. Low marginal tax rates on productive behavior
2. No tax bias against capital (i.e., saving and investment)
3. No tax preferences that distort the economy

Today, let’s focus on #2.

I’ve written many times about why double taxation is a bad idea. This occurs when governments – thanks to capital gains taxes, dividend taxes, death taxes, etc – impose harsher tax burdens on income that is saved and invested compared to income that is immediately consumed.

Which is a bad idea since wages for workers are linked to productivity, which is linked to the amount of capital.

Which countries imposes the heaviest tax burdens on capital? According to a new report from the Tax Foundation, Canada is the worst of the worst (somewhat surprising), followed by Denmark (no surprise) and France (also no surprise).

The nations of Eastern Europe, along with Ireland, win the prize for the lowest tax burdens on capital.

The authors of the report, Jacob Lundberg and Johannes Nathell, make a much-needed point about why governments should not penalize saving and investment.

…capital should not be taxed at all. Taxing capital distorts individuals’ savings decisions. By reducing the return on savings, capital taxes penalize those who postpone their consumption rather than consuming their income as it is earned. Due to compounding interest, capital taxation penalizes saving more the longer the saving horizon is. For long saving horizons, the distortion is very large. This leads to lower saving, a lower capital stock, and lower GDP. Therefore, not taxing capital is in the interest of everyone, even those who spend everything they earn.

The report also contains this fascinating map comparing capital taxation in European nations.

At the risk of stating the obvious, it’s better to be a lighter-colored nation.

This is fascinating data for tax wonks, but it might not perfectly capture the relative attractiveness (or unattractiveness) of various countries. I think two caveats are warranted.

First, it’s quite likely that some Western European nations accumulated lots of capital and generated lots of wealth back in the 1800s and early 1900s when the burden of government was very small and taxes were very low. If some of the capital from that period is still generating returns (and thus tax revenue), it may overstate the tax burden on current saving and investment.

Second, the methodology looks at capital revenues as a percentage of capital income. This perfectly reasonable approach overlooks the fact that tax rates have an effect on the amount of income that is both earned and reported. This is the core insight of the Laffer Curve and it could mean that some countries show high levels of revenue in part because tax burdens are modest (and vice-versa).

That being said, I wouldn’t expect major changes in the rankings, even if there was a way to address these concerns.

The bottom line is that we know how to define good tax policy, but very few governments have an interest in maximizing liberty and prosperity. The challenge is that politicians 1) usually want more money so they can buy more votes, but 2) sometimes let envy trump their desire for more revenue.

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The OECD’s Tax-Free Bureaucrats Urge Higher Death Taxes

Back in 2015, I joked that my life would be simpler if I had an “automatic fill-in-the-blanks system” for columns dealing with the Organization for Economic Cooperation and Development.

Here’s what I proposed.

We can use this shortcut today because the OECD has just churned out a report embracing the death tax. So all we need to do is fill in the blanks and we have an appropriate intro:

The bureaucrats at the Paris-based OECD, working in cooperation with greedy politicians, have released a new study urging more power for governments in order to increase death taxes.

But the purpose of this column is not to mock the OECD, even though its reflexive statism makes it an easy target. Let’s actually dig into this new report and explain why it is so misguided.

This paragraph is a summary of the bureaucracy’s main argument, which is basically an envy-driven cry for more tax revenue.

The report explores the role that inheritance taxation could play in raising revenues, addressing inequalities and improving efficiency in the future. …taxes on wealth transfers – including inheritance, estate, and gift taxes – are levied in 24 of the 36 OECD countries… In 2018, only 0.5% of total tax revenues were sourced from those taxes on average across the countries that levied them. …Overall, the report finds that there is a good case for making greater use of well-designed inheritance and gift taxation… There are strong equity arguments in favour of inheritance taxation..

Here’s some more of the OECD’s dirigiste analaysis.

The report finds that well-designed inheritance taxes can raise revenue and enhance equity… There are strong equity arguments in favour of inheritance taxation… From an equality of opportunity perspective, inheritances and gifts can create a divide between the opportunities that people face. Wealth transfers might give recipients a head start… By breaking down the concentration of wealth…, inheritance and gift taxation can contribute to levelling the playing field… ‘The recent progress made on international tax transparency…is greatly increasing countries’ ability to tax capital… Progressive tax rates have several advantages compared to flat tax rates. …Taxing unrealised gains at death may be the most efficient and equitable approach.

As you can see, the OECD’s argument revolves around class warfare. They think it’s unfair that some parents want to help their children.

By contrast, the argument against the OECD revolves around economics. More specifically, the death tax is a terrible idea because it directly and unambiguously reduces private savings and investment, thus undermining productivity and putting a damper on wages.

Interestingly, the OECD admits this happens. Here’s Figure 2.4 from the OECD report, showing how death taxes (combined with annual income taxes) reduce saving and investment over five generations.

And the above charts don’t even show the true impact because there’s no line showing how much saving and investment would exist with no death tax and no double taxation.

For what it’s worth, the OECD report does acknowledge some practical and economic problems with death taxes.

An inheritance tax directly reduces wealth accumulation over generations. …inheritance taxes may also affect wealth accumulation prior to being levied by encouraging changes in donors’ behaviours. …Susceptibility to tax planning is one of the most common criticisms levelled against inheritance taxes. …There is evidence of widespread inheritance tax planning… Inheritance taxes might lower entrepreneurship by heirs… Inheritance taxes may also jeopardise existing businesses when they are transferred if business owners do not have enough liquid assets to pay the tax. …Double taxation is a popular objection to inheritance taxes…wage earnings, savings, or personal business income…will have in many cases already been taxed. …There might be challenges associated with estimating fair market value for some assets.

If you wade through the report, you’ll notice that the OECD doesn’t have good answers for these problems.

Instead, the basic message is, “yeah, there are a bunch of downsides, but we want to finance bigger government and we resent successful people.”

The only good news is that the report gives us a list of nations that have eliminated (or never adopted) death taxes.

Among the OECD countries that do not levy inheritance or estate taxes, nine have abolished them since the early 1970s. …Austria, Czech Republic, Norway, Slovak Republic, ans Sweden have abolished their inheritance or estate taxes since 2000. Israel and New Zealand abolished these taxes between 1980 and 2000. Australia, Canada, and Mexico abolished these taxes before 1980, and Estonia and Latvia have never levied inheritance or estate taxes. …This is consistent with evidence that inheritance and estate taxes tend to be unpopular.

Here’s the part of Table 3.1 that shows when these taxes were implemented and when they were repealed.

Needless to say, I’d like to see the United States on this list at some point (we were there for one year!).

The OECD closed with some cheerleading and strategizing on how to overcome popular opposition.

…this section considers ways in which governments may enhance the public acceptability of inheritance tax reform… Reframing reforms aiming to raise more revenue.around notions of equality of opportunity and inequality reduction may help increase their public acceptability. …packaging may also be helpful. …If the introduction of an inheritance tax or an increase in existing inheritance or estate taxes…goes hand-in-hand with a decrease in other taxes, especially in labour taxes, which a majority of people are subject to, it may be more acceptable politically.

I can’t resist pointing out that it’s utter nonsense to think that governments would use revenue from a death tax to lower other taxes.

The goal of politicians is always to finance bigger government. That’s true with the death tax. It’s true with the carbon tax. It’s true with the value-added tax. It’s true with the financial transactions tax.

Which is why I wrote four years ago that, “Some people say the most important rule to remember is to never feed gremlins after midnight, but I think it’s even more important not to give politicians a new source of revenue.”

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A Practical Reason to Oppose Wealth Taxation

As an economist, I strongly oppose the wealth tax (as well as other forms of double taxation) because it’s foolish to impose additional layers of tax that penalize saving and investment.

Especially since there’s such a strong relationship between investment and worker compensation.

The politicians may tell us they’re going to “soak the rich,” but the rest of us wind up getting wet.

That being said, there are also administrative reasons why wealth taxation is a fool’s game. One of them, which I mentioned as part of a recent tax debate, is the immense headache of trying to measure wealth every single year.

Yes, that’s not difficult if someone has assets such as stock in General Motors or Amazon. Bureaucrats from the IRS can simply go to a financial website and check the value for any given day.

But the value of many assets is very subjective (patents, royalties, art, heirlooms, etc), and that will create a never-ending source of conflict between taxpayers and the IRS if that awful levy is ever imposed.

Let’s look at a recent dispute involving another form of destructive double taxation. The New York Times has an interesting story about a costly dispute involving the death tax to be imposed on Michael Jackson’s family.

Michael Jackson died in 2009… But there was another matter that has taken more than seven years to litigate: Jackson’s tax bill with the Internal Revenue Service, in which the government and the estate held vastly different views about what Jackson’s name and likeness were worth when he died. The I.R.S. thought they were worth $161 million. …Judge Mark V. Holmes of United States Tax Court ruled that Jackson’s name and likeness were worth $4.2 million, rejecting many of the I.R.S.’s arguments. The decision will significantly lower the estate’s tax burden… In a statement, John Branca and John McClain, co-executors of the Jackson estate, called the decision “a huge, unambiguous victory for Michael Jackson’s children.”

I’m glad the kids won this battle.

Michael Jackson paid tax when he first earned his money. Those earnings shouldn’t be taxed again simply because he died.

But the point I want to focus on today is that a wealth tax would require these kinds of fights every single year.

Given all the lawyers and accountants this will require, that goes well beyond adding insult to injury. Lots of time and money will need to be spent in order to (hopefully) protect households from a confiscatory tax that should never exist.

P.S. The potential administrative nightmare of wealth taxation, along with Biden’s proposal to tax unrealized capital gains at death, help to explain why the White House is proposing to turbo-charge the IRS’s budget with an additional $80 billion.

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Biden Wants America to Have the World’s Highest Tax Burden on Capital Gains

Because of the negative impact on competitiveness, productivity, and worker compensation, it’s a very bad idea to impose double taxation of saving and investment.

Which is why there should be no tax on capital gains, and a few nations sensibly take this approach.

But they’re outnumbered by countries that do impose this pernicious form of double taxation. For instance, the Tax Foundation has a new report about the level of capital gains taxation in Europe, which includes this very instructive map.

As you can see, some countries, such as Denmark (gee, what a surprise), have very punitive rates.

However, other nations (such as Switzerland, Belgium, Czech Republic, Slovakia, Luxembourg, and Slovenia) wisely don’t impose this form of double taxation.

If the United States was included, we would be in the middle of the pack. Actually, we would be a bit worse than average, especially when you include the Obamacare tax on capital gains.

But if Joe Biden succeeds, the United States soon will have the dubious honor of being the worst of the worst.

The Wall Street Journal opined this morning about the grim news.

Biden officials leaked that they will soon propose raising the federal tax on capital gains to 43.4% from a top rate of 23.8% today. …Mr. Biden will tax capital gains for taxpayers who earn more than $1 million at the personal income tax rate, which he also wants to raise to 39.6% from 37%. Add the 3.8% ObamaCare tax on investment, and you get to 43.4%. And that’s merely the federal rate. Add 13.3% in California and 11.85% in New York (plus 3.88% in New York City), which also tax capital gains as regular income, and you are heading toward the 60% rate range. Keep in mind this is on the sale of gains that are often inflated as assets are held for years without adjustment for inflation. Oh, and Mr. Biden also wants to eliminate the step-up in basis on capital gains that accrues at death.

Beating out Denmark for the highest capital gains tax rate is bad.

But it’s even worse when you realize that capital gains often occur because investors expect an asset to generate more future income. But that future income gets hit by the corporate income tax (as well as the tax on dividends) when it actually materializes.

So the most accurate way to assess the burden on new investment is to look at the combined rate of corporate taxation and capital gains (as as well as the combined rate of corporate taxation and dividend taxation).

By that measure, the United States already has one of the world’s most-punitive tax regimes, And Biden wants to increase all of those tax rates.

Sort of a class-warfare trifecta, and definitely not a recipe for good economic results.

For those interested in more details, here’s a video I narrated on the topic back in 2010.

And I also recommend these columns (here, here, and here) for additional information on why we should be eliminating the capital gains tax rather than increasing it.

P.S. Don’t forget that there’s no indexing to protect taxpayers from having to pay tax on gains that are due only to inflation.

P.P.S. And also keep in mind that some folks on the left want to impose tax on capital gains that only exist on paper.

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The Upside-Down Morality and Economic Illiteracy of Class Warfare

My Eighth Theorem of Government is very simple.

If someone writes and talks about poverty, I generally assume that they care about poor people. They may have good ideas for helping the poor, or they may have bad ideas. But I usually don’t doubt their sincerity.

But when someone writes and talks about inequality, I worry that they don’t really care about the less fortunate and that they’re instead motivated by envy, resentment, and jealousy of rich people.

And this concern probably applies to a couple of law professors, Michael Heller of Columbia and James Salzman of UCLA. They recently wrote a column for the Washington Post on how the government should grab more money from the private sector when rich people die.

They seem particularly agitated that states such as South Dakota have strong asset-protection laws that limit the reach of the death tax.

Income inequality has widened. One…way to tackle the problem. Instead of focusing only on taxing wealth accumulation, we can address the hidden flip side — wealth transmission. …The place to start is South Dakota… The state has created…wealth-sheltering tools including the aptly named “dynasty trust.” …Congress can…plug holes in our leaky estate tax system. One step would be to tax trusts at the passage of each generation and limit generation-skipping tax-exempt trusts. A bigger step would be to ensure that appreciated stocks…are taxed… Better still, let’s start anew. Ditch the existing estate tax and replace it with an inheritance tax

There’s nothing remarkable in their proposals. Just a typical collection of tax-the-rich schemes one might expect from a couple of academics.

But I can’t resist commenting on their article because of two inadvertent admissions.

First, we have a passage that reveals a twisted sense of morality. They apparently think it’s a “heist” if people keep their own money.

America’s ultra-wealthy have pulled off a brilliantly designed heist, with a string of South Dakota governors as accomplices.

For all intents and purposes, the law professors are making an amazing claim that it’s stealing if you don’t meekly surrender your money to politicians.

Apparently they agree with Richard Murphy that all income belongs to the government and it’s akin to an entitlement program or “state aid” if politicians let you keep a slice.

Second, the law professors make the mistake of trying to be economists. They want readers to think the national economy suffers if money stays in the private sector.

Nearly no one in South Dakota complains, because the harm falls on the national economy… We all suffer high and hidden costs…getting less in government services. …South Dakota locks away resources that could spark entrepreneurial innovation.

According to their analysis, a nation such as Singapore must be very poor while a country such as Greece must be very rich.

Needless to say, the opposite is true. Larger burdens of government spending are associated with less prosperity and dynamism.

I’ll offer one final observation. Professors Heller and Salzman obviously want more and more taxes on the rich.

But I wonder what they would say if confronted with the data showing that the United States already collects a greater share of tax revenue from the rich than any other OECD country.

P.S. The reason the U.S. collects proportionately more taxes from the rich is that other developed countries have bigger welfare states, and that necessarily leads to much higher tax burdens on lower-income and middle-class taxpayers (as honest folks on the left acknowledge).

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Bob Dylan and the Capital Gains Tax

A “capital gain” occurs when you buy something and later sell it for a higher price. A capital gains tax is when politicians decide they get to grab a slice of that additional wealth.

I’ve repeatedly explained that it is economically foolish to have such a tax because it punishes saving, investment, risk taking, and entrepreneurship.

Simply stated, the capital gains tax is “double taxation,” which is what happens when there are additional layers of tax on income that is saved and invested.

I’m motivated to address this issue again because of a recent column in the Washington Post by Charles Lane.

He wants us to believe that singer-songwriter Bob Dylan has been rewarded by the capital gains tax.

Bob Dylan…just sold the rights to “Blowin’ in the Wind” and 600 other songs to Universal Music Publishing Group for a reported $300 million. …This is a tribute to his genius and, on the whole, to a political and economic system that rewards artists… Nevertheless, some socially conscious musician could write a song protesting the Dylan deal, because of what it reveals about that engine of irrationality and inequality known as the U.S. tax system. A cardinal defect of the system is highly favorable treatment of capital gains relative to ordinary income. The top rate on the former stands at 20 percent; on the latter, it is 37 percent. …the obscure 2006 law known as the Songwriters Capital Gains Tax Equity Act, which permits songwriters — but not painters, video game makers or novelists — to treat the proceeds from selling their copyrights as capital gains, too. …The capital gains break, for him and for others similarly situated, is basically a windfall. …President-elect Joe Biden supports equalizing capital gains and ordinary income rates, at least for households earning more than $1 million. If kept, Biden’s promise would restore a measure of equity and efficiency to the tax system.

At the risk of understatement, I disagree.

What Mr. Lane doesn’t appreciate or understand is that the Universal Music Publishing Group purchased the rights to Dylan’s music for $300 million because they expect his songs to generate more than $300 million of income in the future.

And that future income will be taxed when (and if) it actually materializes.

In other words, a capital gains tax is – for all intents and purposes – an added layer of tax on the expectation of future income. Double taxation in every possible sense.

This is why I’ve pointed out that Biden’s plan will make the tax code more punitive, not more equitable and efficient as Lane asserted.

Since we’re on the topic of capital gains taxation, I’ll also cite some relatively new research from the San Francisco Federal Reserve.

Here are the key findings in the working paper from Sungki Hong and Terry Moon.

This paper quantifies the aggregate effects of reducing capital gains taxes in the long run. We build a dynamic general equilibrium model with heterogeneous firms facing discrete capital gains tax rates based on firm size. We calibrate our model by targeting relevant micro moments and the difference-in-differences estimate of the capital elasticity based on the institutional setting in Korea. We find that the reform that reduced the capital gains tax rates from 24 percent to 10 percent for the firms affected by the new regulations increased aggregate investment by 2.6 percent and 1.7 percent in the short run and in the steady state, respectively. Moreover, a counterfactual analysis where we set a uniformly low tax rate of 10 percent shows that aggregate investment rose by 6.8 percent in the long run. …Our findings suggest that reducing capital gains tax rates would substantially increase investment in the short run, and accounting for dynamic and general equilibrium responses is important for understanding the aggregate effects of capital gains taxes.

And here are two of the key charts from the study.

And here’s the part of the study that explains the above charts.

Panel A in Figure 2…shows the parallel trend in investment between the affected and unaffected firms…positive and statistically significant coefficients after the year 2014 indicate that lower tax rates induced the affected firms to increase investment. Panel B in Figure 2…shows the parallel trend in investment between the affected and unaffected firms…positive and statistically significant coefficients after the year 2014 indicate that lower tax rates induced the affected firms to increase the size of tangible assets.

The bottom line is that is that you get higher wages with more productivity…and you get more productivity with more investment…and you get more investment if you don’t impose harsh tax policies on people who invest.

Which is why the correct capital gains tax rate is zero, whether you’re looking at theory or evidence.

Which is the core message in my video on capital gains taxation.

P.S. There’s also a video explaining why it’s especially wrong to impose the capital gains tax on “gains” that are solely the result of inflation.

P.P.S. And somebody needs to do a video on why it’s an awful idea for the government to tax capital gains that only exist in theory.

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Principles of (Sensible) Taxation

Two weeks ago, I shared some video from a presentation to the New Economic School of Georgia (the country, not the state) as part of my “Primer on the Laffer Curve.”

Here’s that portion of that presentation that outlines the principles of sensible taxation.

Just in case you don’t want to watch me pontificate for nearly 14 minutes, here’s the slide from the presentation that most deserves attention since it captures the key principle of good tax policy.

Simply stated, the more you tax of something, the less you get of that thing.

By the way, I had an opportunity earlier this year to share some similar thoughts about the principles of sound tax policy with the United Nations’ High-Level Panel on Financial Accountability Transparency & Integrity.

Given my past interactions with fiscal people at the U.N., I’m not overflowing with optimism that the following observations will have an impact, but hope springs eternal.

The ideal fiscal environment is one that has a vibrant and productive economy that generates sufficient revenue with modest tax rates that do not needlessly penalize productive behavior. Public finance experts generally agree on the following features

• Low marginal tax rates. A tax operates by increasing the “price” of whatever is being taxed. This is most obvious in the case of some excise taxes –such as levies on tobacco –where governments explicitly seek to discourage certain behaviors. …but there should be a general consensus in favor of keeping tax rates reasonable on the behaviors –work, saving, investment, risk-taking, and entrepreneurship –that make an economy more prosperous.
• A “consumption-base.” Because of capital gains taxes, death taxes, wealth taxes, and double taxation of interest and dividends, many nations impose a disproportionately harsh tax burden on income that is saved and invested. This creates a bias against capital formation, which is problematical since every economic theory –including various forms of socialism –share the view that saving and investment are necessary for rising wages and higher living standards.
• Neutrality. Special preferences in a tax system distort the relative “prices” of how income is earned or how income is spent. Such special tax breaks encourage taxpayers to make economically inefficient choices simply to lower their tax liabilities. Moreover, loopholes, credits, deductions, exemptions, holidays, exclusions, and other preferences reduce tax receipts, thus creating pressure for higher marginal tax rates, which magnifies the adverse economic impact.
• Territoriality. This is the simple notion that governments should not tax activity outside their borders. If income is earned in Brazil, for instance, the Brazilian government should have the authority over how that income is taxed.The same should be true for all other nations.

By the way, “consumption-base” is simply the jargon used by public-finance economists when referring to a tax system that doesn’t impose double taxation (i.e., extra layers of tax on income that is saved and invested).

Here’s a flowchart I prepared showing the double taxation in the current system compared to what happens with a flat tax.

P.S. At the risk of understatement, it’s impossible to have a good tax system with a bloated public sector, which means it’s not easy to be optimistic about future fiscal policy in the United States.

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The Economic Damage of Wealth Taxation

Speculating about tax policy in 2021, with Washington potentially being controlling by Joe Biden, Chuck Schumer, and Nancy Pelosi, there are four points to consider.

1. The bad news is that Joe Biden has endorsed a wide range of punitive tax increases.
2. The good news is that Joe Biden has not endorsed a wealth tax, which is one of the most damaging ways – on a per-dollar raised basis – for Washington to collect more revenue.
3. The worse news is that the additional spending desired by Democrats is much greater than Biden’s proposed tax increases, which means there will be significant pressures for additional sources of money.
4. The worst news is that the class-warfare mentality on the left means the additional tax increases will target successful entrepreneurs, investors, innovators, and business owners – which means a wealth tax is a very real threat.

Let’s consider what would happen if this odious example of double taxation was imposed in the United States.

Two scholars from Rice University, John Diamond and George Zodrow, produced a study for the Center for Freedom and Prosperity on the economic impact of a wealth tax.

They based their analysis on the plan proposed by Senator Elizabeth Warren, which is probably the most realistic option since Biden (assuming he wins the election) presumably won’t choose the more radical plan proposed by Senator Bernie Sanders.

They have a sophisticated model of the U.S. economy. Here’s their simplified description of how a wealth tax would harm incentives for productive behavior.

The most direct effect operates through the reduction in wealth of the affected taxpayers, including the reduction in accumulated wealth over time. Although such a reduction in wealth is, for at least some proponents of the wealth tax, a desirable result, the associated reduction in investment and thus in the capital stock over time will have deleterious effects, reducing labor productivity and thus wage income as well as economic output. …A wealth tax would also affect saving by changing the relative prices of current and future consumption. In the standard life-cycle model of household saving, a wealth tax effectively increases the price of future consumption by lowering the after-tax return to saving, creating a tax bias favoring current consumption and thus reducing saving. … we should note that the apparently low tax rates under the typical wealth tax are misleading if they are compared to income tax rates imposed on capital income, and the capital income tax rates that are analogous to wealth tax rates are often in excess of 100 percent. …For example, with a 1 percent wealth tax and a Treasury bond earning 2 percent, the effective income tax rate associated with the wealth tax is 50 percent; with a 2 percent tax rate, the effective income tax rate increases to 100 percent.

And here are the empirical findings from the report.

We compare the macroeconomic effects of the policy change to the values that would have occurred in the absence of any changes — that is, under a current law long run scenario… The macroeconomic effects of the wealth tax are shown in Table 1. Because the wealth tax reduces the after-tax return to saving and investment and increases the cost of capital to firms, it reduces saving and investment and, over time, reduces the capital stock. Investment declines initially by 13.6 percent…and declines by 4.7 percent in the long run. The total capital stock declines gradually to a level 3.5 percent lower ten years after enactment and 3.7 percent lower in the long run… The smaller capital stock results in decreased labor productivity… The demand for labor falls as the capital stock declines, and the supply of labor falls as households receive larger transfer payments financed by the wealth tax revenues… Hours worked decrease initially by 1.1 percent and decline by 1.5 percent in the long run. …the initial decline in hours worked of 1.1 percent would be equivalent to a decline in employment of approximately 1.8 million jobs initially. The declines in the capital stock and labor supply imply that GDP declines as well, by 2.2 percent 5 years after enactment and by 2.7 percent in the long run.

Here’s the table mentioned in the above excerpt. At the risk of understatement, these are not favorable results.

Other detailed studies on wealth taxation also find very negative results.

The Tax Foundation’s study, authored by Huaqun Li and Karl Smith, also is worth perusing. For purposes of today’s analysis, I’ll simply share one of the tables from the report, which echoes the point about how “low” rates of wealth taxation actually result in very high tax rates on saving and investment.

The American Action Forum also released a study.

Authored by Douglas Holtz-Eakin and Gordon Gray, it’s filled with helpful information. The part that deserves the most attention is this table showing how a wealth tax on the rich results in lost wages for everyone else.

Yes, the rich definitely lose out because their net wealth decreases.

But presumably the rest of us are more concerned about the fact that lower levels of saving and investment reduce labor income for ordinary people.

The bottom line is that wealth taxes are very misguided, assuming the goal is a prosperous and competitive America.

P.S. One obvious effect of wealth taxation, which is mentioned in the study from the Center for Freedom and Prosperity, is that some rich people will become tax expatriates and move to jurisdictions (not just places such as Monaco, Bermuda, or the Cayman Islands, but any of the other 200-plus nations don’t tax wealth) where politicians don’t engage in class warfare.

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A Primer on Dividend Taxation

Assuming the goal is more prosperity, lawmakers who work on tax issues should be guided by the “Holy Trinity” of good policy.

1. Low marginal tax rates on productive activity such as work and entrepreneurship.
2. No tax bias (i.e., extra layers of tax) that penalizes saving and investment.
3. No complicating preferences and loopholes that encourage inefficient economic choices.

Today, with these three principles as our guide, we’re going to discuss a major problem in how dividends are taxed in the United States.

Simply stated, there’s an unfair and counterproductive double tax. All you really need to know is that if a corporation earns a profit, the corporate income tax takes a chunk of the money. But that money then gets taxed again as dividend income when distributed to shareholders (the people who own the company).

So why is this a bad thing?

From an economic perspective, the extra layer of tax means that the actual tax burden on corporate income is not 21 percent (the corporate tax rate) or 23.8 percent (how dividends are taxed on the 1040 form), but a combination of the two rates. And when you include the average additional tax imposed at the state level, the real tax rate on dividends in the United States can be as high as 47.47 percent according to the OECD.

You don’t need to be a wild-eyed supply-sider to think that incentives to build businesses and create jobs are adversely affected when the government grabs nearly half of the additional income generated by corporate investment.

Keep in mind, by the way, that workers ultimately bear most of this tax since lower levels of investment translate to lower wages.

So what’s the solution?

If we want a properly designed system for taxing businesses, we know the answer. Just get rid of the extra layer of tax.

A 2015 report from the Tax Foundation explains how various types of “corporate integration” can achieve this goal.

The United States’ tax code treats corporations and their shareholders as separate taxable entities. The result is two layers of taxation on corporate income: one at the corporate level and a second at the shareholder level. This creates a high tax burden on corporate income, increasing the cost of capital. The double taxation of corporate income reduces investment and distorts business decisions. … Many developed countries have integrated their tax systems in order to mitigate or completely eliminate the double taxation of corporate income. …There are several ways to integrate the corporate tax code. Corporate income can be fully taxed at the entity level (a corporate income tax) and then tax exempt when passed to shareholders as dividend income, or corporations could be given a deduction for dividends passed to their shareholders, who pay tax on the dividend income. Alternatively, shareholders and corporations both pay tax on their income, but shareholders can be given a credit to offset taxes the corporation already paid on their behalf.

For what it’s worth, I think it would be best to get rid of the double tax by eliminating the layer of tax that is imposed on individuals.

In other words, modify the above image in this way.

Though the economic benefit would be the same if the corporate income tax was abolished and the income was taxed one time at the individual level.

I’ll close today’s column with a bit of good news.

A few years ago, the United States had a much higher burden of double taxation because the corporate tax rate was so high. Indeed, the combined tax rate on dividends was the fourth-highest in the developed world.

Today, thanks to the 2017 tax reform, the combined tax rate is “only” the tenth-highest in the developed world.

P.S. The Estonian tax system for businesses is a good role model.

P.P.S. Under Joe Biden’s tax plan, the U.S. would have the world’s-highest combined tax rate on dividends.

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Wealth Tax and Coronavirus

The folks who don’t want to let a crisis go to waste have been very busy in the era of coronavirus, pushing an ever-expanding menu of bad ideas.

• Propping up high-tax states such as New York, Illinois, and California by restoring the tax code’s deduction for state and local tax payments.
• Hindering the efficient allocation of capital and making it more difficult for companies to distribute profits to owners by banning or restricting “stock buybacks“
• Discouraging job creation and reducing take-home pay with a new federal mandate/entitlement for paid sick leave.
• There are also very bad ideas in Europe, such as the proposal that well-governed nations should be liable for the debts of poorly-governed nations.

Now we have another bad idea to add to the list.

A professor from Yale Law School, Daniel Markovits, argues in a column in the New York Times that the virus is a great excuse to impose a wealth tax.

Our extraordinary battle against the pandemic should draw on the immense reserves that the most privileged among us have accumulated over decades of abundance. To achieve this goal, America should institute a wealth tax. …the relief effort should be funded through a one-time wealth tax imposed on the richest Americans… An exemption for the first $2.5 million of household wealth would exclude the bottom 95 percent from paying any tax at all and leave the top 5 percent with total taxable wealth of roughly $40 trillion. A 5 percent tax on the richest 5 percent of households could thus raise up to $2 trillion. …this one-time wealth tax…appeal ought to cross partisan lines. …A wealth tax would fund the relief effort in a way that gives meaning to shared sacrifice in the face of a universal threat.

My initial suggestion for Professor Markovits is the same one I put forth for Bill Gates. He should lead by example and donate a big chunk of his income, as well as the bulk of his savings and investments, to the IRS.

As an Ivy League professor, I’m sure he’s comfortably positioned as a member of the infamous “top 1 percent” of taxpayers, so he can be a guinea pig for his idea. To make things easy, the government has a website for him to use.

But let’s set aside snark and focus on the economic consequences. This issue deserves serious attention, not only because it is a threat in the United States, but also because it’s becoming an issue in other nations.

Such as Argentina.

Argentine Economy Minister Martin Guzman has backed the idea of a wealth tax on the country’s rich…to…find money to help cope with the Covid-19 pandemic. The tax would affect 11,000 people with fortunes of at least $2 million, Guzman said… He spoke in an interview with journalist Horacio Verbitsky, published on the website El Cohete a la Luna. President Alberto Fernandez, in a separate interview, spoke of the need for wealth redistribution.

And South Africa.

The South African government will consider a proposal for a one-off wealth tax during an economic recovery planning meeting… Such a tax could assist Africa’s most industrialized economy as it bounces back from the coronavirus outbreak and a five-week lockdown that is scheduled to be lifted on 30 April. The proposal comes from a group of economists, led by former South African National Treasury budget chief Michael Sachs.

The big problem with all of these proposals is that they ignore the crippling economic impact of wealth taxation.

The important thing to understand is that such taxes impose very punitive implicit tax rates on saving and investment. As seen in the accompanying chart, the actual tax rate depends on how well affected taxpayers are investing their money.

And it doesn’t take extreme assumptions to see that many taxpayers will face implicit tax rates of more than 100 percent!

And since all economic theories – even foolish ones such as socialism – agree that saving and investment are vitally important if we want higher living standards, any sort of wealth tax is a big mistake.

Actually, that’s an understatement.

In a normal economy, a wealth tax is a big mistake. But we’re now dealing with the very painful economic fallout from the coronavirus.

We will have a desperate need for lots of private capital if we want to restore prosperity as fast as possible, which is why imposing a wealth tax nowadays (in addition to other forms of double taxation that already exist) would be a catastrophic blunder.

And if the class-warfare crowd succeeds in their campaign to punish the rich, poor people will suffer the most.

P.S. Some people argue that a one-time wealth tax, similar to what Prof. Markovitz proposes and what South Africa is considering, wouldn’t have adverse economic effects because it penalizes productive behavior in the past (and there’s no way for people to reduce work, saving, and investment that already took place). But as I explained when debunking IMF arguments for a one-time wealth tax, this assertion is flawed because a) people will adjust their behavior when such a tax is discussed, b) people won’t trust it is a one-time tax, and c) the money will be used to finance a larger burden of government spending.

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If You’re Worried about High Household Debt and Low Levels of Saving, Get Angry at Washington

In this interview on Fox Business, I repeated my oft-stated concern that the Federal Reserve’s easy-money policy of artificially low interest rates (avidly supported by Trump) may have created the conditions for a boom-bust cycle.

For today’s column, though, I want to focus on the part of the interview where I fret about structural rather than cyclical factors.

More specifically, whenever there is angst and concern about household debt, I get rather frustrated because some folks want to blame the American people for not saving enough.

That may be true, but I point out that the real problem is that the federal government lures people into being short-sighted.

• We have pervasive double taxation of income that is saved and invested (see accompanying chart), so the message from Uncle Sam is to immediately consume any after-tax income.
• We have provisions in the tax code, such as the bias for debt over equity for businesses (somewhat mitigated by Trump’s 2017 tax plan) and the mortgage interest deduction for households, that encourage borrowing.
• We have a plethora of programs, such as Social Security, housing subsidies, unemployment insurance, college subsidies, and Medicaid/Medicare, that undermine incentives to save.

Given all these policies, I’m actually surprised that the national savings rate isn’t much lower.

By the way, I should emphasize that there’s nothing necessarily wrong with debt. It’s perfectly sensible for many households to borrow to buy a house, a car, or to finance education.

As I noted in the interview, what matters is keeping a sound ratio of debt to assets, and a sound ratio of interest expense to income.

It’s not easy for people to be sensible, however, when there are so many anti-savings policies from Washington.

I’ll close with a bit of good news.

Because the United States is a quasi-tax haven for foreigners, we do attract an immense amount of money from overseas. So even though the federal government discourages us from saving, we have access to capital from all over the world.

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Wealth Taxation and Confiscatory Effective Tax Rates

With their punitive proposals for wealth taxes, Bernie Sanders and Elizabeth Warren are leading the who-can-be-craziest debate in the Democratic Party.

But what would happen if either “Crazy Bernie” or “Looney Liz” actually had the opportunity to impose such levies?

At the risk of gross understatement, the effect won’t be pretty.

Based on what’s happened elsewhere in Europe, the Wall Street Journal opined that America’s economy would suffer.

Bernie Sanders often points to Europe as his economic model, but there’s one lesson from the Continent that he and Elizabeth Warren want to ignore. Europe has tried and mostly rejected the wealth taxes that the two presidential candidates are now promising for America. …Sweden…had a wealth tax for most of the 20th century, though its revenue never accounted for more than 0.4% of gross domestic product in the postwar era. …The relatively small Swedish tax still was enough of a burden to drive out some of the country’s brightest citizens. …In 2007 the government repealed its 1.5% tax on personal wealth over $200,000. …Germany…imposed levies of 0.5% and 0.7% on personal and corporate wealth in 1978. The rate rose to 1% in 1995, but the Federal Constitutional Court struck down the wealth tax that year, and it was effectively abolished by 1997. …The German left occasionally proposes resurrecting the old system, and in 2018 the Ifo Institute for Economic Research analyzed how that would affect the German economy. The authors’ baseline scenario suggests that long-run GDP would be 5% lower with a wealth tax, while employment would shrink 2%. …The best argument against a wealth tax is moral. It is a confiscatory tax on the assets from work, thrift and investment that have already been taxed at least once as individual or corporate income, and perhaps again as a capital gain or death tax. The European experience shows that it also fails in practice.

Karl Smith’s Bloomberg column warns that wealth taxes would undermine the entrepreneurial capitalism that has made the United States so successful.

…a wealth tax…would allow the federal government to undermine a central animating idea of American capitalism. …The U.S. probably could design a wealth tax that works. …If a country was harboring runaway billionaires, the U.S. could effectively lock it out of the international financial system. That would make it practically impossible for high-net-worth people to have control over their wealth, even if it they could keep the U.S. government from collecting it. The necessity of this type of harsh enforcement points to a much larger flaw in the wealth tax… Billionaires…accumulate wealth…it allows them to control the destiny of the enterprises they founded. A wealth tax stands in the way of this by requiring billionaires to sell off stakes in their companies to pay the tax. …One of the things that makes capitalism work is the way it makes economic resources available to those who have demonstrated an ability to deploy them effectively. It’s the upside of billionaires. …A wealth tax designed to democratize control over companies would strike directly at this strength. …a wealth tax would penalize the founders with the most dedication to their businesses. Entrepreneurs would be less likely to start businesses, in Silicon Valley or elsewhere, if they think their success will result in the loss of their ability to guide their company.

The bottom line, given the importance of “super entrepreneurs” to a nation’s economy, is that wealth taxes would do considerable long-run damage.

Andy Kessler, in a column for the Wall Street Journal, explains that wealth taxes directly harm growth by penalizing income that is saved and invested.

Even setting comical revenue projections aside, the wealth-tax idea doesn’t stand up to scrutiny. Never mind that it’s likely unconstitutional. Or that a wealth tax is triple taxation… The most preposterous part of the wealth-tax plans is their supporters’ insistence that they would be good for the economy. …a wealth tax would suck money away from productive investments. …liberals in favor of taxation always trot out the tired trope that the poor drive growth by spending their money while the rich hoard it, tossing gold coins in the air in their basement vaults. …So just tax the rich and government spending will create great jobs for the poor and middle class. This couldn’t be more wrong. As anyone with $1 billion—or $1,000—knows, people don’t stuff their mattresses with Benjamins. They invest them. …most likely…in stocks or invested directly in job-creating companies… A wealth tax takes money out of the hands of some of the most productive members of society and directs it toward the least productive uses. …existing taxes on interest, dividends and capital gains discourage the healthy savings that create jobs in the economy. These are effectively taxes on wealth—and we don’t need another one.

Professor Noah Smith leans to the left. But that doesn’t stop him, in a column for Bloomberg, from looking at what happened in France and then warning that wealth taxes have some big downsides.

Studies on the effects of taxation when rates are moderate might not be a good guide to what happens when rates are very high. Economic theories tend to make a host of simplifying assumptions that might break down under a very high-tax regime. …One way to predict the possible effects of the taxes is to look at a country that tried something similar: France, where Piketty, Saez and Zucman all hail from. …France…shows that inequality, at least to some degree, is a choice. Taxes and spending really can make a big difference. But there’s probably a limit to how much even France can do in this regard. The country has experimented with…wealth taxes…with disappointing results. France had a wealth tax from 1982 to 1986 and again from 1988 to 2017. …The wealth tax might have generated social solidarity, but as a practical matter it was a disappointment. The revenue it raised was rather paltry; only a few billion euros at its peak, or about 1% of France’s total revenue from all taxes. At least 10,000 wealthy people left the country to avoid paying the tax; most moved to neighboring Belgium… France lost not only their wealth tax revenue but their income taxes and other taxes as well. French economist Eric Pichet estimates that this ended up costing the French government almost twice as much revenue as the total yielded by the wealth tax.

In other words, the much-maligned Laffer Curve is very real. When looking at total tax collections from the rich, the wealth tax resulted in less money for France’s greedy politicians.

And this chart from the column shows that French lawmakers are experts at extracting money from the private sector.

The dirty little secret, of course, is that lower-income and middle-class taxpayers are the ones being mistreated.

By the way, Professor Smith’s column also notes that President Hollande’s 75 percent tax rate on the rich also backfired.

Let’s close with a report from the Wall Street Journal about one of the grim implications of Senator Warren’s proposed tax.

Elizabeth Warren has unveiled sweeping tax proposals that would push federal tax rates on some billionaires and multimillionaires above 100%. That prospect raises questions for taxpayers and the broader economy… How might that change their behavior? And would investment and economic growth suffer? …The rate would vary according to the investor’s circumstances, any state taxes, the profitability of his investments and as-yet-unspecified policy details, but tax rates of over 100% on investment income would be typical, especially for billionaires. …After Ms. Warren’s one-two punch, some billionaires who generate pretax returns could pay annual taxes that would leave them with less money than they started with.

Here’s a chart from the story (which I’ve modified in red for emphasis) showing that investors would face effective tax rates of more than 100 percent unless they somehow managed to earn very high returns.

For what it’s worth, I’ve been making this same point for many years, starting in 2012.

Nonetheless, I’m glad to see it’s finally getting traction. Hopefully this will deter lawmakers from ever imposing such a catastrophically bad policy.

Remember, a tax that discourages saving and investment is a tax that results in lower wages for workers.

P.S. Switzerland has the world’s best-functioning wealth tax (basically as an alternative to other forms of double taxation), but even that levy is destructive and should be abolished.

P.P.S. Sadly, because their chief motive is envy, I don’t think my left-leaning friends can be convinced by data about economic damage.

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