Here is the closing paragraph of his short but interesting piece:
We might be especially moved to consider a consumption tax if we consider that Piketty’s proposed wealth tax seems in any case to be much higher than it sounds. If we are to assume, say a 5% return on property, then a 2% per annum tax on wealth would amount to about 40% of property income. If investment is financed by property income, this implies a very considerable reduction in investment. Is this desirable? One might doubt it, especially since the effects on investment would be substantial, even apart from incentive effects, which might also be quite considerable.
I would stress that a capital gains tax — not indexed for inflation — shares many properties of a wealth tax. In recent academic debates, this point about wealth taxes is not being made nearly enough.
A wealth tax strikes me as too difficult to implement and would introduce all kinds of new complications into the tax system. If you tax capital gains, interest income, rental income, consumption, and reinstate the inheritance tax, you accomplish similar goals within existing tax systems. A wealth tax means somehow getting citizens to accurately disclose and value ownership interest in things like artwork, foreign real estate, business partnerships, intellectual property rights, financial assets that don’t trade on exchanges, etc. It is much easier to measure and tax the cash income that comes from these ownership interests (or to tax capital gains at the time of sale) than to tax ownership itself.
Given that there are countries that have a wealth tax, it certainly is not “too difficult” to implement. In Switzerland, for example, there is a wealth tax of about 0.5% overall, but no capital gains tax. The difficulties you mention are addressed by exempting household items and by having good, simple rules on how to value real estate, small businesses, etc. These rules are broadly accepted as they usually set tax values significantly below market prices. I prefer a wealth tax over a capital gains tax, because the former does not punish me for investing my assets wisely.
How much you get punished depends on the ratio of the rates. The 0.5% wealth tax of Switzerland along with no capital gains tax is quite a good deal for the wealthy. On the other hand, if the tax increased even to just 1%, any investor would almost certainly be better off under a long-term capital gains rate of 15%.
The point of a wealth tax from a Piketty-esque perspective is quite simply to reduce the fortunes of the wealthy in the long-run. A 0.5% tax with “simple” rules and exemptions for household items (like the works of art that hedge fund managers are fond of collecting these days?) along with the abolition of the capital gains tax sounds, as I said, like an excellent deal for the wealthy and a system that can be easily gamed to thwart the policy objective of the tax.
If the purpose of government is protection, then it’s like insurance. How do insurers figure the premium that you think pays for lots of your potential losses? Based on your income? Based on how much the price inflates? Based on the wealth the property is assessed at?
Do you think insurers are wrong in how they charge for their services by using wealth?
The ideal capital gains tax is zero if the goal is to maximize wealth creation and government revenues over the longer term. The taxing of realized gains provides a perverse incentive to hold onto properties which have gained value even if better investments are available. This is demonstrated by the short-term spike in cap gains tax revenues whenever the rate is cut. Resources are misdirected to avoid taxes on the gains. Wealth creation tends to improve government coffers as well as social priorities; environmental stewardship is nearly directly proportionate to per capita income and wealth of a nation. We do more for the ecology when we can afford to, and it turns out that also works out better for the ecology.
Is it better to disincentivize hard work through labour taxation or to disincentivize investment through capital taxation? It’s hard to enjoy looking at zeros in an account, so you probably put them to work either way, but when you tax labour too much, people may decide not to work so hard.
I don’t pretend to have a definitive answer, but seeing as the money has to come from somewhere to meet the service demands of a democratic society, I think it is by no means a foregone conclusion that the ideal capital gains tax is zero.
Better to disincentivize consumption since only when you consume do you take something away from others. Work and invest all you want, there’s no reason you should have to pay tax on it.
I completely agree. I almost got into consumption taxes, but then decided not to.
I see income taxes on profits and labour as acting like an implicit subsidy on imports. The only way to tax all products (imports and domestic production) in a given market equally is to tax the consumption, not the production and profits/income. This would provide a competitive advantage against the products of any country which did not use a similar system. Any products imported by individuals would face the sales tax upon import, as is the case in Canada, thereby doing away with concerns that people would just buy their products in other countries to evade the tax.
As for concerns about the poor, this is easily addressed with a sales tax rebate for low income people, as is the case in Canada. At $10k income, the rebate is very small because it is impossible that you are paying much sales tax at such low income. So the rebate increases with income up to a certain amount, then decreases to nothing by about $40k.
You could just greatly increase the amount one and contribute to an IRA.
“The taxing of realized gains provides a perverse incentive to hold onto properties which have gained value even if better investments are available. This is demonstrated by the short-term spike in cap gains tax revenues whenever the rate is cut.”
Actually, an expectation of future capital gains tax cuts as well as the strange way inheritances are treated under current U.S. law might explain a lot of this phenomenon. The only reason to hold onto a sub-par investment where you have big unrealized capital gains is if you either expect taxes to be lower in the future or if you expect to just ride out the investment until you die and pass it on tax free (with the stepped up cost basis) to your heirs. Credibly committing to keep capital gains rates fixed and doing away with the stepped up basis would mean no rational investor would hold onto a position when better investment opportunities are available. An irrational one might but then if you admit the existence of irrational investors, the social value of incentivizing trading in assets starts to come into question…
Sure but at the margin, less investments will be “better” if you have to pay a big tax to buy into them
Given capital gains comes from the price inflating above the labor cost of the capital assets, doesn’t a zero capital gains tax reward doing everything to block labor investment in competing capital assets, and investments in innovation?
If you have a big house built in 1920 that cost $500k in current labor costs that costs $1000 in energy per month, it will only inflation to a price of one million if it is very scarce. If I am building $500k LEEDS certified homes down the road that have $20 per month energy costs, will you have any hope of capital gains on your equivalent cost home?
I suppose you might argue that with scarcity driving your home to a million, I can reap huge capital gains spending half a million on labor and then selling a hundred LEEDS homes for one and a half million, because scarcity is never satisfied and thus capital gains price inflation is an iron law of economics. Frantic investment on my part will not impact prices of old capital.
But that has been demonstrated as wrong in frantic home building, frantic drill baby drill, and I’m sure other examples.
Asset churn is not investing – investing requires paying labor to build new capital assets whether buildings, technology, human skills.
Capital gains taxes are basically taxes on profits (flows). Wealth taxes are taxes on stocks.
They may have similar properties in some senses, but they differ by orders of magnitude. Moreover, capital gains taxes are 0 unless you’re making money.
In a world with $156 trillion in financial assets (http://www.businessinsider.com/156-trillion-global-financial-assets-2014-3), much of which held by corporations which do not pay capital gains taxes, I just don’t buy the argument that low capital gains taxes are needed to promote more investment. This only makes sense to me in the context of a closed economy where the wealthy are squandering their money instead of investing it.
Think of it. If you’ve got $1 million, or a $1 billion, what else are you going to do with your money? Accept a small gain, or buy 10 more yachts?
Exactly because they tax upside more than downside (making the investor’s payoff more concave) we’d expect capital gains taxes to discourage investment risk taking. So higher capital gains taxes can change the pattern of investment even if they don’t change the quantity of savings.
OneEyedMan,
You can offset capital gains with capital losses. The capital gains rate also tends to be a flat % in most countries.
That tends to offset that effect, no?
I agree.
His apparent support of capital gains taxes (relative to income taxes) seems to be based on a very different premise than what I’m talking about.
“Moreover, capital gains taxes are 0 unless you’re making money.”
Since the US does not index to inflation, capital gains taxes are only 0 when you’re effectively losing a sufficient amount of money.
Good point. I’ve seen this point before but entirely forgot about it.
Perhaps one could say that the “wealth tax component” of a capital gains tax is then (inflation * capital gains tax rate)?
So, at 1% inflation and 15% capital gains tax, you have an implicit 0.15% wealth tax.
But I still don’t believe that it has a very strong dis-investment effect when the capital gains tax is in the range of 10, 20, 30%, since wealthy people who pay lots of capital gains taxes are not very likely to consume all that much more regardless of the capital gains rate. A 90% capital gains rate would be disastrous, of course.
Capital gains is either inflation, or untaxed labor investment. Inflation is created by stopping competing capital investment to create scarcity to inflate the price of old depreciating capital assets. So, rewarding capital gains is rewarding the monopoly power seeking to block investing in competing capital, and it depends on idling factors of production.
Except for individuals who labor to invest in their homes or in their small business just to get income for their labor by selling the asset they invested their labor in without paying income taxes.
What I’m going to do with $1 million is invest it at the new, fun rate of 0.25% (instead of zero) and make a princely $2,500 a year in riskless interest. Maybe I can buy 10 toy boats for my bathtub with that.
If I invest in equities and make more, that is a return from entrepreneurial risk-taking (I am providing risk capital to someone who might lose it), not from merely having the capital. Only the riskless rate is the return from merely having the capital.
Try to take my $2,500 away and we’ll have a “discussion.”
I devoted the early part of my career converting ordinary income to capital gains (back when the difference in rates was far greater), an exercise that substantially lowered my clients’ taxes but had little if any economic or social advantages (or substance). Piketty’s wealth tax misses the mark not because it unfairly taxes capital but because it treats all capital alike: contrary to Piketty, not all capital is alike. Indeed, the problem today is that the owners of capital aren’t investing in productive capital, preferring instead to speculate in financial assets and real estate, both for the preferential tax treatment and the possibility of a quick profit as the relatively few owners of capital compete for speculative investments, driving up the prices and creating the bubbles we have come to know all too well. The farce of the myth of owners of capital as job creators is captured perfectly by The Big Short, a movie that is both entertaining and accurate.
A large part of real estate is productive capital. Commercial property is all productive by definition. Residential property can be productive, when it’s supplying workers to the economy. This is particularly the case for rental property. Without landlords investing in rental properties, we wouldn’t have a flexible workforce.
Admittedly some residential property is not productive capital. Building an extra bedroom or a swimming pool in the corner of my garden might increase my house’s capital value, but it’s hardly productive. The question is, how do you distinguish between the two? How do you tax the latter but not the former?
If you are a landlord, do you want better rental units built down the street that will rent for just $10 a month more than you charge? What will that do to the value of your capital. Will your rental units stop providing housing? If you could block those new units by using zoning, would you do so to protect the value of your rental units?
Sure, but it doesn’t matter what the landlord wants. One landlord doesn’t have much political power compared to a building full of tenants. Instead it’s the neighboring homeowners who fight against more apartments being built. Renters are (usually) poorer; their kids drag down the local schools; etc. It’s the homeowners who vote for zoning; not the landlords.
Anyway you’ve missed the point. Real estate is productive capital. Zoning doesn’t change that.
“How do you tax the latter but not the former?”
The landlord writes off the cost of the investment, but the residential property owner doesn’t (and, now I’m really unsure about this, but wouldn’t they pay capital gains taxes on the increased value of the house when selling, despite having invested in increasing its value?).
Money is fungible. I see no difference whether I buy $1m of stock in a company (and let them decide how to invest) or invest $1m myself. Capital should simply flow to who has the best investment prospects. “Financial speculation” is actually quite a good method for doing so. Consider stocks with huge valuations – amazon, facebook, etc. You might call that speculation. I call that the market throwing capital at companies with investment opportunities.
We have quite a lot of experience from history that shows that speculation combined with the use of extreme leverage is not “quite a good method for” allowing capital to flow to the best investment prospects.
You misinterpret what high stock prices mean as well. Huge valuations for Amazon and Facebook mean that existing shareholders can sell their shares to others and rake in huge realized capital gains. It is a form of betting on the future cash flows of investments these companies have already undertaken. A liquid secondary market can make it cheaper for companies to raise funds through an IPO but I think there is a case to be made that we reached the point of diminishing returns to liquidity a while ago.
So, buy shares of a drug company buying competitors to shutdown spending on labor that will increase competition driving down drug prices thus allowing drug price hikes is the same as spending the same amount of money paying workers to build rental units that will help drive down apartment rents?
Lost wages vs increased wages. Higher prices vs lower prices. The first generates capital gains, the latter can destroy the past capital gains of existing landlords.
>>If investment is financed by property income, this implies a very considerable reduction in investment>>
There wouldn’t be any reduction in investment if the government invested the money, e.g., building roads. Government may not be good at picking winners and losers, but that doesn’t mean it can’t invest in things that are necessary and wouldn’t be otherwise provided by the market.
Yes. The money doesn’t just disappear. There are plenty of investment opportunities available for government to fund.
Deadweight loss and good luck with that.
Roads, water and sewer, reliable utilities are deadweight losses?
You education that you have is a deadweight loss and you be better off if illiterate and math is beyond your understanding?
If a business’s owner, educated employees are a deadweight loss and you pay school drop outs higher wages than college graduates?
The real world has more variables and choices than econ 101.
The current capital gains tax is much less like a wealth tax than Tyler suggests because the tax is only paid at the taxpayer’s discretion and gains at death are stepped up and effectively eliminated.
But then the estate tax is a pure wealth tax, so that takes the place of the cap gains tax on death.
But estate tax is pretty generous, only on over $6M or something right
Right, and indexed to inflation. Still, that’s a feature not a bug….tax the wealth of the rich, the 1%, not the upper middle class. Also helps prevent dynastic wealth.
It’s not nearly high enough to prevent dynastic wealth, and moreover many accounting and finance companies have quite a lot of employees who are very specialized in helping to avoid these taxes.
But it’s a revenue stream whose opponents would probably get major blowback were they to try to make it a big deal.
The only way to ‘avoid’ the estate tax is to donate the estate to charity, which works for me. You can only gift so much to your family, or even in trusts. Not that wealthy people can’t set things up so their kids are also wealthy (use the allowable gifts to buy life insurance in a dynasty trust, etc), but the estate tax prevents exponentially multiplying fortunes.
Arrow must be 100 years old; I hope to have his wits when I’m close to that age.
As for wealth taxes, I’m against them. Only little people should pay taxes. In fact, I saw an article once that said the optimal tax is one that hits the middle class the hardest, which gives incentive to either drop down one bracket and become poor, or, strive hard to get into a higher bracket where the rich are. Makes sense to me; a sort of “Laffer Curve” for individuals.
Whats the value in having people drop from the middle class into poverty?
More ‘girlfriends’ for Ray to hire of course.
If the value of an investment is the present value of all future cash flows then what are the real differences between taxing the present value of the investment and taxing the cash flows produced by that investment?
The real argument against taxing wealth is that such taxes favor consumption over investment. Consumption provides short-term benefits both to the consumer and to those who provide what is consumed, but investment can provide longer-term benefits in improved productivity.
Considering the already-dismal savings rate in the USA, wouldn’t it make more sense to tax consumption than to tax investments?
There’s also the serious problem of attempting to value certain properties.
What do you do when the wealthy buy art to evade this tax? There’s no stream of cash flows from a Picasso.
Does every property need to be continuously revalued? It’s hard enough trying to value property correctly. Good luck trying to value classic cars, 19th Century wines, Renaissance paintings, antique jewelry and custom built airplanes.
Taxing capital gains and consumption is a much easier mechanism for taxing the wealthy.
I don’t really see TC’s point. Sure, capital gains taxes, like all taxes, are distortionary, and it goes without saying that higher capital gains discourage investment. This is all very obvious.
Arrow’s point on wealth taxes doesn’t seem to me like it applies to capital gains taxes. Taxes on capital gains are taxes on the income. What Arrow did was show that small wealth taxes are huge income taxes. It’s very unclear to me how capital gains taxes exhibit a similar phenomenon. It’s a great argument against the magnitude of the wealth taxes proposed by Piketty, but TC’s attempt to turn this into an argument about capital gains taxes seems like a non sequitur.
For any wealth tax, make sure to count pensions as an asset.
You’ll never see a pro-wealth tax federal employee do an about face as fast as when you agree with them that those with assets should be taxed, including sweetheart pensions worth millions of dollars.
Watch them suddenly discover the concept that people work hard to earn their assets, so let’s not be tooooo hasty.
“You’ll never see a pro-wealth tax federal employee … including sweetheart pensions worth millions of dollars.”
Don’t forget the state employees. While the average may be lower, there are plenty of state employees with pensions worth millions, also.
And while you’re at it, don’t forget to calculate the value of sweetheart job security.
I am a retail investor in stocks and bonds. I buy paper that I think will either be worth more tomorrow than today or paper that will pay me something regularly over time.
I do not understand why this is called investing.
As far as I can see it is more like gambling. The few dollars I buy and sell have absolutely no influence over the course of the enterprise I am ‘investing.’ in Furthermore, I don’t really care what happens to the investee over time.
To call this investing is a big hoax. A big hoax perpetuated by the rich class, including me I might add, though I am not rich rich, just rich.
It is gambling and should be taxed as such. Tax the gains as ordinary income and allow losses to be written off as loses on schedule A.
And while I’m at it do not allow inherited assets a stepped up basis.
To some people, poker isn’t gambling.
Moreso when it comes to “investing”.
Poker is a game of playing the odds. The better players can make inferences from the cards they see as well as from the physical gestures of the 6 or so other players at the table. Does player five have a “tell.?”
Poker players actually have better information available to them than most retail “investors.” Retail investors are up against thousands of others whom they cannot see and do not even know who they are. And what is worse, a “tell” in poker equates to inside information in “investing.” And, as far as I know, that is illegal, unless you are a congress critter.
If poker is gambling, then so should stock investing, at least, after the start up phase of a company is done.
Much to my surprise a column in this month’s Fortune magazine agrees with me:
http://fortune.com/2015/12/16/investment-advice/?iid=sr-link1
Stanley Bing says:
“6. If You Want to Gamble, Go to Vegas.
Have you been? Visit sometime. Stand in the middle of a big casino. Now spend some time wondering how this is different from the investment game. Go ahead. Tell me how.”
This whole subject reminds me of the story of the kid who noticed that the king had no clothes on.
A lot more winning investors than gamblers.
@msgkings:
I’ve not recovered from the 2008 crash yet. Have you?
I am an investor. So according to my experience you are just wrong.
Got any statistics to prove that investing in stock provides better net returns than inflation over the years? If so, provide them. And even if that is true, it just means that it’s a good game for investors, but it does not negate the argument that it is still gambling.
Capital gains on stock transactions should be taxed the same as gambling, because that is what it is. That is what it is from my experience. I would be glad to sign up for an investment service that guaranteed great returns. But so far none has materialized. Because they are all rolling the dice!
Keep gambling!@!@!@!@!
Good point on inflation and capital gains. If you have $100 in wealth and there’s 6% inflation, then when you sell it in 12 years it will sell for $200 and you’ll be taxed about .25(100) = $25, which is similar to a 2% wealth tax each year. I hadn’t realized this argument for not taxing capital gains at death.
Keynes said the exact same thing. I am very surprised Arrow does not cite him. The context was wartime rationing; Keynes pointed out that a highly progressive consumption tax was a much better way of achieving the goal of having everyone share in sacrificing for the war effort. What he says is precisely applicable to other kinds of inequality, I haven’t looked at it in a while but it reads exactly like Arrow’s piece.
I refuse to pay any more attention to Piketty.
WHile not intending the comment to be in support of any wealth tax I’m struck by one thing. A very standard assumption about behavior is made here — reduce the returns to investments and investments will decline. That’s being had as a unviersal but I question that universal is true.
Consdier that most to the top (possilbly 2 or 3) 1% already have incomes that are beyone what they can spend and weath that their children and their children could probably live better than the to 70% without doing anything but consuming the wealth yet they still work hard to get more. I suspect that retucing the retruns some of these people earn would simply make them invest more and work harder to make more. One of the reason they are at the top is their drive to acquire more — that never satisfied and too much is never enough. We also have to consider corporations which I think act as in that “too much is never enough” manner.
So the question would be who’s doing most of the investing investors who are more interested in amassing waalth or those who investe for income. One might cast that as big/institutional investors and small investors. If the suggested behaviors traits play out then the weath tax also leads to further asymmetry in wealth statistics, where the waelthy iincrease their nvestment and the not so wealth decrease their investment, though perhaps income statistics flatten out a bit (maybe).