With Democrats such as Alexandria Ocasio-Cortez and presidential candidate Elizabeth Warren proposing wealth taxes, on this episode of the Capitalisn’t podcast, hosts Kate Waldock and Luigi Zingales break down how these taxes have or haven’t worked in other countries and whether they could work in America.
Kate: Hello, Capitalisn’t listeners. Thanks so much for joining our program. I just wanted to mention that you might be hearing some changes to the show’s sound. We want to know what you think. Do you like the changes? Do you hate them? Send us an email at email@example.com. That's Capitalisnt, without an apostrophe, dot podcast at gmail dot com.
Luigi: A wealth tax. You may have heard this term thrown around a lot lately.
Kate: Plans to implement a tax specifically on wealth have been put forward by Democrats like Alexandria Ocasio-Cortez and Elizabeth Warren.
Luigi: The pushback to those ideas has been intense.
Speaker 1: I think the idea that rich people are undertaxed is ridiculous.
Speaker 2: I mean, I think the question of fairness is a really crucial one, right? We live in a time of extreme wealth inequality, and that means inequality of power.
Kate: I’m Kate Waldock from Georgetown University.
Luigi: And this is Luigi Zingales from the University of Chicago.
Kate: And you’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.
Luigi: And, most importantly, what isn’t.
On this episode, we want to talk about wealth taxes. What are they? How do they work? And should we consider implementing one in America?
Debate around this idea of a wealth tax started entering the headlines in January, when Senator Warren proposed a wealth tax on the super rich. Under Warren’s plan, the tax rate on wealth would be 2 percent up to $50 million. If your wealth exceeds a billion dollars, then on the exceeding part it would be 3 percent. Just to give you an idea, it targets only 80,000 families in America. The estimates done by two economists at Berkeley suggest that you should be able to raise $2.75 trillion over 10 years. Now, Warren’s proposal includes what is called a punitive exit tax. So, if you are a US citizen and you want to give up your citizenship in order to avoid a tax, you have to pay 40 percent on the net worth above $50 million, and that’s a lot.
Kate: Yeah. Here's looking at you, Eduardo Saverin, the Facebook guy who gave up his citizenship in order to protect his Facebook wealth.
Luigi: Yes. And, not surprisingly, a lot of rich people said that this was crazy. So, Mike Bloomberg said Warren’s proposal was unconstitutional and made an analogy with Venezuela.
Michael Bloomberg: We need a healthy economy, and we shouldn’t be embarrassed about our system. If you want to look at a system that’s noncapitalistic, just take a look at what was perhaps the wealthiest country in the world, and today, people are starving to death. It’s called Venezuela.
Luigi: And Howard Schultz, the former Starbucks CEO, called the Warren plan ridiculous.
Howard Schultz: Well, if that plan was put in place, it probably could fund the government for a day or two. So, that’s not the answer.
Kate: To be honest, I am surprised that they didn’t have more choice words to use to describe the plan considering that they are billionaires. Obviously, they are going to say bad things about it.
Luigi: First of all, let’s think about a wealth tax in an international context, because the idea that wealth taxes exist only in places like Venezuela is completely wrong. They do exist in developed countries. There is an association of developed countries that is called the OECD. Five nations within the OECD do raise wealth taxes, even if the amount of money they raise with these taxes is relatively limited. Now, what is interesting is, of those countries, the most famous for adding wealth taxes is Switzerland.
Now, you don’t associate Switzerland with socialistic ideas, and so the idea of having a wealth tax is not necessarily a socialist idea. Now, it depends a lot about how high those taxes are. In Switzerland, they actually vary by canton, so not all cantons have the same tax.
Kate: What is a canton?
Luigi: A canton is kind of a county, but they have much more independence. Switzerland has a form of provinces. The level of wealth tax is more of the order of 0.5 percent, 0.7 percent, not as aggressive as the one that Senator Warren proposed. However, they start at a much, much lower level. They start at the order of $200,000, $300,000, not at $50 million. It's quite different.
Kate: So, if a bunch of other countries have implemented a wealth tax before, then that’s good news for us. That means that there’s a precedent and we can look at them for empirical evidence of the efficacy of this sort of tax. So, how effective has it been?
Luigi: Interestingly, there is less research than you would expect on this, but there is a very relevant paper that has been written precisely on this Switzerland experiment, because there is so much variation in tax rates across cantons. The bottom line is that the kind of sensitivity of reported wealth to taxes is higher than the sensitivity that we observe of reported income on income taxes. The question that is raised is, what drives this sensitivity? Because most people will expect that, especially in Switzerland, people will move from one canton to the other. If my canton raises taxes, I might move to the next one with the lower taxes. That doesn’t seem to be a first-order effect in Switzerland.
Now, it seems that the major source of this variation is either underreporting, that people tend to report less when taxes go up, which is not that surprising. And the second is that they might save less, and that is the part that as economists, we’re more concerned, because, of course, we would like people to save and invest, and a tax on wealth is a tax on savings, a tax on the willingness to actually invest in the long term. As Switzerland shows, and other countries have shown, it is possible to have wealth taxes. The question is, what are the benefits and costs?
Kate: Back in 1995, there were 15 countries with a wealth tax, and, as you mentioned, now there’s only five OECD countries that have one. So, in your opinion, what's the primary reason that wealth taxes are disappearing?
Luigi: I think it's twofold. First of all, Europe tends to have a taxation based on residency, not citizenship. So, if you are a wealthy guy in Sweden, you move to Monte Carlo, and you avoid income tax and wealth tax. Some economists have studied that all the best Swedish soccer players move to Spain, because income taxes are lower there, and so there is nobody left in Sweden playing soccer of any value because the taxes are too high. So, the mobility to avoid taxes in Europe is much bigger as a result of the fact that if you get out of the country, you don't have to pay the local wealth or income tax.
The Warren proposal is clever, if oppressive, if you want, but clever in this dimension, because you say, there is an exit tax. So, if you want to relocate to Monte Carlo, you're welcome, but we take away basically almost half of your wealth if you go.
Kate: Don’t you think that lobbying had anything to do with it, though? I mean, yes, there’s one component that’s like, yeah, they weren’t as successful in raising money and revenue as they expected to be, but surely, there were a lot of rich people who lobbied against these wealth taxes as well.
Luigi: This is certainly a possibility, and some people claim that Macron, the president of France, abolished the wealth tax as a compensation for the rich donors who supported his presidential campaign. We cannot know because there is not a lot of disclosure, but I think that it is surprising that a candidate that comes from the Socialist Party and would like to have a more, if you want, egalitarian society, decides to eliminate precisely what? The wealth tax.
Kate: Yeah. Another issue with a wealth tax is that it’s hard to track wealthy people, right? They are sneaky, and they have a lot of wealth and a lot of holdings and a lot of different types of assets, and you have to hire people, whether it’s the IRS in the United States, or other taxing authorities in other countries, you have to hire people to go after wealthy people and keep track of what they have. And so, there’s pretty high administration costs with a sweeping tax like a wealth tax.
Luigi: Actually, the IRS already keeps track of what you own around the world, and in fact, recently, they have stepped up the level of monitoring so much so that it is very difficult for American citizens to open accounts in other countries. My daughter moved to France, and she has been trying for six months to open a bank account in France, and because she's an American citizen, most banks say, “We don't want to deal with you. You are too expensive because we need to report to the IRS what you deposit and what you make.” And because she's not going to deposit a lot of money, the cost is bigger than the benefit. So, I think that, in fact, a lot of monitoring is already taking place.
Kate: All right, so Warren has put forward this wealth tax plan. Other countries have tried it with different degrees of success. Overall, it hasn’t been the biggest revenue raiser, but it has raised some money. What are the actual benefits and costs of a wealth tax?
Luigi: The biggest benefit, in my view, is to diversify your source of tax raising. There is a fundamental principle in public finance that you don’t want to raise all your taxes in one form. Why? Because every form of taxation is distortive, and so spreading it out across various forms tends to reduce this distortion. The second is a good way to reduce tax elusion. Our listeners probably remember that during the 2012 presidential campaign, it came out how little taxes Mitt Romney was paying. If you are super wealthy, you find a lot of ways to elude. And here we're not talking about evasion. Elusion is perfectly legal, but the richer you are, the better your lawyers and the more creative they are in finding loopholes.
Having a wealth tax is a way to compensate for that, especially if you make this compensation explicit. So, imagine that you say, you pay 2 percent in tax on your wealth above $50 million, but you can deduct from that 2 percent every income tax on that wealth you actually paid. That would be a compensatory tax for all the wealth that you have and you don’t pay taxes on. The third argument, which is an argument that has a long intellectual history, is that you would like to tax unproductive capital. So, imagine that there are two siblings with the same amount of wealth, and one of these siblings invests all his money in productive enterprises, and the other one buys a gigantic real estate and a few Monets and just enjoys life looking at the Monets, spending his time in the big real estate.
The second guy will pay much, much less in taxes than the first one, when the first one is really helping society to produce more and create more jobs, create more growth. So, I can see an argument to increase the taxes or introduce a wealth tax and maybe decrease the income tax. So, very often, the argument of a wealth tax or not a wealth tax is always framed in the context of, do we add another tax? And so, people say, “No. We don’t want to add another tax.” But the question is not whether we want to add another tax. The question is, what is the optimal mix of taxes we want to use? And I think that the wealth tax with some qualification might be a good component in this portfolio of fundraising or revenue-raising mechanisms.
Kate: I would say that the benefit that most people envision is much simpler. Which is that it seems fairer. Maybe it will reduce inequality, unclear whether or not it would be large enough to reduce inequality. But if you need to pay for something, if the government needs to raise some revenue in order to pay down some of its debt or to pay off some of its interest, where should that money be coming from? Should it be coming from wealthy rich people who are worth over a billion dollars? Or should it be taxes that are raised on people who earn $10,000 a year? And the former just seems a little bit more fair, and it may reduce inequality.
Luigi: You might be right that this is what people emotionally like about it. Personally, that’s not what I like. In fact, it’s what I fear. For two reasons. Number one, I think that taxes at the level that have been used in the past or even at the level much higher than was proposed by Senator Warren, are not going to fix the inequality in the country. So, if you really want to fix inequality, then we are starting to talk about expropriation, and we know the experience of countries where there was a gigantic inequality in land ownership, that some countries went the direction of expropriating some of the largest landowners’ plots in order to redistribute land. That’s a redistributive policy that is pretty aggressive. I think it’s going to cause a lot of tension.
Second, I understand that at some level you say, it’s easy that when I want something, somebody else pays for it. The problem is, if you go down that path, you don't know what the limit is. Both in terms of spending and what are the terms of taxing? In fact, one of the strongest arguments against the introduction of a wealth tax is the so-called slippery slope argument. Why do you want to stop at 1 percent? Why don't you want to go to two? Why don't you want to go to three? What is the limit in the taxation of wealth?
Kate: I’m sorry, but the slippery slope argument, I am just tired of hearing it as an excuse for no government intervention whatsoever, because if the government does anything, then it’s going to lead to the slippery slope, and then they are just going to be expropriating everyone’s wealth, and they are just going to be nationalizing every industry, and pretty soon we’re going to end up like Venezuela. Sorry. Sorry if am sounding a little bit like Michael Bloomberg there. It is just so ridiculous to imagine that poor, single mothers are going to have so much power that the 1 percent tax on wealth that’s levied on rich people is all of a sudden going to go to 100 percent. Just because we’ve never had this sort of tax before, and it’s unclear how it would be implemented and it would just run out of control. I mean, given the extreme distortions of power in favor of the wealthy, rather than the normal person in this country, I think, if anything, the truth would be the opposite.
If this sort of wealth tax were ever implemented at all, the slippery slope would move in the opposite direction. We would just chip away at it over time so that it eventually disappeared, kind of like what’s happened with the inheritance tax in the United States.
Luigi: But actually, the history goes in the opposite direction, because the income tax was introduced at the beginning of the 20th century and initially was only 1 percent. Within 50 years, it reached 90 percent, so once you start to introduce a taxation, I think that there is a tendency to use that as a source of revenue every time you need some. And the other question is, who do you define as rich? Because the definition of rich is somebody that makes more than you do. Everybody is happy to tax the ones that are above $50 million because none of us is in that category. But if you keep going down, at some point it will reach your level of wealth, and then you start saying, “Why me?”
Kate: I mean, A, that’s the whole point of a progressive tax system. Yeah, there will be discontinuities. There are with any tax system. That’s fine. And, B, if it reaches down to the level of someone who has a wealth of $100,000, even though that person just from a distributional perspective is not terribly wealthy within the United States, as long as they are only paying a penny of additional wealth tax, fine.
Luigi: But they are not paying just pennies in the sense. In Switzerland, in many cantons, they pay 0.7 percent, 0.8 percent of their wealth above $300,000, which is a significant amount of money. Now, the good news in Switzerland, they pay very little, sometimes none, in income taxes, and that compensates for this. But if you keep adding, then it is true that it does create a strong disincentive to accumulate and work. We need to consider the incentive effect of taxes, and often they are exaggerated, but they do exist, and they should not be ignored.
Do you really think that if you are taxed 90 percent, you are going to work as hard as if you are taxed at 15 percent?
Kate: No, I don’t think that that’s true, but I also don’t think that a 90 percent marginal tax rate shuts down productivity all together, as many people argue it would.
Luigi: Honestly, I do think that it will have a negative effect, but I think that a taxation of 90 percent even on a margin, is in my view, immoral, because it is taking away. So, it’s expropriation. I wouldn’t call it taxation. It is expropriation. I’m the first one to say we all should contribute to funding the public goods and people who are more wealthy should contribute more. There is no doubt about this. More in absolute terms, and in proportional terms. I am in favor of progressive taxation. However, I think that there should be limits. The risk of not adding limits justifies why there is this fear for introducing new taxes. If there was a constitutional amendment, say, that you cannot tax more than X percent of the wealth, I think that it would be easier today to introduce a tax on wealth, because people are afraid of the slippery slope, and I think there is some value to the argument, even if wealthy people can be very influential in presidential campaigns and in congressional elections.
However, I think that the risk of saying, let’s sort of soak the rich and just redistribute, is a very poisonous policy that historically has not led to very great outcomes.
Kate: All right, fine. I'll meet you halfway. I am in favor of a wealth tax and a constitutional amendment that limits the wealth tax for 45 percent of your wealth.
Luigi: That's called expropriation.
Kate: In Piketty’s book, which we’ve discussed on this podcast, so I don’t want to rehash those issues, but he does present a great example that was salient in my mind, which is that he compares Liliane Bettencourt, the heiress of the L’Oréal fortune, to Bill Gates. And between 1990 and 2010, Bill Gates’s wealth grew from $4 billion to $50 billion, so a 12.5 X return. Whereas Liliane Bettencourt’s wealth grew from $2 billion to $25 billion. Same return, but she didn’t work at all. Doesn’t this highlight the problem with wealth and taxation? Which is that once you have a lot of money, if markets are doing well, it’s just easy to make a ton of money without being a productive member of society.
Luigi: That’s definitely true, but if you invest that money in the stock market, you take the risk, you provide the capital to innovate and grow, I don’t know why you should be penalized. I think it’s much more problematic if that money was invested in Monet paintings, and I’ve nothing against Monet, but Monet paintings, and they tripled or quadrupled in value. In fact, there is a long tradition even among classical liberal economists to favor some form of taxation of rent or taxation of the unimproved value of land. And even Milton Friedman, one of the most free-marketeer and antitax economists, said that some form of taxation on land is probably the least evil of all the taxes and should be a part of it. So, the idea of taxing something that grows in value without any contribution on your part, I think it is a sound idea. I disagree that if you invest in the stock market, and I think that Bettencourt was investing money in the family company, this is saying it is completely a passive thing, because you are taking a lot of risk in the process.
So, I will . . . I agree with part of the argument but disagree with the rest.
Kate: I mean, we were talking about capital gains in particular. I think the fairness fundamentally comes down to whether or not you think capital markets are already efficient. How much efficiency loss or how many distortions would be introduced to the system by raising taxes or introducing a new type of tax, and also how profits are being made in the first place, right? Are stocks going up because entrepreneurs are innovating and they are creating new goods and they are improving society? Or are stocks going up because companies are monopolies, or because they have cozy relationships with the government and they are able to entrench themselves? And I think if you take the view that, first, a lot of profits or a lot of rents come from sources that are not necessarily good for society. And, number two, that capital markets are actually pretty efficient, at least in the United States, and that if we change taxes a bit, it’s not like people are going to stop investing in new ventures.
It’s not like entrepreneurs are going to stop creating new businesses. I think this is where a lot of the debate needs to take place, but at the same time, we don’t really know the answers to those questions. It’s impossible to know.
Luigi: Wait a minute, we do know that there is an elasticity of investments to taxation. So, if you increase taxes, you are going to have less investment. Now, of course, the big question is, what is the magnitude? But the fact that it exists, I think is undoubtful. On the other point, I agree that we have monopolies. We have distortion, et cetera. But we know in economics that you cannot use an instrument to fix all the problems. You tend to have the need to have one instrument per objective. So, if you are concerned about monopolies, as we discuss in this podcast, there is the antitrust to do that. And you can do even more legislation targeted to that. If you are concerned about corruption or cronies, you want to introduce legislation or enforce legislation on that front. I don’t think that a generic tax on wealth will fix the problem.
Kate: In response to your response to my point about the elasticity of investment, sure, that’s true, but another thing that’s true is that that’s going to constantly change over time. It’s going to change as economies mature, and it’s going to change as the types of investments we have to make also change, right? As innovation itself changes. And so, it’s impossible to know in this exact moment what that magnitude is. And, yeah, you said that, sure, we might not know magnitudes, we just know signs, but if the magnitude is pretty small, then I’m not too concerned.
The recent example that we have is that when Trump cut taxes in 2017, there wasn’t a huge increase in investment, at least not what we were expecting. What happened was that companies ended up paying out a lot of that money to their shareholders. And so, if we had a ton of great investments to make, we would have expected more investments to be made as companies had more money. And so, this tells me that there is room to raise taxes without introducing these huge distortions to capital markets.
Luigi: Certainly, there is some room in this direction, and if I remember correctly, when we discussed the Trump tax reform, both of us agreed that it would not have spurred investments. Some of the promises that were made were a bit excessive. So, I will certainly not disagree on this. But I think what is important to understand, and this is one of the reasons that people are so negative about the idea of a wealth tax, is that it feels like you are taking advantage of the people who have saved in the past and they cannot change their decision. So, the good thing about the income tax is that you generally know how much you are going to be taxed before you work. And so, at the end of the day, it is a choice you make, do I work more, and I make more money, but I am taxed more? Or do I work less? With the wealth tax, the decision to accumulate has been done in the past.
That decision is sunk, and then you come and say, “I want to take a piece of the action.” Why is this so problematic? In economics, we call this time inconsistency, because if you start fearing that this is what's going to happen, people will not invest on a massive scale. In countries where expropriation is likely, and Latin America comes to mind, foreign companies tend not to invest. Why? Because they have experienced situations in which they invested, and after the investment, they were expropriated in one form or another. You can fool people only once, because later they learn. The risk of introducing a system of a wealth taxation is that people will not invest for fear that this taxation will be an expropriation later on in the future. That’s the reason why some form of bound, a constitutional bound to this, will be useful precisely to avoid this fear.
Kate: OK. Sure. If you want to implement a constitutional bound in order to make this tax, or in order to rein it in and make sure it’s not expropriative, that’s fine, but still, we need to go back to the point that the numbers being introduced are on the order of 1 or 2 percent, maybe. In some countries, much less. A, I don't think that that is a punishment or a burden on people who have saved. And, B, I don’t think that if wealthy people were taxed on the order of 1 percent of their wealth, then all of a sudden, they are going to stop saving, and all of a sudden they are going to start consuming caviar for every single meal because it’s just so not worth it for them to save. I don’t think that that would really change their behavior at all, actually.
Luigi: For sure it would change their behavior. They will start to distribute the wealth to their children and relatives, so as to be below the threshold of $50 million or below the threshold of $1 billion. And they will spend an enormous amount of money in lawyers to try to figure out ways to avoid that. So, in the current system, there are so many loopholes in inheritance tax because you can create a trust and avoid the tax that, basically, it ends up being a subsidy to tax lawyers. That’s one of the reasons why in many countries it was either reduced or abolished. You start with a clean wealth tax, and then the lobbying introduces so many loopholes that by the end, it raises very little revenue and creates a lot of distortion. So, unless you are able to eliminate all those distortions, then creating a wealth tax or inheritance tax does not make a lot of sense.
Kate: I sort of feel like you just contradicted your earlier point about the slippery slope, right? How can it be that a potential cost of a wealth tax is that it’s going to increase so much that it’s expropriative to rich people, but at the same time, another problem with it is that rich people will lobby so much for the introduction of loopholes that eventually they won’t be paying any wealth tax at all.
Luigi: Actually, no, because I think that there are some aspects that are very visible and become politically salient. What is the tax rate? And the idea of soaking the rich is a pretty popular idea throughout the world. And so, the idea of increasing the rate, you can win a campaign by saying, “I'm going to tax the rich. And I'm going to increase the rate at X.” It is very hard to say I win a campaign by eliminating a loophole that most people don’t understand what it is. And, as a result, I think that the vested interests are particularly good at creating the loopholes. And, if you want, the more popular, or populist, parties, are very good at increasing the tax rate. And then you end up exactly like in the ’60s, where you had a very, very high tax rate and an enormous amount of deductions and loopholes that make the system incredibly inefficient.
Kate: Yeah. I think that that’s a great point. When it comes to taxation, a lot of people say, “What's the issue? Is it the rate or the base?” The rate is the percentage of the tax, and the base is how much money you are being charged that tax on, and loopholes allow you to shrink the base, because they allow you to hide how much money it looks like you are either making or how much you actually have. And, in practical reality, the real issues right now revolve around the base. But the base is hard to understand because there are so many rules, and there are so many laws, and it’s just hard to have a simple conversation about it, whereas it’s easy to talk about the rate. So, as you mentioned, Luigi, all of the political discussion is about the rate, when the actual discussion we need to be having should be about the base.
So, Luigi, a wealth tax. Is that a Capital-is or a Capitalisn't?
Luigi: I think in the proper form and shape as we have discussed, a wealth tax is Capital-is. I think Switzerland is a very capitalistic country, and they have a very well-functioning wealth tax.
Kate: I think it's a Capital-is as well, probably for reasons that you disagree with, but at the end of the day, if 1 percent of American households own 40 percent of the country's wealth, that’s a problem to me. Solutions that may have been proposed to combat an issue like that, they’re not working, and so something needs to happen. If this becomes expropriative, fine. I acknowledge that there is potential for it to be expropriative, and so put a cap on the tax.