Microsoft founder Bill Gates made headlines last week when, in an interview with Bloomberg, he expressed openness to the idea of Elizabeth Warren’s wealth tax, which would impose a tax of 2 percent on the net worth of individuals with over $50 million in assets.
Warren’s wealth tax has spurred fierce debate among economists. Berkeley economists Gabriel Zucman and Emmaneul Saez, two of the wealth tax’s fiercest advocates, have argued that the tax would raise about $2.75 trillion over a decade, and would not pose significant additional enforcement problems. On the other hand, former Clinton Administration Treasury Secretary Larry Summers and University of Pennsylvania professor Natasha Sarin fiercely criticized the proposal, and argued that the wealth tax would raise much less revenue thanks to implementation problems.
The wealth tax could also bring serious negative economic costs as well as being difficult to administer. By taxing all wealth, Warren’s proposal would treat productive investment, such as a new factory, in the same way as private consumption, like a vacation home. Similarly, it would tax supernormal returns to investment less than it would tax normal returns to investment, which is the opposite of how taxes on capital should work. Supernormal returns, which tend to be driven by extraordinarily successful investments, are less responsive to taxation, while normal returns to investment are much more responsive.
These two factors combined indicate that the wealth tax would reduce economic growth by raising taxes on saving and productive investment, in addition to it being difficult to enforce. With these theories in mind, it’s not surprising that European countries have moved away from wealth taxes in recent years.
So the wealth tax seems like a mistake. But the popular demand for raising taxes on the uber-wealthy. It’s not that surprising, either. While Americans traditionally and rightfully lionize entrepreneurship and business success, they have historically held contempt for hereditary aristocracy and the idle rich: for example, Thomas Jefferson and Benjamin Franklin both supported some form of estate tax. However, the estate tax, like the wealth tax, has a large, negative impact on savings and investment, hurts long-term economic growth, and has high compliance costs.
Is there a way to tax the wealthy, specifically those with intergenerational wealth, without creating these destructive consequences of the above policies? The answer, as Joseph Sternberg of The Wall Street Journal recently suggested: tax consumption. A value-added tax, or a VAT, is a tax on the value added at every stage in production. It is similar to a sales tax, except that it is harder to avoid, given that the tax is imposed on several transactions in the supply chain instead of the final retail sale. However, the tax is effectively paid by the consumer. Economists tend to think of broad-based consumption taxes like the VAT as less economically harmful than personal income taxes, and certainly less economically harmful than taxes on capital.
One might be wondering why implementing a consumption tax, like a VAT, would on the whole raise taxes on the wealthy. After all, value-added taxes are at least somewhat regressive. However, this problem can easily be solved: instead of just implementing a value-added tax, lawmakers could use a VAT to replace the payroll tax, which is a much more regressive revenue source. The Progressive Policy Institute, a center-left think tank, included a similar proposal in their new budget blueprint.
When the Tax Policy Center analyzed what would happen if the employer-side payroll tax was replaced with a value-added tax that would raise the same amount of revenue, they found that the bottom four income quintiles would have lower tax burdens, while the top quintile would see a tax increase.
As several economists have noted, a value-added tax is effectively a tax on both labor and old capital, as opposed to the payroll tax, which is just a tax on labor. What does that mean? It means that taxes would be raised substantially on the idle rich, who mostly receive the benefits from investments that have already been made, and do not pay payroll taxes. On the other hand, the productive rich, who own businesses and are looking for new ways to invest and grow, would not see nearly as big a tax increase.
Swapping the payroll tax for a VAT has numerous appealing characteristics. It would make the tax code more pro-growth and more progressive, while increasing taxes the most on wealthy taxpayers coasting on past success. Conservatives have historically objected to a VAT on the grounds that it will inevitably lead to higher taxes, even if it’s initially passed in a revenue-neutral package. Given how the gas tax hasn’t been raised since 1993, not to mention how individual and corporate rates have fallen over the past 40 years, there’s reason to doubt that hypothetical. And the Progressive Policy Institute’s proposal has an interesting backstop against overtaxation: the VAT rate will automatically drop a few points in the case of recession.
The Democratic candidates for president have a lot of programs they’d need to fund if elected, or otherwise they’d add even more to the trillion-dollar deficits that have become the norm during the Trump administration. If they want to raise revenue from the rich, they ought to leave proposals like the wealth tax behind, and consider swapping the payroll tax out for a VAT.