Thinking about wealth taxes

As you might have heard, Thomas Piketty’s “Capital in the Twenty-First Century” has sparked a bit of conversation about the economics of inequality and growth. The book is part description of hundreds of years of data about the distribution of income and wealth, part theorizing about the roots of these trends, and part prescription for reducing these inequalities. The last part has been perhaps the most controversial, with the French economist calling for a global wealth tax. But as time has passed, economists and other analysts have taken a deeper look into some of the economics of the wealth tax—and some of the results are very interesting.

A session at the Allied Social Science Associations meeting in San Francisco last week dug into the topic of wealth taxation, with two of the papers citing Piketty’s proposal. One paper, by Emmanuel Farhi of Harvard University and Iván Werning of the Massachusetts Institute of Technology, focuses on the forces Piketty cites in his analysis of wealth taxation: r and g, with r being the rate of return on capital and g the growth rate of the overall economy. In Piketty’s famous formulation, if r is greater than g then the economy will trend toward increasing inequality.

Farhi and Werning focus on how the difference between r and g affects the optimal tax on bequests—the passing on of wealth to the next generation. The two economists find that under traditional models, the difference between the rate of return and the growth rate of the economy really didn’t matter much. But then they built a model that allows for political concerns, in the sense that redistribution may be preferable because high levels of inequality could be destabilizing for the political system. Once those considerations are included, the difference between r and g does matter. The higher the difference, the higher the level of optimal tax on bequests.

A second paper at the same session took a different approach to looking at a wealth tax. Fatih Guvenen of the University of Minnesota, Gueorgui Kambourov and Burhan Kuruscu of the University of Toronto, and Daphne Chen of Florida State University look at the efficiency effects of taxation. The economists compare a tax directly on wealth to a tax on capital income (the income derived from wealth) and find that shifting to a wealth tax would improve the efficiency of the economy.

To understand their result, consider two similarly wealthy individuals. One received his wealth through inheritance and really isn’t doing much with it while the other received her wealth through entrepreneurial means. Since the entrepreneurial wealth holder is using capital more efficiently, the return on capital is going to be higher. In a system where capital income is taxed, she’ll be taxed more than the guy just sitting on his wealth.

A wealth tax, however, would shift the tax burden more onto the less active wealth holder. This, in turn, would give him a lower rate of return, and capital would shift to the more active individual. In other words, the redistribution would be a reallocation to more productive means. As the authors point out, however, this would also mean an increase in wealth inequality.

For anyone who wondered if the economics profession would engage with the ideas Piketty proposed in his book, this session was good proof that it has and will likely continue doing so.

Photo of Thomas Piketty in Sweden, June 30, 2014. (AP Photo/Janerik Henriksson)
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