Taxing Wealth and Capital Income

Abstract

Taxing the wealthy is a hot issue among Democratic candidates for president. Sen. Elizabeth Warren (D-MA) is proposing an annual wealth tax on the richest households, while other candidates are proposing higher taxes on incomes, estates, capital gains, and corporations.

Calls for tax increases are animated by claims about the fairness of income and wealth distributions in the economy. Warren wants to address “runaway wealth concentration,” while Sen. Bernie Sanders (I-VT) says that the wealthy are not “paying their fair share of taxes.”

The proposed tax increases run counter to the international trend of declining tax rates on capital income and wealth. The number of European countries with a Warren-style wealth tax has fallen from 12 in 1990 to just 3 today.

The Europeans found that imposing punitive taxes on the wealthy was counterproductive. Wealth taxes encouraged avoidance, evasion, and capital flight. In most countries, wealth taxes raised little revenue and became riddled with exemptions.

This study discusses why targeting wealth for higher taxation is misguided. Wealth is simply accumulated savings that economies need for investment. The fortunes of the richest Americans mainly consist of active business assets that generate jobs and income. Increasing taxes on wealth would not help workers, but instead would undermine productivity and wage growth.

Basic economic theory suggests that taxes on capital should be low, and that conclusion is strengthened by the realities of today’s global economy. Furthermore, wealth taxes are even more distortionary than current federal taxes on capital income.

Nonetheless, taxing capital in a fair and efficient manner is a challenge. This study argues that the best approach would be a consumption-based tax system. Such a system would tax capital income but in a simpler way that does not stifle investment and economic growth.

Keywords: Wealth tax, Democrat tax policy, Bernie Sanders, Elizabeth Warren, top percent, targeted taxation, billionaire, millionaire, federal tax, progressive tax

JEL Classification: B51, H57, H20, H24, H25, H23