Why a VAT is the best “wealth tax”

The Democratic presidential candidates all have plans to collect revenue from the rich in order to help the poor and middle class.

The plans differ substantially. But only one of the plans is practical.

We live in a time of great economic inequality. It is undeniable that disparities in income and wealth are far greater today than they were 50 years ago.

The government is going to pursue new policies to help people economically. So what is the best approach?

One proposal is a new tax on millionaires and billionaires. Every year, households would be taxed 2% on wealth exceeding $50 million and 3% on wealth exceeding $1 billion. The revenue would fund programs such as universal child care and college tuition.

The political appeal is clear: millions of Americans would benefit from the new spending, while a small sliver of the population would bear the cost. One of the plan’s designers admits that 0.1% of families would pay this tax.

Determining how much money those families owe, however, would be incredibly difficult. There are many problems, one of which is that there are many kinds of wealth with no market valuation.

Consider Rihanna. She is fabulously wealthy, but to put a number on her wealth, the IRS would have to estimate the present value of her songs and their possible future royalties. There is often no market price for such intangible assets.

Rihanna is fabulously wealthy, but it is impossible to calculate her net worth.

Any estimate would be a guess, and yet it would have to be made.

A similar situation arises for family businesses. When businesses are sold, accountants often attribute significant value to an intangible asset called good will. To assess the wealth tax, the IRS will have to estimate the good will of virtually every family business.

Good will is hard to measure: It includes things like a business’s brand name, reputation, technology, and its network of customers and contacts. Any simple formula that the IRS tries to apply will result in major inequities and unfairness.

Another big problem is that the wealth tax would raise less revenue than its proponents believe, as rich people would take actions to avoid it.

For example, the tax would incentivize high-wealth couples to divorce. A married couple can exempt $50 million of wealth from the tax, but two unmarried partners could each exempt $50 million for a total of $100 million. Given the 2% tax rate, married couples could gain $1 million per year in taxes by divorcing.

Giving money to adult children would also reduce a family’s tax liability. A married couple with three adult children could, by divorcing and gift-giving, exempt $250 million from the tax.

In addition, rich people planning to give much of their wealth to charity would now have an incentive to accelerate that giving, shrinking the wealth base subject to the tax. And we could go on. There are countless ways for people with vast resources to avoid a complex tax like this one.

In other words, the wealth tax is simply unworkable.

In other words, the wealth tax is simply unworkable.

—AYFAQ.com

Andrew Yang’s approach is entirely different. He proposes a value-added tax, which has been proven remarkably efficient (economically) in every European country. And the universality of his Freedom Dividend would make it simple to administer.

Yang’s proposal targets those who spend lavishly. Consider two CEOs each earning $10 million a year. One spends all his money living the high life, drinking expensive wine, driving Ferraris, and flying a private jet to extravagant vacations.

The other lives modestly, saving most of his earnings and accumulating a large nest egg. He plans to leave some of it to his children and grandchildren, and the rest to charity.

Ask yourself: Who should pay higher taxes?

The “wealth tax” hits the frugal executive hard but charges the extravagant spender nothing at all. The Yang proposal hits the spender hard and takes a smaller bite from the frugal person who has saved his money. If you think that society could benefit from fewer extravagant spenders and more careful savers, Mr. Yang’s proposal makes much more sense than a wealth tax.

Joseph Sternberg of The Wall Street Journal agrees that taxing consumption with a VAT is the best way to tax the wealthy. It is a tax on the value added at every stage in production. It is similar to a sales tax, except that it is much harder to avoid, given that the tax is imposed on several transactions in the supply chain instead of the final retail sale. Economists 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. A value-added tax is effectively a tax on both labor and old capital. The existing payroll tax is just a tax on labor, and is extremely regressive. In effect, taxes would be raised substantially from the idle rich, who mostly receive income from investments that they have already made, and who pay virtually zero in 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.

The wealth tax could also have serious economic costs, as well. The proposal treats productive investment, such as a new factory, in the same way as private consumption, like a vacation home. By contrast, a VAT allows businesses to deduct the VAT already paid on inputs to their production. In the end, the wealth tax would reduce economic growth by raising taxes on saving and productive investment. Considering these problems makes it obvious why numerous European countries have abandoned wealth taxes in recent years.

Austria, Denmark, Germany, Finland, Luxembourg, Sweden, and Iceland all had wealth taxes, and they all repealed it because:

  • Wealth taxes contributed to capital drain, promoting the flight of capital as well as discouraging investors from coming in.
  • Wealth taxes had high management and administrative costs, especially relative to the returns.
  • Wealth taxes distorted resource allocation, particularly involving certain exemptions and unfair valuation of assets.

On the other hand, a VAT (known in some countries as a GST, goods and services tax) is already in place in 166 of the 193 countries with UN membership, including every industrialized country except for the United States.

If the goal is to raise revenue from wealthy taxpayers to strengthen the social safety net, Mr. Yang’s plan is far more likely to succeed.

Persuading voters to embrace Mr. Yang’s idea, however, won’t be easy. Americans will need to think harder. Under his plan, lower-income families would get back (in the Freedom Dividend) far more money than they pay in taxes. Those who spend over $120,000 a year in taxable goods and services will see their taxes increase. Higher taxes are always a hard sell.

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. But given how the gas tax has barely budged, and individual and corporate rates have fallen over the past 40 years, there is little reason to think that overall higher taxes would actually occur.

Overall, Mr. Yang’s plan is much more likely to work. But whether it can win over public opinion remains to be seen.

References:

[1] Yang vs. Warren: Who Has the Better Tax Plan?
[2] N. Gregory Mankiw: On the Economic Ideas of the Right and the Left Today
[3] Would a “Wealth Tax” Help Combat Inequality? A Debate with Saez, Summers, and Mankiw

Leave a comment

Your email address will not be published. Required fields are marked *