Late in March, President Biden proposed a “Billionaire Minimum Income Tax.” When for-profit businesses make claims about their products, they are subject to “truth in advertising” regulations and can be fined for violating such regulations. Not so with politicians. If Biden’s label had to clear such regulations, it would flunk on two grounds: (1) it’s not just a tax on billionaires, and (2) it’s not just a tax on income.
Moreover, even though his proposed tax would target very wealthy people, it would hurt more than the people targeted. As is well known among economists, taxes don’t always “stick where they land.” They often hurt people who are not the intended targets. The Biden tax would hurt wealthy people. But it would also hurt tens of millions of American workers—by reducing the amount of investment in capital.
False Numbers—And Definitions
Although Biden pitches the tax as a tax on billionaires, it would apply to any household with a net worth of $100 million. Apparently some people in the Biden administration, maybe including the president, are innumerate: $100 million is 90 percent less than $1 billion. That’s not a close call.
Also, when you hear that a tax is on income, you think it applies to income, right? But this tax would include unrealized capital gains as income. Unrealized capital gains are not income. Say you own a house that grows in value from $1 million to $1.3 million in a year. By Biden’s standards, the appreciation in your house’s value gave you $300,000 in additional income even though you didn’t sell the house.
So if you’re a person with a net worth of $100 million or more who has large unrealized capital gains, you’re really facing not a tax on income but a tax on wealth.
New York Times reporter Zolan Kanno-Youngs is among those who play along with Biden’s fiction. In the first paragraph of his March 28 news story titled “Biden to Include Minimum Tax on Billionaires in Budget Proposal,” he refers to “a new minimum tax on billionaires.” In his second paragraph, Kanno-Youngs, to his credit, explains that the tax would apply to people with a net worth of $100 million or more. But he then proceeds, in the third paragraph, to call it “a tax on billionaires.” Of course, it is, but it’s also a tax on anyone with a net worth between $100 million and $999,999,999. Describing it as a tax on billionaires is like saying that people over age ninety are legally allowed to drink. That’s true, but it’s also true that people age twenty-one or more are legally allowed to drink. That’s not just a detail.
Who Bears the Burden?
One of the most important things you can learn in an economics course that deals with taxes is that the burden of a tax is not necessarily borne by the entity that is taxed. A shorthand way of saying that is that a tax doesn’t always stick where it lands.
That point applies even more strongly than usual to taxes on wealth. The reason is that the decision to create more wealth is highly discretionary, especially for people who are already wealthy. Because it’s discretionary, you can easily choose not to create more wealth. Let’s say you have a net worth of $100 million and are thinking of starting a new firm. You probably think there’s a substantial probability that the firm will succeed—or else you wouldn’t bother—and if it does, you will become wealthier. But if the firm succeeds and you don’t sell it, you will pay this proposed added tax on wealth. That would make you less likely to start the firm in the first place.
When people start firms, they typically invest in capital. Capital is not money. We economists define capital as produced goods used to produce other goods or services. A “big” example of capital is a plant that produces manufactured goods. A “small” example is a sewing machine. The more capital that workers have to work with, the more productive they are. The more productive they are, the higher their wages. So more capital leads to higher wages.
A way to see this at a small scale is an example I owe to Jeffrey Hummel, an emeritus professor of economics at San Jose State University. Hummel points out that in the movie Castaway, the character played by Tom Hanks created capital when he made a spear to catch fish. Using a spear made him much more productive than he was when he tried to catch fish with his bare hands.
Back to capital. If higher taxes on capital cause the budding investor not to start a new firm, then the capital that would have been created won’t be created. If that happens, wages won’t be as high as they would have been. Thus a tax on wealth, which, as noted, is what the proposed Biden tax really is, will hurt workers as well as investors.
A tax on wealth, moreover, has another effect that makes productivity and wages lower than otherwise: it takes wealth away from people who are using it productively and gives it to the government. So even in the highly unlikely case that the tax doesn’t reduce the incentive to create capital, it will cause the amount of capital to be less than otherwise. Less capital, once again, means that productivity will be lower and real wages will be lower than if there had been more capital.
A Tired Refrain: Higher Taxes, More Spending
Jason Furman, an economics professor at Harvard University and a former chairman of President Obama’s Council of Economic Advisers, recently argued for the Biden tax in a March 29 Wall Street Journal op-ed titled “Biden’s Better Plan to Tax the Rich.” He argued that the current way of taxing capital gains, taxing them only when the asset is sold and the gains are realized, is inefficient, is unfair, and narrows the tax base.
His efficiency argument is itself narrow. He doesn’t even mention the fact that taxes on capital gains reduce the incentive to invest. He points out, correctly, that with the current method, people have an artificial incentive to hold onto assets, thus preventing capital “from flowing freely to those who can make best use of it.” He’s correct, but he doesn’t discuss an obvious solution: cut the tax rate on capital gains further to reduce that incentive. This would have the advantage of encouraging people, even more than our current system does, to invest. That, of course, would help not just the wealthy but also workers.
Furman’s fairness argument is also narrow. He notes that the current system more heavily taxes people with stocks that pay dividends than people with stocks that appreciate. His point is correct, but he misses a more basic point about fairness: most people with stocks earned the money to buy them and, therefore, already paid taxes on those earnings. And if they didn’t earn the money but inherited it, the odds are high that those they inherited it from earned the money. So a tax on wealth is double taxation.
Moreover, most millionaires did not inherit their money. Reason editor Liz Wolfe recently wrote:
Financial planning firm Ramsey Solutions’ 2021 millionaire study found that 79 percent of the 10,000 US millionaires surveyed did not receive any inheritance from their families. Of those who did receive inheritances, who are in the top 1 percent, Federal Reserve data show those inheritances were to the tune of $719,000 on average.
Of course, a millionaire is not a centimillionaire; I don’t want to make a Biden-type mistake. But similar data apply to the ultra-wealthy. A 2019 study by Wealth X found that 67.7 percent of the world’s people with a net worth of $30 million or more were self-made and an additional 23.7 percent had a combination of inherited wealth and earned wealth.
Finally, argues Furman, the current system narrows the tax base and, for the government to increase taxes, it would be better to have a broader base than higher tax rates on a narrow base. But notice his implicit assumption: that the federal government should increase taxes. What about cutting spending or even just cutting the rate of growth of spending? Furman seems allergic to such an idea. In “Furman, Summers, and Taxes” (Defining Ideas, May 1, 2019), I noted how hesitant Furman and his co-author Lawrence H. Summers are to propose any cuts in government spending. And, as I noted in “Who’s Afraid of Budget Deficit? I Am” (Defining Ideas, February 20, 2019), I pointed out that Furman and Summers “assume, for every single problem they address, that the solution is more spending.”
One service Furman does provide in his recent Wall Street Journal op-ed, though, is to admit a shocking downside of Biden’s proposal: you might not get your money back even if the capital gain disappears. Furman writes:
Mark-to-market taxes can create problems for people whose assets fall in value after Dec. 31, leaving them with a tax bill for phantom gains. Spreading out tax payments over multiple years would solve this problem for most taxpayers, because if the gains disappear, they would have paid only a fifth of the taxes upfront and wouldn’t be on the hook for future tax payments.
But would they be “on the hook” for the 20 percent they’ve already paid. Furman seems to be saying they would. So paying “only” 20 percent of taxes on capital gains even if the capital gains disappear is Furman’s idea of a solution. Talk about unfair!
Don’t Make a Flawed System Worse
Our current tax system, by taxing capital, is both inefficient and unfair. It’s inefficient because it taxes people who use capital productively rather than taxing consumption; it’s unfair because taxes on capital constitute double taxation. Many economists’ next step in such reasoning is to advocate a consumption tax because that ends the double taxation.
I don’t advocate a consumption tax. Starting from scratch, it would be better than the income tax. But we’re not back in 1913, when the Sixteenth Amendment gave the federal government the power to impose an income tax. The odds are high that any consumption tax would be added on top of an income tax. A better way to get something akin to a consumption tax would be to switch to a flat income-tax system along the lines of Robert E. Hall and Alvin Rabushka’s proposal in their book The Flat Tax.
But let’s not tax further those who are creating wealth, not just for themselves, but for tens of millions of American workers.
