Wall St. Economist Weighs in on Proposed Wealth Taxes

Wealth Tax

In spite of all the economic concerns out there about the proposed wealth taxes from Bernie Sanders and Elizabeth Warren, one Wall St. Economist thinks they are too small.

The fact that modern economies are living on borrowed time is far from news, even though not a lot of people care or dare to think about the long-term consequences of the massive deficits that are being rung up year after year.

The U.S. has moved beyond just measuring its deficits in the billions of dollars and have now graduated to the trillion-dollar deficit club, a feat that we will have achieved two years running once 2019 is in the books.

This is not anything that we can hope to ever really resolve, as we really can’t cut government spending anywhere near as much as needed nor can we raise taxes enough to ever repay the massive debt that is already on the books.

The only sensible way forward is to limit government spending to what is really necessary and eliminate what we can without having too negative an impact upon the economy. This is much easier said than done, but does require that we closely examine expenditures and at least include long-term consequences in the equation.

The problem with our political system is that allows for the decisions of government to be made by those who may not care about the future, much like the claim that we don’t care about the state of the earth and may deprive future generations.

Some things do grab our attention from time to time, like Social Security being reduced to a hand-to-mouth mechanism to redistribute taxes, and this is seen as a sort of crisis, although it’s nothing compared to the real crisis that will come later when the U.S. can no longer borrow enough to meet its debt obligations.

What we do need to avoid is to take actions which markedly accelerate this march toward the financial and economic cliff, and realize that all this borrowing will eventually require the piper to be paid and we just won’t be able to do that.

If we aren’t comfortable with cutting back spending, we might even see not doing so as reasonable, as cutting will reduce the size of our economy and make things anywhere from more difficult for people to make ends meet or to find work to causing a financial catastrophe if we take this approach far enough.

Sadly, austerity measures really don’t work that well generally, but if we used this to cool down economies that require this, to manage inflation, changes in fiscal policy could be used to not only improve our debt load at least somewhat, but also to serve a useful purpose in managing our economy, much like the Fed raises rates or sells bonds to cool things off at times.

Fiscal policy is one of two ways that a government manages its economy, with the other one being monetary policy, the sort of things that central banks do. Given that the approach we use with fiscal policy has our foot on the gas all the time and we really don’t use the brakes much, its usefulness in tempering the economy is very limited.

The Fed can accomplish this quite nicely though, and they can just put up interest rates enough to achieve whatever desired effect in slowing down the economy that they choose. This leaves the problem with government overborrowing unaddressed though, but even unaddressed is better than what some Democratic candidates want to do, which is to increase it recklessly.

Making the Ultra Rich Pay our Way May Seem Like a Fine Idea on the Surface

Bernie Sanders and Elizabeth Warren seem to believe that the solution to this massive extra spending is just to raise taxes, and one of the things that they are both considering is putting forth a wealth tax to pay for it all. The biggest problem with this is that they are using numbers that just aren’t even close to being realistic as far as what these proposed taxes will raise for the government, which will result in not only the wealth taxes constricting the economy, it will also add a lot to our current deficits.

Bernstein economist Philipp Carlsson-Szlezak has examined these two wealth tax proposals, and interestingly, he feels that they are too modest, which we should find even more disturbing.

It can be challenging to predict just how much money this sort of wealth tax will raise due to variations in compliance. We cannot just assume that all we have to do is threaten to take away a big chunk of someone’s income and especially a lot of their wealth and just expect them to obey without objecting.

It’s also not that easy to predict what will happen to the economy as a result of these higher taxes, and all taxes do affect the economy negatively. This has to be taken into account as well to arrive at the net change in tax revenue that is simply being assumed naively by these candidates.

The problem is that people already go to great lengths to avoid paying tax, and we can’t just assume everyone or even that many people will just accept this willingly. They will avoid even the small stuff, and what these wealth taxes will do to them is on the far end of this scale.

The incentive for avoidance will go way up, because a wealth tax involves so much more money taken from them, in the billions in some cases. Carlsson-Szlezak rightly points out that whether the objective of the proposal from Sanders is to eliminate billionaires, this will be the result. He has calculated that under the current proposals, billionaires in the United States will eventually become extinct, and he’s even figured out that the most anyone would be able to hang on to would be around $700 million in wealth.

Sanders, on the other hand, freely admits that there should not be any billionaires, so Carlsson-Szlezak’s conclusion is at least consistent and should not surprise.

When you lose more money than you make, your wealth decreases, and the level that we’d be seeking here is the one where your income and your tax obligation equalize. The more wealth you have, the more you will have taken from you each year, if you sit back and take it willingly that is.

Figuring out what compliance level we may expect here is the trickiest part of all, and one that is very easy to get wrong on the optimistic side. Warren and Sanders don’t make any adjustments and just take the simple-minded approach and assume no resistance, and Carlsson-Szlezak is guilty of the same error.

In addition to grossly overstating the revenue from this, no one seems to be looking at the other side of this, the reduction in tax revenue from others not included in the scheme, and this has nothing to do with tax rates and has everything to do with taxing a smaller economy at the same rate.

Losing Massive Amounts of Wealth is Not Ever an Acceptable Outcome

The size of an economy depends primarily on its level of investment, which is the bedrock that any economy lays on. Wealth taxes will reduce investment in the United States pretty significantly. First of all, there will be less to invest since the IRS has a big hand in their pocket. Some therefore may invest less, but the real risk is that others may just pack up and leave and take their billions that they have to invest elsewhere.

You lose all of the tax revenue from these folks, but that’s not even the big part, as you also lose the tax revenue from taking the current macro income levels and turning them down due to the economic contraction that will result. This concern is aside from things like people suffering financial hardship from this, which we certainly don’t want, if we pay this price to get back even less tax revenue overall.

Carlsson-Szlezak sees Warren’s proposal as being more pragmatic. Of the two, it is the more pragmatic to be sure, and with Sanders’ campaign now on the rocks, getting at least a more pragmatic scheme would be at least preferable.

The problem he actually has with Warren’s wealth tax, as well as with Sanders’, is that he doesn’t see this making much of a dent in our fiscal troubles. He cites the fact that we’re expected to spend about $12 trillion more than we take in over the next decade, with Warren’s plan only delivering about a quarter of that, and Sanders’ idea only providing a fifth of that.

He proposes that we greatly increase the size of the net of this wealth tax, and predicts that we’ll need to lower the threshold to those who have only $900,000 of wealth in order to make up for our projected deficit.

Neither candidate is all that concerned about reducing the deficit though, and neither are putting forward this wealth tax as a goal to do that. It is instead supposed to pay for their new programs, like free college and free health care for everyone. This is a goal of Carlsson-Szlezak’s though, and it’s a worthy goal actually, but it must actually be pragmatic or even be something other than invoking pain we can never choose to endure.

According to Warren, this is supposed to cost $2.75 trillion over 10 years, which is also the amount that she projects that her wealth tax would provide. Having this match up does look pretty convenient and all we have to do is lean on some extremely rich people who aren’t really entitled to that much wealth and get them to pay for everyone’s health care and schooling.

On the other hand, once we calculate in the level of compliance that we may reasonably expect from a wealth tax, this revenue number goes down from $2.75 trillion to only $25-$75 billion. That’s not even a decent sized ante to this game. We could just add this massive amount of new spending to the debt though by way of increasing the deficit though, and that would actually be a much better idea than the wealth tax, because the wealth tax is far from neutral.

In order to seek out this $25-$75 billion, a relative pittance, we’re going to be doing a lot of harm to the economy. If we’re aiming the tax at $2.75 trillion and we only hit $0.05 trillion, the mean of these projections, we’ve lost $2.745 trillion in wealth. The only real way to get around this is to just take the money out of the country.

It’s not that we will only lose $2.745 trillion in wealth, we’d lose even more, as this is the tax end of the equation, not the principal amounts that are being taxed. If you want to avoid paying this much tax, you have to move a lot more wealth than this out of the country.

This would have devastating effects on the economy which would not only dwarf the paltry additional tax revenue that is collected by such a wealth tax, it would also reduce the amount of tax collected overall, and drastically if this weird science project was allowed to continue for long enough. With the level of compliance predicted, $75 billion max paid out of a tax bill of $2.75 trillion, this tells you that few indeed would be paying this. This means almost all won’t, and these are people who famously hold the vast majority of wealth in the country.

The vast majority of our wealth disappearing isn’t exactly a worthy goal, and by any measure, this would cripple the country economically. The net liabilities of these plans over the next 10 years would be far greater than just this $2.75 trillion, and we’d not only add the cost of these programs to our already alarmingly high deficits, we’d be seeing them grow much larger from the reduction in tax revenue from this attempt to crush our economy.

We already are spending our way into oblivion, and while really ramping up this spending will take us to the edge of the cliff sooner, if we use taxation recklessly as well, like these wealth tax proposals do, this will have us falling off the cliff much sooner.

We won’t even be able to spend our way out of a mass capital exodus like a wealth tax would cause, and this is not something that you can just undo like with putting a tax rate back down. We must think very carefully about what we are doing here. If we do not, once we get to the point where enough rain falls that we finally wake up, this rain will cause permanent economic damage.

Wealth taxes like this won’t just cannibalize billionaires, they will cannibalize everyone else too.

Monica

Editor, MarketReview.com

Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.

Contact Monica: [email protected]

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