Peter Orszag: Better ways than a wealth tax to shrink inequality

06/05/2014 12:00 AM

06/04/2014 5:33 PM

In the hoopla over whether Thomas Piketty’s data on growing global inequality are correct, an important question about how to address the problem has been obscured. Piketty describes his own global wealth tax idea as more of a “useful utopia” than a practical policy suggestion. Is there anything more plausible that can be done?

Two suggestions come to mind, at least for U.S. policymakers. The first is a progressive consumption tax. This kind of tax is already embraced by many conservative thought leaders because it is, compared with other types of taxes, economically efficient. But it is efficient in no small part because it imposes a tax on wealth. People have no way to convert their money into anything they consume without paying the tax.

As William Gale and Benjamin Harris of the Brookings Institution have pointed out, the efficiency benefits from a consumption tax occur from a combination of effects, including imposing a one-time tax on existing wealth. As they note, this tax on wealth that already has been accumulated “is a major component of the efficiency gains because of the creation of a consumption tax.” The dirty little secret about consumption taxes is that their putative benefits come largely from Piketty’s core idea: a tax on wealth.

The inherent problem with a consumption tax, though, is that it is regressive, because low- and middle-income people consume a larger share of their money than high-income people do. So while a plain vanilla consumption tax would tax wealth, it would exacerbate the core problem that Piketty is worried about.

The solution to this dilemma is a progressive consumption tax, such as the X tax proposed by the late Princeton University professor David Bradford. Under the X tax, wages are subject to a progressive tax and business cash flow is taxed at the highest wage-tax rate. The result is a consumption tax that imposes larger proportionate burdens on high-income families than on low-income ones. This version of a consumption tax would mitigate the distributional concerns but still impose a substantial tax on existing wealth. Its parameters could be adjusted to focus increasingly on the very wealthy, rather than the merely wealthy. And yet the X tax has been promoted by the conservative American Enterprise Institute, whose economists are most unlikely to embrace a simple wealth tax.

Three caveats should be noted for the record. First, the AEI economists favor imposing a consumption tax that gives generous transition relief to existing owners of capital, substantially reducing the tax on current wealth and also attenuating the efficiency benefits of the reform. Such relief is not a necessary component of the reform, however, and progressives could insist on minimizing the transition relief – in the name of economic efficiency and to accomplish the tax on existing wealth. Second, the X tax was not originally designed to address concerns about the top 0.01 percent rather than, say, the top 10 percent, and modifying it to do so would require a stretch, albeit only one about parameters rather than, as with a wealth tax, the entire construct. Finally, the AEI economists favor imposing a progressive consumption tax as an alternative to existing forms of taxation. But such a tax could instead be added to the existing system.

Another idea to address growing concentrations of assets that would be more practical in the U.S. than a global wealth tax would be to shift the U.S. estate tax to an inheritance tax. The difference between the two is crucial: While an estate tax imposes the same tax burden on bequests regardless of how many people receive them and therefore regardless of the impact on wealth inequality, an inheritance tax creates an incentive to split up large estates among a larger number of beneficiaries, thereby lessening inequality over time.

Consider as an example a $50 million estate. Under the estate tax, that $50 million is subject to the same tax regardless of whether it is bequeathed entirely to one person or dispersed among 10. Under an inheritance tax, by contrast, the $50 million inherited by one person in the former case would be taxed at a much higher rate than the $5 million inherited by each of 10 people in the latter.

Neither a progressive consumption tax nor an inheritance tax may be politically viable at the moment, but everything in life is relative. Compared with a global wealth tax, they seem eminently doable.

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