Why even the perfect income tax can’t substitute for a wealth tax

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After they finish hemming and hawing about “constitutional” arguments, opponents of proposals for an American tax on very large fortunes typically make one of two arguments:

• a more-progressive, better-enforced income and estate tax code could achieve the same revenue goals as a wealth tax, or;
• a value-added tax, like those used to fund European social democratic welfare states, would be a better method of raising the same amount of revenue.

I think the arguments for a wealth tax are fairly intuitive to an ordinary American, but since these opposing arguments are made with such consistency, I also think it’s worth breaking down the problems with each.

A tax on current income can’t fix past errors

One of the most interesting problems in the US income tax code is that no one has any idea what the “correct” income tax brackets and rates are. The brackets in use during the Clinton administration produced two years of budget surpluses, before the original temporary Bush tax cuts, the permanent Obama extension of those cuts for all but the highest earners, and the additional temporary Trump/Ryan cuts went into effect.

But perhaps, as Alan Greenspan argued at the time, the Clinton tax code raised too much revenue, and by paying off and thereby depriving the world of secure US debt, our budget surpluses would eventually strangle the global channels of commerce.

So, what is the “right” income tax code? Is it the permanent Obama tax rates and brackets, which we’ll revert back to in the 2026 tax year? Or is it the Clinton tax rates, which produced a fiscal surplus at the end of the 1990’s before Bush’s cuts and wars devoured the federal budget?

What’s even worse, in addition to gutting federal revenue for a decade, the Trump/Ryan income tax cuts made some modest improvements: raising the standard deduction and capping the state and local tax deductions reduced the number of filers who benefit from itemizing deductions, and over time might even put some downward pressure on home prices.

Simply reverting to the Clinton tax code would reverse that modest progress; the next round of income tax reform, in addition to raising rates, should instead build on those positive changes by eliminating itemized deductions entirely.

The $10 trillion question is, what shall we do about the debt we incurred paying for those tax cuts?

Conservatives are right: it’s a mistake to fill the hole with income taxes

People sometimes get upset around here because of my distaste for conservative politicians, but there’s no partisan content to the observation that people respond to incentives. When you tax income, you discourage income-earning, and when you subsidize income, you encourage income-earning. Once we agree on this simple observation, we can have all the partisan fights we like.

My point here is quite simple: the people paying taxes under the perfect income tax system, whether it is higher, lower, or the same as today’s income tax system, will not be the same people who benefitted from the income tax cuts of yesteryear.

During the 2000’s, a high-earner  saw their top federal income tax rate fall from 39.6% to 35% between 2003 and 2012, rise to 43.4% between 2013 and 2017, and fall again to 40.8% in 2018 and 2019. That means between 2003 and 2019, these policies overall increased the deficit by $410,000 per million taxable dollars in the top tax bracket.

But the people in that top tax bracket, in those years, are now 16 years older. The years when the US Treasury was shoving out $27,000 in free money per million dollars in earnings were likely the highest-earning years of their lives. Now, they’re retired or nearing retirement, easing out of the workforce, perhaps taking on some light consulting gigs, and carefully managing their estate plans and taxes.

It’s absurd to say that a high-earner today, whatever the correct calculation is of their fair contribution to their federal, state, and local governments, should also have to pay the share of wealthy individuals who paid too little for the preceding decades!

A VAT is clumsy, ineffective, and un-American

As I mentioned up top, a value-added tax, which is a complicated form of national sales tax, is one answer to this problem: while people may have squirreled away unfathomable fortunes during the low-tax years, we can get them, or their descendants, to pay their share when they eventually spend it. You may have avoided income taxes on the money you use to buy a yacht, but a 10% VAT lets us reclaim the same money on the back end.

But a value-added tax is a clumsy solution, for two reasons. First, since it’s paid by the poor and wealthy alike, either tax rebates or additional, clumsily-targeted low-income tax cuts are required to make sure it’s the wealthy who end up bearing the burden. Second, and even worse, it makes the mistake of assuming that the value of wealth is in the spending, and however popular this belief is elsewhere, it’s never had any purchase among Americans. The extremely wealthy are incapable of spending even a fraction of their fortunes, but that does not make them poor — on the contrary, it makes them rich.

Conclusion: a wealth tax surgically targets the beneficiaries of our past mistakes

The idea of a wealth tax is the simplest, cleanest expression of the sentiment that something went wrong. Again, this has no partisan content. Both Democrats and Republicans, every time tax reform is enacted, rush to assure us that actually, ultimately, eventually, we’ll raise more revenue, we’ll reduce the deficit, we’ll grow the economy more quickly.

The deficits were real but the growth was fake. And now we’re left with the question: who will make up the difference? Should we all pitch in together with a national sales tax? Should we all tighten our belts and agree to cut Social Security benefits? Should we forego infrastructure spending or disaster recovery?

Or should we ask the beneficiaries of five decades of folly to agree that we simply made a mistake, and that it’s time to make it right?

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