In its weekend edition of January 29th the Wall Street Journal published two articles about taxing the rich, a “How to” challenge from cartoonist Scott Adams and a historical survey authored by Joseph Thorndike, director of the Tax History Project of the non-profit Tax Analysts organization. Interestingly, it was the tongue-in-cheek cartoonist who offered the more positive and productive food for thought. Without laying aside his entertaining irreverence Adams started with the indisputable observation that “rich people have enough clout to block higher taxes on themselves”, and challenged the public to use its imagination to seek new and better ideas. In contrast Thorndike, from the very title of his article, “Soaking the Wealthy: An America Tradition” reiterated the intellectual dishonesty that has stymied and stalled current tax reform efforts.
We have never soaked the wealthy. (Yes, at post WWII peaks we certainly had very high marginal tax rates on wages and salaries, but even then we left substantial protections and loopholes available to holders of pre-existing wealth.) Nor should we try to soak the wealthy. Pretending that we do, or that that is a desirable goal, does not advance the debate.
Inclusive of employment taxes, today the working middle class pays higher marginal tax rates than the very wealthiest among us. Our treatment of employment taxes seems deliberately designed to obscure this fact. The progressive tax rates that Thorndike claims we rely upon apply to less than 25% of our overall national/state/local tax burden. I don’t, and we shouldn’t, advocate trying to make the rich pay higher tax rates than the middle class. But the working middle class should not be subsidizing low tax rates for the wealthiest among us. Thus, Adams’ question of “how to tax the rich,” cuts right to the core of the challenge. We think we should, we pretend we do, but we currently don’t effectively tax the rich.
There is a key insight that has been overlooked in our current debate about tax reform alternatives: income (at least taxable investment income) is a poor proxy for wealth. Our investment income tax policies have built in rate preferences and tax avoidance mechanisms. Our tax policies impose lower rates on investment income than upon salary and wages, subsidize loss and low return investments, and obstruct the fluid reallocation of capital to more productive uses. These misplaced preferences are the driving energy behind the asset bubbles which have undermined the stability of our economy. Income deferrals and re-characterizations, and valuation manipulation strategies have become more profitable than pursuing productive job-creating investments. Furthermore, the structure which we use relative to investment income makes it impossible to raise rates without stifling growth. The structure of our current investment tax policies, particularly the corporate income tax, is a drag on economic growth.
If you acknowledge these facts a potential answer begins to emerge: we should tax wealth directly instead of pretending that taxing investment income is a viable proxy. We should repeal the corporate income tax, capital gains and dividend taxes, estate and inheritance taxes, taxes on interest and any other mechanisms aimed at taxing returns on capital, and replace them with a nominal annual tax on accumulated net assets – at a rate consistent with the rate applied to earned income. If you assume a WACC of 6% to 8% (weighted average cost of capital, the blended return on assets) a 2% asset tax equates to 25% to 33% of investment income – roughly equivalent to the range of marginal rates currently applied to wages and salaries.
Simultaneously flatten and reduce earned income rates to a maximum of 25% (inclusive of employer and employee SS/Med contributions) and you will return more equal treatment to the tax code and stimulate both hiring and real wage growth for the working middle class – thus stimulating consumer demand (supported by real wages not asset bubbles).
Some may worry that an 8% return on capital is too high a target. But I would posit that putting a practical floor under interest rates (precluding the Fed from continuing to pursue zero interest rate policies which benefit financial institutions to the detriment of investors) and moderating bubble valuations would make the long-term 8% target reasonable. Or you could make it a 1.75% tax?
Comments, replies and rebuttals are invited and will be welcomed – either privately via email or publicly as comments on this website.
Author – A Citizen’s 2% Solution: How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget. ISBN 978-0-9828328-0-6