Massachusetts senator and Democratic presidential contender Elizabeth Warren has broken with that consensus by proposing a tax of 2% on net worth above $50 million and 3% above $1 billion. It may never be enacted; yet in spirit it marks a historic pivot in the focus of capital taxation, from growth to inequality.

While there is no “right” level of inequality, it stands near historic highs and Democrats are unified in wanting to reduce it. Taxing wealth is an immensely appealing, nearly surgical strike at its most glaring manifestation. Yet it may not be an efficient response.

Income consists of money received each year in the form of wages, benefits, interest, dividends, capital gains and government transfers. Wealth consists of income you’ve saved over your lifetime or inherited, then invested in assets such as cash, bonds, stocks, property and stakes in a business, minus debts.

Wealth has always been more skewed than income and the imbalance has grown since the financial crisis. The median U.S. family’s income, adjusted for inflation, fell 4% between 2007 and 2016, while its wealth plummeted 20%, according to Federal Reserve figures. For the richest 10% of families, median income rose 9% while wealth leapt 27%. More than 80% of American households had less wealth in 2016 than on the eve of the last recession, in great part because their homes, the principal asset for most families, were below their precrisis values whereas stocks, whose ownership is concentrated among the rich, have roughly doubled since 2007.

Two broader economic forces have accentuated the trend: low interest rates, which boost property and stock prices; and unusually high profits. Treasury estimates that 52% of all investment income this year will flow to the richest 1% of families by income. The richest 0.1% of families are expected to earn nearly $1.5 trillion, of which 60% will be from investments.

This poses a number of challenges. For the middle class, stagnant wealth limits their ability to buy a home, pay for college or respond to a financial emergency. Wealth imbalances may also undercut economic growth because assets, which typically rise in response to interest rate cuts, are concentrated among people who are less inclined to spend.

For policy makers who want to tax the rich more, this limits the reach of income and consumption taxes. Shielding capital income leaves a big chunk of the richest families’ incomes untouched by taxes, says Greg Leiserson, director of tax policy at the Washington Center for Equitable Growth, a left-of-center think tank.

While property and some estates are already taxed, a wealth tax would hit every form of wealth. It can also be quite selective: Ms. Warren estimates only 75,000 families would pay her tax, yet it would raise $2.75 trillion over 10 years.

This would create administrative headaches such as how to precisely define wealth to limit avoidance. It also would raise economic issues. It was barely a year ago that Republicans slashed the U.S. corporate tax rate to closer to international levels in hopes of juicing growth. A wealth tax would go in the opposite direction. For example, on an investment in a company averaging 8% annual returns, a shareholder may expect her holdings to grow 8% per year. A 3% wealth tax on that increase represents, on average, an implicit 37.5% income tax, on top of the corporate taxes. And unlike the corporate tax, it would have to be paid even if the company made no money that year.

Mr. Leiserson predicts the effects on investment and growth would be small, and offset by public investments financed with the tax.

Denmark abolished its wealth tax, borne by the wealthiest 2% of families, between 1989 and 1997. In the subsequent eight years, the wealthiest families’ net worth rose 30%, according to a study by Katrine Jakobsen and three co-authors distributed last year by the National Bureau of Economic Research. The authors attribute most of this to increased saving.

Alan Auerbach, an economist at the University of California at Berkeley, thinks this shows a U.S. wealth tax would reduce wealth and saving by enough to hurt investment and economic growth. This might be offset if the U.S. turns to foreign savings to finance an investment. This, however, means foreigners would take a bigger share of U.S. income.

There may be more effective ways to tax wealth. A large chunk of capital gains are never taxed because shareholders bequeath shares to their heirs without selling them. President Barack Obama proposed in one of his budgets taxing unrealized capital gains at death. Adam Looney, a Brookings Institution economist who worked on the proposal, says it would have raised roughly $200 billion over a decade. Mr. Auerbach says taxation at death seems to have less effect on the saving of the wealthy than taxation during life.

An even better response would be to attack the concentration of economic power that results in monopoly-like profits by reducing barriers to competition. Competition policy, unlike tax policy, faces no tradeoff between equality and growth.

Appeared in the March 7, 2019, print edition.
Credits: Wall Street Journal

These face-offs between states are part of a larger national debate that has intensified this year as new Democratic governors in California, Connecticut, Illinois and New Jersey push to raise taxes even higher. They say higher taxes are necessary to pay for better services. But it’s far from clear that the already-high taxes in these Democratic strongholds have created better government and happy residents. People in states with high taxes are more likely to say they are eager to move elsewhere, and polls show residents increasingly questioning whether they are getting value for government “investment.”

Seven of the eight states with the highest percentages of people who want to move elsewhere are solidly Democratic in party affiliation, according to Gallup polling. Most are high-tax environments. “Even after controlling for various demographic characteristics including age, gender, race and ethnicity, and education, there is still a strong relationship between total state tax burden and desire to leave one’s current state of residence,” Gallup concludes.

When Monmouth University’s poll asked New Jersey residents why they wanted to leave, 30% listed taxes. But 24% said the overall high cost of living soured them on the Garden State, and 28% listed quality-of-life issues, including corruption, traffic and lack of economic opportunity.

In most polls, infrastructure—roads, bridges and airports—ranks high among the basics that citizens and businesses expect government to provide. This should be an area in which rich, high-tax states vastly outperform their peers, but the opposite is true. In CNBC’s annual ranking of the best and worst states for business, seven high-tax states were among those ranked lowest in infrastructure quality—Connecticut, Hawaii, Maryland, Massachusetts, New Jersey, New York and Rhode Island.

Even more startling, Texas ranked as having the best infrastructure. Also scoring high were Tennessee, which has the third-lowest tax burden as a share of state personal income, and Florida, ranked fourth-lowest in taxes. There seems an almost inverse relationship between the resources that state governments take in and quality of infrastructure.

J.D. Power polling shows that the U.S. airports ranked lowest among travelers include New York’s LaGuardia and JFK, New Jersey’s Newark Liberty, Philadelphia International, Chicago O’Hare, Los Angeles International, Honolulu Inouye International and Boston Logan. Almost all serve high-tax blue states.

A major driver of these failures is the alliance between left-leaning politicians (mostly, but not exclusively, Democrats) and public unions. As state and local budgets have fattened, public employees have captured a growing share of the rising revenue. Connecticut, the state with the second most heavily unionized public workforce, introduced an income tax in 1991. According to a Yankee Institute report, state revenue has since expanded 71% faster than inflation. The fastest growth has been spending on employee benefits and debt payments—aptly termed “nonfunctional spending.”

Labor-friendly laws make it tough to restrain these costs. Illinois’s pension woes, among America’s worst, keep deepening because of powerful state protections prohibiting government from altering the rate at which public workers earn retirement benefits, even for future work.

Infrastructure building costs have become stratospheric thanks to union-friendly policies. While Europe and Japan typically build rail and subway tunnels for between $160 million and $480 million a mile, according to calculations by Israeli transit writer Alon Levy, New York’s

Second Avenue subway line cost $2.8 billion a mile, and its No. 7 subway-line extension cost $2.1 billion a mile. Unionized tunnel workers, so-called sandhogs, receive $111 an hour in New York, compared with $38 an hour in Detroit and less than $40 an hour in Germany.

Costly regulations also plague the blue-state-model. Metro markets where residents are most dissatisfied with the availability of affordable housing are overwhelmingly high-tax Democratic locations, including Los Angeles, New York and San Francisco, according to demographer Wendell Cox. Blame regulations. “High prices have little to do with conventional models with a free market for land,” wrote Harvard economist Edward Glaeser and Wharton’s Joseph Gyourko in a 2002 paper. “Instead, our evidence suggests that zoning and other land use controls, play the dominant role in making housing expensive.”

Blue-state failures are so grave, they outweigh occasional successes. High-tax Democratic states spend from 50% to nearly 100% above the national average per student in public schools. That’s paid off in quality, according to a study by the financial website 24/7 Wall St., whose list of top public schools by state includes Massachusetts, New Jersey and New York.

But even as these states educate young people, they’re losing them. From 2011 through 2015 the three top states exited by millennials were New York, Illinois and New Jersey, according to a study of census data by the think tank Illinois Policy. Texas attracted the greatest number of young adults.

That’s a problem, Gov. Murphy would no doubt say, that Jersey could fix with a few billion dollars’ more government investment.

Appeared in the February 26, 2019, print edition.
Credits: Wall Street Journal

Emboldened Democrats are pressing for a top rate of 77% on estates and 70% on income over $10 million.

f  or decades, the debate in the U.S. over taxing the rich has been a familiar game of tug of war. Republican presidents Ronald Reagan, George W. Bush and Donald Trump pushed top tax rates down. Democratic presidents Bill Clinton and Barack Obama pushed them back up.

Back and. forth, up and down, the discussion remained within fairly narrow bounds. Republicans made the case for lower ‘taxes and economic growth, Democrats argued for higher taxes and economic fairness, and since 1986, the top individual rate has stayed between 28% and 39.6%.

The tax debate emerging today is a different game altogether, and it may provide the biggest jolt to the American tax system in a generation.  Emboldened by poll numbers showing public sympathy for their views, Democrats are proposing a range of ambitious tax hikes on the rich. Sen. Bernie Sanders (I., Vt.) has floated a top rate of 77% on estates. Sen. Elizabeth Warren (D.; Mass) has suggested a new annual levy on fortunes exceeding $50 million. Rep. Alexandria Ocasio-Cortez (D., N.Y.) is urging the party to support a tax rate of 70% on income over $10 million.

Democrats, even those who favor more measured approaches, suddenly find themselves in new terrain, contemplating not just piecemeal tax increases but a wholesale reversal of the Reagan-era shift in tax policy. Their rallying cry is what they see as the urgent need to push back against the widening economic inequality in the U.S. over recent decades.

If history is any indication, they have their work cut out for them. Since the 19th century, bold tax increases have usually depended on a combination of factors: class-based populist discontent, which is abundant today, and a great national trauma-a war, a major economic slump-to unify the country behind higher taxes on the rich in a spirit of shared sacrifice. The open question for today’s Democrats is whether reducing inequality is a compelling enough cause to move the country and the Congress.

Until. the -Civil War, the federal government funded itself largely through tariffs, which fell heavily on consumers. Congress didn’t adopt an income tax on the rich until it become clear that new revenue would be needed to pay for holding the Union together. “If a man rolling in wealth and bloated with stocks … refuses to pay taxation for the· support of the Government, and to save the nation from the consequences of this rebellion, he ought to go to prison,” declared Sen. John Ten Eyck of New Jersey in July 1861.

The income tax was an emergency measure and lapsed after the war. Congress passed a new in-come tax decades later, partly in response to the, recession set off by the financial panic of 1893.

Appeared in the February 16, 17, 2019, print edition.
Credits: Wall Street Journal