Which inequalities matter and which taxes are appropriate?

Should we attempt to influence how much of their income/wealth the rich spend versus invest?
A consumption tax would presumably result is less consumption and more savings/investment. This might or might not be desirable. If the economy was underperforming because of too little investment, we might want to encourage investment/discourage consumption. But if plenty of funds are flowing into investments, then we might wish to encourage consumption, as this would reduce the runaway growth of inequality which Piketty attributes to(r>g).

“If investment is financed by property income, this implies a very considerable reduction in investment.”

Why? The money doesn’t vanish. Rather see it spent on new schools than $100 million super yachts.

Consumption clearly matters more than wealth. A penniless, starving Somali technically has more wealth than an american who graduated med school yesterday with $100,000 in debt, but he his not better off. Or, if you want a less extreme comparison, take two people who both had the same lifetime income. One of them leaves leaves their kid 10,000 in assets the other goes 10,000 dollar vacation with the kid right before his death. Is there any moral reason to tax one more than the other?

“If, instead of being available to the poor, the additional output were somehow reinvested in the productive sector, we would find a world in which the ratio of investment to consumption is steadily rising. This is not the world we live in, and would produce visible results contrary to even casual observation.”

I heard Arrow once respond to Sen, and I was surprised to hear him cite Sombart. Perhaps he would be interested that Tugan-Baronwsky tried to show just this–that, yes, the economy could be driven forward by producing machines to produce machines to produce machines. Rosa Luxemburg found this as absurd as Arrow does here. Hayek explored the same idea. To use Hayek’s metaphor the continuous flow of the river of investment can vary independently of the level of the tide (sales of final goods) at the mouth. The upper reaches of the volume of water is affected by the immediate flow of the tributaries to the maintstream (variations in new and replacement technology). In any given period there is no obvious correspondence between changes in the upper reaches and the sale of final goods; nor between the sale of final goods and employment.

“In the neoclassical picture, consumption is the ultimate end of the economy. The rich accumulate for ultimate consumption, perhaps of generations in the far future, or, in some significant part, for philanthropy. Piketty seems instead to have a picture of the economy as a process of automatic accumulation, without regard to planned consumption. This is not a realistic account of how rich people – or indeed anybody – treats their income. It also leads us to ignore the politics of how this wealth is actually consumed.”

First point to get here would be why Piketty rejects an understanding of consumption in terms of the life-cycle hypothesis.

Second, it is quite possible for rentiers to actually increase annually their flow of consumption income even if they invest a rising percentage of their returns (see Otto Bauer’s updating of Marx’s reproduction schema in 1913). That is, there is no necessary contradiction–within broad limits– between rentiers enjoying rising annual consumption and investing a rising percentage of their income.

Thirdly, I agree with the gist of this comment. I fault both Weber (Protestant Work Ethic) and Marx (Accumulate, accumulate. That is the Moses and the Prophets) for depicting capitalists as ascetic social servants of the accumulation process.

If we consider only economic arguments,

why would we want to do that? If I only consider Tuesdays, it’s been snowing quite a bit lately, but that leaves out the vast majority of the actual information

@8 is a good point, but let me play devil’s advocate against Piketty. Most of my comments have been in defense of him, but let me try the other side.

Given the multidimensionality of inequality it could be that top centile controls more income and wealth and that the capital share of income increases while inequalities in morbidity, longevity, well-being and educational attainment narrow or at least do not worsen. It could be that for the least well-off life is getting absolutely better off by such measures as well. All this could be the beneficent result of continued capital accumulation and growth in total output. These gains may compensate to some extent to the shame that Anne Cudd astutely said wealth poverty may bring.

Of course this is not what is happening.

But it could be that the emergence of rentier society is not easily connected with sharpened social suffering and indignation about income and wealth inequality. It could also be that norms shift such that rentiers as a whole tend to become philanthropists, which would also dampen popular indignation at rentier domination. So what the rentiers are not accumulating, they are gifting to society.

That the rentier structure of society contradicts the meritocratic ideology in terms of which the results of market tests and outcomes are justified may turn out to be a minor nuisance, but surely not a cause of indignation.

mmm…
I’m very disappointing in this rather simplistic criticism. Wealth is as much about power as it is about (postponed) consumption. Power matters.
And this
“If we are to assume, say a 5% return on property, then a 2% per annum tax on wealth would amount to about 40% of property income. If investment is financed by property income, this implies a very considerable reduction in investment. ”
includes a massive ceteris paribus fallacy. The macro-economy firstly doesn’t just invest out of property income, investment is mainly driven by (expected) growth in consumption in the first place and can be debt financed. An interest rates can adjust to maintain the desired supply of finance. Not to mention that the government can (and arguably should) invest part of the revenue from such taxes. This may be different investment, but in the right places may be more important than private investment (it seems almost a consensus these days that governments at the current time invest too little).

Another way to think about this is that (and these arguments for simplicity have been assuming a closed economy – open economies may work differently) you cannot consume unless something has been produced. And in order to produce, you need to invest first. So the investment precedes the consumption and is part of the cost of the consumption. There is no real sense in which you can either invest or you can consume. (And see other economic arguments relating to the circular flow of money, that in fact investment generates savings – not the other way around – simply because if you don’t invest then income falls to match savings and investment ex post. So the whole argument – reducing savings => reducing investment is a fallacy.)

Chris,
thanks, I just want to add one more thing if I may, then I will be silent. I am distressed by an increasing tendency to not clearly distinguish between ordinary Keynesian effects and incentive effects. It seems even top economists in their public pronouncements keep mixing the two things up all the time, rather than making sure they identify them both distinctly. Here we have Arrow saying that if money is taken from the pot that is used for investment then investment will fall. But that money doesn’t just disappear – it depends what happens to that money. You should NEVER use ceteris paribus arguments in macro-economics. Macro-economics is what happens when you drop the ceteris paribus.

Some people seem to have missed the point on this:

” If we are to assume, say a 5% return on property, then a 2% per annum tax on wealth would amount to about 40% of property income. ”

He is not saying it is a problem to have a 40% tax because it is mean to rich people. Read one line further:

“If investment is financed by property income, this implies a very considerable reduction in investment. ”

What this implies is that the rich will consume their wealth rather than invest it. This will cause a fall in the complement to labour, capital, and lower real wages. A progressive consumption tax however incentivises the rich to invest more and drive up real wages. Both taxes can be calibrated to generate similar revenues so they allow for the same amount of redistribution or government investment.

Final point, on the political side of things lobbying will be measured for tax purposes as individual consumption or charitable donations (or business expenditure). Pushing rich people to accumulate wealth less will push them to consume more, which in this case will lead to more expenditure on lobbying.

“They accumulate wealth by investing in industry, thereby increasing output in the future.”

I know that’s what the models say is supposed to happen, but frankly it seems just as likely that wealth is accumulated by blowing up massive asset bubbles that then crash the global economy when they burst.

Business investment will only happen if businesses are facing greater demand than they can provide – taxing consumption will tamp down further on the consumption side of the economy, making investment less profitable and directing more savings into speculation rather than investment.

Inequality of wealth promotes instability precisely because rich people don’t actually consume all that much relative to what they invest, which throws the savings/consumption balance in the economy seriously off-kilter, with negative consequences for all.

Confiscating some of that excess savings and turning it over to people who will actually use it to consume goods and services that people need is a much better idea than a tax that will only encourage more savings in a saving-rich, growth-poor ecosystem.

Also there is too much material consumption globally – so it is not just a matter of making consumption less unequal, but about decreasing overall consumption as well as attending to issues of equity.

wearestrangemonkeys @18
No I didn’t miss his point, it is just that it doesn’t make sense, and you missed my point. The point is he makes a ceteris paribus extrapolation that can’t possibly happen that way (if only the tax was raised and nothing else changed the economy would not stagnate, it would collapse). This is also a problem with Picketty by the way. Somewhere along the line somebody would have to increase consumption or the investments would all make a loss. And that breaks the driving assumptions about a constant rate of return and 100% savings from investment income. One solution would be to have the taxes used for investments by public bodies (for instance perhaps on the Norwegian model), another would be for interest rates to change so that savings behaviour from wages or investment income changes. Another of course is that any extra production is exported, but that just pushes the problem of “where will the final demand come from” somewhere else.

Arrow writes, “Why, after all, do we consider inequality in wealth, income, or consumption to be undesirable? If we consider only economic arguments, it is because the poor are being deprived of goods that are valuable to their lives, exactly because they are more basic than the desires of the rich… If we are truly concerned with inequality, we should be most concerned with the distribution of consumption.”

Steve Horowitz made precisely the same argument as Arrow in our recent discussion of inequality, and it is well taken. The problem is thinking that, as Horwiz stated and Arrow comes dangerously close to implying, that consumption is “what we really care about.” Here are some other things people care about, which inequalities of income and wealth impact:

1. Freedom
2. Power and domination
3. Democracy
4. Opportunity
5. Responsibility
6. Job Security
7. Time with friends and family
8. Quality of work life
9. Respect

I could go on and on. Are we wrong to care about these things? Is the discipline of economics really so limited? Long story short, inequality of wealth and income matter, even if consumption inequalities are not growing as fast as income and wealth inequalities.

reason @25

Several people made similar points to yours earlier so I didn’t target it at your point in particular. My apologies but it is not at all clear to me what you are saying.

It sounds like you are claiming that Arrow is ignoring the issue of the knock on effects of tax. This would be surprising given his Nobel Prize was for developing the main economic framework for looking at the interaction between multiple markets, i.e., allowing all things to not be equal. Its possible but I don’t see any evidence of that. I expect that what is really happening is not that Arrow is ignoring GE effects but that you have an unorthodox or heterodox model or pseudo-model in mind that would create different knock on effects to those that result from applying the standard framework. As it is not at all clear to me what you are saying I can’t agree or disagree with you.

Well of course I made a mistake. If the tax applies to only the top centile but they have 35% of the wealth and make a higher return than other wealth holders (say 8% instead of 5%), then they have much more than 35% of the capital income–say a bit over 50%. But I think my other point is still correct.
Out of that capital income they will be paying a 2% tax on their wealth. This will still leave them much more of their capital income than the 60% indicated in the OP. It should leave them 75% of their capital income. They get an 8% return on their capital but only pay a 2% annual tax on their wealth.

I stand back and look at the numbers I just posted. Unbelievable. Could the top 1% in wealth really be receiving at least half of the total capital income? I think Piketty said that the top 10% have 70% of the wealth, and the top 1% half of that. I think he estimates that the top 1% may have returns in the range of 8% if the average is 5%. So that gives the top 1% more than half of the total capital income, no? Could this be right? Wow!
I must go back to the book and look at the numbers again. But if this is true, does a 2% tax on the top centile’s wealth holdings seem onerous?

reason @34

But I don’t see why you think he ignored knock on effects or policy decisions – most mainstream models are going to give the results that he claims. There is one minor thing he ignores, that I will note below, but it is really minor and irrelevant to the overall argument. As I said, I think you have a different model in mind – its not that Arrow has ignored knock on effects. If I am correct then you need to argue that he is using the wrong economic model for the circumstances.

Looking at your particular comment and considering this in the medium run (to disentangle this from cyclical fiscal and monetary policy effects)

“ The macro-economy firstly doesn’t just invest out of property income,”

Note when he uses property income he is talking about all capital holdings. So holding stocks you knock 2% off the return. If you hold bonds you knock 2% off the return there too. If you hold cash then presumably you knock 2% off the returns there. This is a general disincentive to accumulate wealth full stop and will push the rich towards consuming more. He does ignore the GE (or even PE) effects here to some extent, the price of bonds would have to go up to reflect the lower demand for investment. But given he is using ball park figures here there would be little point in getting into this feature. They would not, keeping it ceteris paribus for a moment, unravel the main result of reducing the incentive to hold wealth i.e. to invest in capital assets.

“investment is mainly driven by (expected) growth in consumption in the first place”

I don’t think this is true. Switch mainly for partially and we might be closer to the truth. I would probably say “jointly determined by beliefs about future consumption and supply capacity”. But we would be pulling ourselves up by the bootstraps if we wanted to say that higher consumption caused by lower proportional investment would increase investment in expectation of the higher consumption. I suspect you are not saying that – but it does sound a little like that.

“and can be debt financed.”

Someone has to hold the other side of the debt. That is they have to hold the bonds which are getting taxed by the wealth tax. This will induce a reduction in lending, an increase in interest rates and a reduction in investment. A further reduction in investment will occur as a result of the expected wealth tax in the event of the venture becoming successful and making the borrower rich. This second effect may be small, it may not, the evidence on the effect of expected future taxes is mixed.

“An interest rates can adjust to maintain the desired supply of finance.”

That is not at all clear. If all wealth is being taxed then you might be able to shift people away from government bonds towards other forms of wealth holdings but they are still going to want to consume more of their wealth than they did previously. Note further that even in cyclical situations the central banks have had limited success at inducing investment through lowering interest rates. Trying to induce a long run increase investment through perpetually low interest rates is going to be much much less effective.

“Not to mention that the government can (and arguably should) invest part of the revenue from such taxes. This may be different investment, but in the right places may be more important than private investment (it seems almost a consensus these days that governments at the current time invest too little).”

The government can raise revenues for the purpose of investment in many ways – for example with the progressive consumption tax suggested by Arrow. Unlike the wealth tax a consumption tax increases private investment and can similarly be used to fund public investment.

I think that your better argument is that we should perhaps not be focusing only on the economic dimension but on the political dimension. I think the economist can be excused to some extent for focusing on the area where he has expertise. There will be plenty of others making the political point.

“This is a general disincentive to accumulate wealth full stop and will push the rich towards consuming more.”
There is no more than the top 1 or at least .01% can consume. This is what the example of Liliane Bettencourt is getting at. She can’t possibly consume more than 5% of her capital income. You know, Fitzgerald and all that.

To add to the other critiques here, inequality of consumption is much more difficult to measure than other forms of inequality. It is no doubt important, but income is a fairly good proxy.

In order to measure consumption directly, you would need a complete set of consumption activities by individuals. It’s more practical perhaps to use change in total assets (minus income) as a measure of consumption, but that data will be subject to all sorts of errors.
Then you have the problem of things like cars and houses. A car renter might appear to consume (pay) more than someone who owns their car. The idea of creating a progressive consumption tax seems equally infeasible because of the difficulty of measuring consumption.

I do not know that measuring consumption is any more ambiguous than first-order indications of welfare. The real difficulties come when you acknowledge the connection to production. The distribution of consumption claims in an economy organised instrumentally to produce goods for consumption motivates production. Could a different distribution of consumption produce more, enabling more consumption? Economists are infamous for trapping such thoughts in such cul de sacs of the mind as Pareto optimally, but inequality raises anew the question of whether wealth liberates or oppresses. The neoclassical model posits a self-limiting diminishing return on investment in an accumulating stock. Piketty suggests saving may blow past that limit even as concentration of wealth at the top sharpens the pointy end of the stick. Wealth at the margin becomes pathological. He raises this prospect in detached, abstract fashion, but he raises it.

Peter Dorman writes:
“What is the model of investment that underlies this? I get the impression it’s that wealth owners receive an exogenously determined pretax flow of investment income, some of that income is withdrawn by a Piketty-inspired tax, and then a portion of what remains is dedicated to productive investment using a hurdle rate of return sensitive to the property income tax rate. Thus such a tax reduces the volume of investment through both income and substitution effects.”

But this reproduces Arrow’s error–you don’t leave any room for the luxury consumption of the rentier. This is likely what takes a hit from a wealth tax because the rentier is motivated keep the rate of growth of his capital as high above the growth rate of income, as possible. This is how he raises his social status relative to society, and that is what is motivating the rentier over and above conspicuous consumption that has already reached its limits.

The best way to hit the consumption of the rentier is the wealth tax, given the difficulties and imprecision of a consumption tax; Arrow has it backwards here.

The wealth tax will relieve the rentiers of the strain they are under to find more and more difficult ways to consume their income in ways that may actually have negative marginal utility.

peter dorman @43

“I will pass by his suggestion that we refocus our attention on consumption”

I don’t think you should as he is comparing the two:

“We might be especially moved to consider a consumption tax if we consider that Piketty’s proposed wealth tax seems in any case to be much higher than it sounds.”

My interpretation, and the stronger interpretation, is that this is an exercise in comparing a consumption tax that raises the same revenue as the wealth tax. I expect, given Arrow is no slouch, this is the one he meant. As the revenue is the same in both cases I think we can ignore the parts of point (1) and (2) that refer to the efficacy of fiscal policy and public investment.

“What is the model of investment that underlies this? I get the impression it’s that wealth owners receive an exogenously determined pretax flow of investment income”

I doubt it. Arrow is using rough numbers and doesn’t put a quantity on the reduction in the supply of investment funds. Given this, it doesn’t make a lot of sense going into the GE or PE effects of a reduction in the supply of investment. Unless you have a story where the GE effects are going to totally undo the reduction in supply.

Regarding the part of point (1) not about fiscal policy, this only works if capital is able to capture more as a result of the tax than it was previously. If this is the case then that would have to be at the expense of labour. However, this seems unlikely – the taxes reduce supply of capital and increase the bargaining power but cannot completely offset it otherwise the supply will not have gone down. Unless there is some strange mechanism by which there is an increase in the bargaining power of capital not related to a change in supply this argument doesn’t seem to hold.

Regarding the part of point (2) that is not about the value of public spending,

“that doesn’t mean that amassing savings causes greater investment”

I don’t think this holds either. The amassed “savings” is going to largely be ownership of, and claims on the returns of, investment. There are many savings vehicles, the most common one for the rich is not cash but bonds and equity. These bonds and equity represent prior investment. The amassing of savings is the accumulation of claims on investment – so reducing saving rates is going to reduce the level of total savings by reducing the total amount of investment and hence capital.

I cannot speak to point (3). Some references would be good. I would have thought that there is a large literature showing that investment responds to corporate and capital taxes as theory would suggest. Of course none of this can speak to a world where the tax is implemented globally and capital has nowhere to “run”. In the absence of empirical evidence we can only rely on what theory suggests – that wealth tax will harm investment whereas progressive consumption taxes will spur it.

Better to tax the wealth directly; almost all of the “centile” rentiers’ income is saved and would thus not be taxable. Seems to be a huge threat of revenue loss if only consumption is taxed. What would appear to be charitable donations such as contributions to politicians’ foundations and the buying of economics departments may not be taxable as consumption. Arrow does not clarify whether his consumption taxes would preserve exemptions for charitable donations. wearestrangemonkey also does not clarify.
I also think the risks of the wealth tax reducing investment are being exaggerated, but this creates a problem for Piketty if the main goal of the wealth tax is to reduce the difference between the rate at which wealth is growing and the rate at which income is growing.

Rakesh Bhandari @48

A wealth tax necessarily exempts charitable donations, such as lobbying, because charitable donations reduce wealth one for one. Whereas exempting charitable donations from a consumption tax is a choice. Perhaps we want to make no exemptions, perhaps we want to try and select what charities are exempted.

“Whereas exempting charitable donations from a consumption tax is a choice. Perhaps we want to make no exemptions, perhaps we want to try and select what charities are exempted.”

I was trying to imagine the politics that lead to the adoption of a highly progressive consumption tax. Add in that charitable donations would not be exempted, and it’s frankly impossible for me to imagine. Adding more income tax brackets with much more steeply progressive marginal rates seems a walk in the park by comparison.

That could just be my failure of imagination, of course, but I doubt it.

weareastrangemonkey

Could you give a precis of the virtues of a progressive consumption tax? because I am not seeing it on my own. First, since the super wealthy consume less as a percent of income, doesn’t that fact alone blunt the potential progressivity?

One reason to tax wealth is to force an audit that identifies and enumerates wealth. Corporate and personal income taxes serve a similar purpose as do VATs to an extent. What does a consumption tax do?

What are the behavioral effects supposed to be? You mentioned lobbying as charity above and I was confused.

This post seems to ignore the rest of the seminar. There have been many excellent gains given why inequality is not all that matters at a normative level – power, status and health, for starters – and it doesn’t appear to give any reason for thinking otherwise.

@54, Bruce, so maybe the real reason Piketty wants a wealth tax rather than more progressive and estate taxes is the light that would be thrown on society by the information that would have to be collected? It’s not as if he is hiding this motivation. OK will have to re-read the chapter on the wealth tax.

Bruce wilder @54

Virtues of consumption tax,

See links @51
See http://morgana.unimore.it/bilancini_ennio/frank-progressivetaxation.pdf
See http://web.stanford.edu/group/scspi/_media/pdf/pathways/summer_2010/Frank.pdf

Basically, a lot of consumption is about relative position. A consumption tax ends up being a tax on this ‘rat race’. It distorts labour and investment decisions less than an income or wealth tax would. People also seem to tend towards shortsightedness when saving and a consumption tax also cuts against this. The lower propensity to consume of the rich, that you mention, in no way inhibits the potential for progressivity because when you are taxing consumption you can tax at rates exceeding 100% if you want. Suppose someone earning 10 million consumes only 20% of their income, if you want you can tax them at 300% and claim a total of 80% of their income (falsely assuming they don’t reduce consumption, but you get the point).

Auditing, whatever we do we can always run such an audit as you describe. None the less a consumption tax would require auditing people’s savings/investment/wealth to establish what proportion of their income they are consuming.

Behavioural effects, see links mentioned and other discussion of the effects of taxes on decisions.

The charity point, merely that a wealth tax would shift people away from investing (accumulating wealth) and towards consumption. From the perspective of a wealth tax any money I spend on lobbying will not be hit by the wealth tax i.e. it will effectively be consumption.

Lobbying and charity point, was in response to other people, I think. But anyway, plenty of lobbying is classified as charity and this makes it exempt from many kinds of taxes such as income taxes. It is incidental.

It is possible that Piketty really wants the wealth tax for the beneficial results that the information gathered would have for democratic decision-making. Here it would be great to have a history of how changes in the way the state gathers and presents information has affected democratic deliberation both in and outside formal political channels. There was a great comment elsewhere on how Piketty’s interest in knowledge can be traced back to the Enlightenment tradition of Condorcet. Piketty may be content with the tax being nominal while the penalties for non-reporting and false reporting be steep and unforgiving!

But of course there is more to it, and it is there on pp. 524 f for anyone who cares to read that far in the book.
Personal income or consumption taxes result in the wealthy perhaps paying taxes on only 1 or perhaps at most 10 percent of their actual income. There is thus no way to make them progressive enough that the wealthy would be contributing out of their income at the same rate most people are. Without the wealth tax, the tax system cannot but be regressive, perhaps even steeply regressive; and it will not put burdens on the wealthy alone to contribute what their ability to pay allows.

Note that Arrow and Bill Gates who has already made the same argument for consumption taxes don’t really engage Piketty’s reasoning here.

Lastly I do not think the arguments for negative effects on investment are strong at all–we could have stronger social investment for which there are higher marginal gains than private investment; we could have the same volume of investment financed by workers’ savings given the tax relief that they enjoy due to the wealth tax; the wealthy probably would reduce their own consumption more than their investment.

Which is to say: an “undistorting” tax framework will lead to no negative changes, but also no positive changes.

[there’s also some major conceptual issues, since the very existence of “property” is a government-mandated distortion. There’s no a-priori proper “undistorted” state, no absolute frame of reference: you can’t just dismiss something as “distorting”, because everything distorts in incomparable ways. You have to pick not the least distorting but the one that generates the distortions you want, which means you have to look at what the distortions actually are.]

@63 Collin Street: “specifically, we want to encourage the rich to invest less and consume more.”

I think this is Marshall Steinbaum’s reason for criticizing the consumption tax (it seems that Steinbaum, DeLong and Boushey have a forthcoming book from Harvard on Piketty).

But of course this argument assumes that

1. that a wealth tax would work as the neoclassical economists are telling us–it would raise rentier consumption since any addition to wealth would be taxed more progressively. I see no reason to believe this.

2. It’s based on underconsumptionist theory–that the prospects of final consumption have to be brightened first one way or another for capital investment and therewith employment to rise. Here the deal with the devil is to spur capital on to an orgiastic feast of consumption as a way to power the economy to full recovery. This is not the place to get into this theory, so all I shall say is that there are some grounds for skepticism.

.

“Wealth is as much about power as it is about (postponed) consumption. Power matters.”

I may just be insufficiently imaginative, but aren’t enough of the power aspects of wealth found in the spending of it to make that a distinction without a difference? I suppose every now in then power is found in the withholding of spending, but you can’t do that for very long and maintain the power.

“Many commenters are concerned about the way the wealthiest wield their power in the political realm, but surely political contributions could be considered consumption and, above a certain threshold, progressively taxed. Perhaps this could be a more workable response to the Citizens United decision than a constitutional amendment.”

This seems unlikely in the extreme. Political contributions are considered protected speech. If they were treated as consumption in a consumption tax regime, you’d be taxing free speech, thus constraining it. Good luck selling that sort of thing to a Roberts court.

Disappointing.

Warren Buffett apparently lives quite modestly. Are we meant to believe that he is no better off than someone with much less wealth but who consumes the same amount as him?

The tax system already privileges some expenditures over others. Charitable contributions are deductible while political contributions are not (at least in theory). Were consumption to be taxed more broadly, it’s not at all obvious that political expenditures should be treated differently than professional services like landscaping, housecleaning, remodeling, cosmetic surgery, accounting and legal work.

OK I am just trying to understand this proposal to replace proposals for progressive wealth taxes and income taxes with a highly progressive consumption tax.

I must be missing something because it seems to me that a consumption tax regime would create tax revolt sentiments not seen here since the American Revolution.

OK say the rentier has $1Billion in holdings and a 8% return.

That gives us $80 million in capital income

Say $50 million goes to real investment (I do this to give 3 as the difference between r and g, which we can estimate at best as 2%; Piketty gets his explosive wealth concentration from r-g moving from 2 to 3)

Another $10 million goes to tax-deductible philanthropy

and $10 million of actual luxury and political consumption is disguised as investment

so with a progressive consumption tax of 80% of every dollar spent on consumption this gives us for consumption (C)

1.8C =10 million which is what is left after the $70 million is taken from the $80 million in capital income
so
$5.5 million for C or annual consumption
$4.5 million is paid in consumption tax

So in this case the wealthy would be taxed $4.5 million out of $80 million in capital income–a tax rate on the wealthiest of only 6% which would be a wildly regressive tax system.

Perhaps the consumption tax would lead the rentier to give a few more million to philanthropy or invest a bit more, but that advantage cannot compensate for how wildly regressive such a system would be.

And the consumption tax would as much encourage the wealthy to disguise their consumption as cut it. And if they better disguise it, they won’t be accumulating more or paying taxes on consumption. The consumption tax would fail on its own terms. And again it would be highly regressive and would probably give birth to a great tax revolt.

At least a straight wealth tax of 2% yields $20 million straight off. And then in addition with the right income taxes the wealthy would be paying taxes at a higher rate than those without assets.

If we see investment decline due to a wealth tax, I am saying that the critique of the life-cycle hypothesis gives us reason to believe that it won’t be real investment that is cut first but luxury consumption that had been disguised as investment. That gives us $10 million of the wealth tax right there without touching at all investment.

Now of course Gates’ warning is that the wealth + income tax will force the rentiers to cut their investments and philanthropy. This is probably right but not so dire a situation.

So if they cut their philanthropy they are not cutting their investment as the OP warns. But then we have Gates’ argument that his philanthropic expenditures (or Paul Allen’s in Ebola research) have higher social returns than the US state can get. But this is not the argument that the academic critics of the wealth tax are making. And it has not been considered here yet.

Investment may indeed be cut but not necessarily by much, and there is no reason that the state could not carry out high-return social investments with the revenue from the wealth tax.

Plus, whatever cut there is investment may be the necessary price to pay for the tax system to have at least the semblance of fairness.

@73:
Gun ownership, while a political taboo, is a “fundamental right” I’d be happy to tax the shit out of.

“Were consumption to be taxed more broadly, it’s not at all obvious that political expenditures should be treated differently than professional services like landscaping, housecleaning, remodeling, cosmetic surgery, accounting and legal work.”

This strikes me as a statement of the form “were a fish to become a man, it’s not obvious at all that he couldn’t ride a bicycle.”

reason @83, please clarify: Are you trying to encourage investment by increasing the marginal propensity to consume through rejection of consumption taxes; or are you trying to discourage investment by not penalizing consumption?

Some misconceptions here about consumption taxes.

By one definition, cash income minus net savings (net purchases of assets), consumption is pretty easy to measure. Of course, when intangibles are involved it becomes difficult, but the main point I think is that taxing cash income minus net savings is relatively easy to administer. It’s a cash-flow measure. Measuring ‘economic’ income including some things like imputed rent for owner-occupied housing is another matter.

It’s not obvious a system based on consumption would have less revenue. It might have more since it could include a VAT component, and it could be founded on an agreement from elites to accept a bigger revenue system in return for a less progressive one.

In the direct component of a consumption tax, one can include or exclude any expenditure you like, including political donations or charity. It’s simple as long as it’s cash. If it’s not cash, such as a donated work of art, then the valuation problems are back.

It’s hard to imagine a progressive consumption tax improving inequality, in and of itself. The numbers just can’t work, as others have pointed out. A bigger revenue system with progressive spending could advance equality.

Wealth taxation is inherently more difficult because it would entail annual valuation of assets that were not traded. Some assets could be subject to simple rules, e.g., common stock valued at its Dec 31 value, or whatever. Real estate, closely-held businesses, options, etc would be a different story.

Taxing transfers of wealth — estates and gifts — is a bit easier since it only entails valuation once, when transferred. Keeping this in the tax base of a consumption tax is easy and would clearly improve progressivity.

To me the only plausible version of a wealth tax is one with a very low (<1%) rate that supplements other revenue sources. It would cost a lot to administer and be useful more for the information it provided than for the revenue net of administrative costs.

weareastrangemonkey @87

Sorry I said something that will almost certainly be misconstrued:

“The only thing within mainstream economics close to your description of expected consumption being necessary to generate investment is short-run macro analysis. ”

I am not saying people do not think about what people will want in the future when making their investment decisions. I am saying that in standard models that the increased supply resulting from higher investment will create its own demand in the medium to long term.

Also, weareastrangemonkey, I think you’ve been a bit rude to essentially tell reason to go away and read an economics book. You might be an economist but that doesn’t give you a right to look down your nose at him/her, especially as their viewpoint seems fairly defensible.

@65 is correct about asset valuations not being representative of reality, e.g. that Facebook has a market capitalization greater than General Electric at the moment. I would attribute that to current investor attitudes (e.g. expectation of high returns through deux ex machina/techno-utopianism) as well as regulator capture (widespread acceptance, even by the SEC, of non-GAAP in earnings reports).

I don’t blame the Protestant work ethic, as someone else mentioned earlier. Part of that ethic was mediating ostentatious and selfish behavior, and fostering willingness to help one’s community, e.g. by buying locally, hiring locally, investing in property, plants & equipment rather than stock buybacks. Arrow’s wealth tax proposal is well-intended; it attempts to use public policy/government, to mitigate disproportionate concentration of wealth among a tiny elite. It reminds me of the ineffectiveness of the past 8 years of unorthodox monetary policy, e.g. recent zero or negative interest rate policies. Unintended consequence are rife. Also, I suspect that a wealth tax on individuals would be evaded by those who would be impacted the most by it. I don’t have a better idea than Arrow’s.

Wealth inequality IS bad. It results in concentrations of power that undermine pluralist democracy. This effect played out during the 2008 financial crisis (investment bank and AIG bailouts by taxpayers), and is doing so again, right now, in the US territory of Puerto Rico. Some of the wealthiest individuals in the country, whose wealth is derived from financial markets not industry (hedge funds) have enough power to demand that Puerto Rico reduce educational and healthcare spending, see yesterday’s New York Times Power of plutocracy: Biggest hedge funds want Puerto Rico to cut basic services in order to reap 20% returns:

A handful of wealthy investors are trying to rewrite the social contract of an entire United States territory. Puerto Rican officials say they have already cut public services and slashed central government spending by a fifth to keep ahead of payments to the hedge funds and financiers. David Shaw, John Paulson and David Tepper are wealthy investors with a stake in Puerto Rico’s fortunes… These hedge funds are among the largest in the world, with a combined tens of billions of dollars under management. Some of their founders and principals are also donating large sums in the presidential campaign. David E. Shaw of D.E. Shaw has given more than $800,000 to Mrs. Clinton…

They have no self-restraint, but I don’t know who or what is capable of reining in such excess and greed. These people will not be deterred by public policy initiatives such as a wealth tax.

Whatever became of the concept that the purpose of taxation is to provide revenues for the functions of governments?

Is concern with forms of equalities in a society a proper function of its government?

If so, what is not?

weareastrangemonkey @87
You write as though you believe the neo-classical model to be the truth. A model is a model, with it’s strengths and weaknesses. I think the economy is performing outside the range of usefulness of the neo-classical model. A model is not the same thing as the real world.

Max Sawicky @86
Yes, I pretty much agree with everything you are saying there.

R. Richard Schweizer @94
>Whatever became of the concept that the purpose of taxation is to provide revenues for the functions of governments?

The concept remains valid. While I like the idea of government acting to redistribute wealth, I don’t believe that it works. People must be willing to act altruistically and compassionately toward the less fortunate of their own free will, or at a minimum, be willing to obey tax authorities out of a overall ideological support for the common good. Forcing the issue leads to totalitarianism.

These consumption and wealth tax proposals seem like nudge theory behavioral economics directed at very high net worth individuals, a form of libertarian paternalism. Economic measures to address extreme points in difficult-to-model settings, e.g. due to regulator capture, is futile. It is too little, too late.

@reason 101

– If the bank lends the money for consumption, I’m making an indirect financial investment: the bank created a title and reaps interest on it, of wich part (a very small part) comes to me.
– Certainly I could use the money to pay off debts but I have not an indefinite quantity of debt (luckyly). When it happens in the aggregate, an economic crisis ensues, as the increase of debt that used to fuel consumption ceases.
– If the banks holds an amount of reserves (that are liabilities to the bank) that is not related to the quantity of debt it issues, it has a problem.

I made a difference between “real investiment” (basically building new factories) and “financial investment” (like buying bonds or land or similar assets, plus lending). Aggregate demand certainly spurs “real investment”, but “financial investment” doesn’t need aggregate demand, in fact I think part of financial investment is recycled into demand (like the bank that makes a consumption loan in your example).

My opinion is that total investment (real+financial) is a function of the profit share, but the amount of useful real investment is limited, so excess profits go into financial investment instead than in real ones, and likely are recycled into demand, creating the debt-addicted economy we all know and love.
Hence, I think that we are in a situation of excess profits.
What limits real investment? I’ve no idea, but maybe we are already close to full productive capacity. If this is the case, then the corret policy is to shorten the workweek and rise somehow the wage share.

There is also the question: can real and financial investment have totally unrelated profit rates?

weareastrangemonkey @99
Well in a sense I feel I’ve wasted my time with you as well. My whole point is the basic neo-classical growth model (and here we should be specific that we mean the growth), is basically incompatible with the assumptions of the features of Piketty world. If rich people save and invest their capital income and maintain constant returns on investment, that capital will grow at an increasing rate and capital income will become an increasing part of all income, implying consumption will be a falling part all income. So how will these increasing returns be generated? Surely, the standard model would predict rising wages (labour now being the relatively scarce factor) and falling returns to capital.

Secondly, show me where Kenneth Arrow actually addresses the knock-on effects. He postulates an increase in taxes, but makes no assumptions about what happens to the proceeds. Where does he consider changes in wages, interest rates and exchange rates?