[IMGCAP(1)]When was the last time you saw an auditorium, full of experts, get truly excited about tax theory?
It happened at the last annual meeting of the American Economic Association. The early morning meeting was overflowing, with attendees sitting on the floor and standing in the aisle. There were barbs traded by the panelists and unheard of heckling from the audience.
Some of the principal players in the current world of economics were together with author Thomas Piketty challenging each other over Piketty’s bestselling book Capital in the Twenty-First Century. The book, which topped The New York Times bestselling hardcover nonfiction list in May of 2014, has proved an overnight sensation. Since its recommendations involve changes in tax policy, tax professionals should be mindful of the debate.
The focus of the book is income and wealth inequality. French economist Piketty claims that since historical returns on investment are greater than economic growth, capitalism has a built-in tendency toward expanding inequality. He argues that the only way to reduce the growing inequality is through taxes. He proposes a global wealth tax of 2 percent and a progressive income tax as high as 80 percent.
An interesting side note is that France just eliminated its 75 percent tax on millionaires after one short year of failed results and unintended consequences.
Piketty’s book has received global praise from politically liberal icons like Paul Krugman, but much of the mainstream has been more critical, which gave rise to the debate at the recent AEA meeting in Boston.
Two of the interesting tax questions raised were about definition and efficiency. Piketty suggested that a wealth tax was superior to a consumption tax because consumption was too hard to define. U.S. tax professionals know all about the strain of definition, since much of the complexity in the 3.7-million-word U.S. tax code is about defining income.
In practice, consumption is defined quite easily as used in the current sales tax; however, Piketty’s concern was that the wealthy (he mentioned the Koch brothers) would “consume” by making donations to buy power and influence, even suggesting (joking?) that they could buy off his current academic challengers.
He also wants to tax inherited wealth at a different rate than self-made wealth, which is impractical with a consumption tax. Tax professionals know that wealth has its own glut of definitional problems, such as market valuation for illiquid assets. Idaho has a high percentage of millionaires, but many are potato farmers whose only ability to pay tax is through selling their land. The question about definitions is a concern for all tax bases, including income, sales and wealth. However, the current sales tax arguably provides the least debate over definitions, while property tax and estate tax involve a lot more definition-based court cases.
Economists measure the efficiency of a tax not only in the cost of collection, but also in the dead-weight loss of economic activity. The panelists pointed out to Piketty that a consumption tax was more efficient than a wealth tax and that a tax on capital decreased the welfare of workers. Piketty did not disagree, but suggested that a key goal of his proposal was wealth redistribution instead of efficiency.
Piketty’s proposals are still a little utopian. His proposals would require unlikely coordinated cross-country agreements, even though currently countries are very competitive over taxes, as they try to attract companies and the wealthy through favorable tax options.
On top of the impractical nature of his proposals there is still significant debate about the foundation for Piketty’s theories. Many economists challenge his use of wealth as a proxy for capital. Much of the growing wealth in his charts comes from housing price increases, which is largely price appreciation and should not represent growth.
Greg Mankiw of Harvard shared his view that return on wealth would have to be at least 7 points greater than growth in order to lead to a permanent inequality trend. And Kevin Hassett of the American Enterprise Institute referred to statistics that show the source of growing income inequality is the growing gap in wage income between skilled and unskilled workers rather than a function of capital returns.
While the debate ended with handshakes and admiration for Piketty’s book (primarily the number of copies sold), the points of argument were not agreed and promise that this lively debate will be continued.
Even though currently no tax legislation is in process from this “most important economics book of the year” (according to Paul Krugman), the recent State of the Union Speech contained many proposals that shadow Piketty. How these debates are resolved will steer long term tax policy.
Dr. Richard Parsons is an assistant professor of economics and finance at Texas A&M University—Texarkana.
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