Conversations with E21: Wojciech Kopczuk on Wealth Taxes
Wojciech Kopczuk is a professor at the School of International and Public Affair and the Department of Economics at Columbia university. Kopczuk is a leading scholar on tax policy and income and wealth inequality. His work has been published in top economics journals, including American Economic Review, Quarterly Journal of Economics, Journal of Political Economy and Review of Economic Studies.. He is a co-editor of the Journal of Public Economics and associate editor of the American Economic Journal: Economic Policy. Kopczuk holds a BA in Economics and an MSc in Computer Science from Warsaw University, and an MA and PhD in Economics from the University of Michigan.
Has wealth inequality worsened over time?
Yes, it has worsened somewhat. However, there’s a range of estimates in the literature as to how much. The most aggressive ones are biased upward. The state-of-the-art estimate comes from Owen Zidar, Eric Zwick, and Matt Smith—this estimate is what I would point to as the neighborhood of where the truth might be. But the problem with measuring wealth inequality is that observing wealth is hard. Calculating it depends on lots of assumption and imputations, and for this reason any estimate should include clear error bounds or confidence intervals.
But my best guess is that inequality has increased.
Who are the wealthiest Americans? Why do they look different than Europeans?
We know who they are—they are entrepreneurs, primarily first-generation entrepreneurs: Bezos, Gates, Buffett, and the Google guys. You find some exceptions, but mostly they became wealthiest Americans by building their own companies.
Is it very different in Europe? I don’t pay as much attention to the structure of the wealthiest list there as I do in the US. I am not making categorical statements, but since there is quite a bit of dynastic wealth in Europe, it is hard to know anything about the wealthiest Europeans because the data is hard to observe. There is quite a bit of dynastically owned wealth in, say, Sweden, and there are very important and old family-owned firms in Germany. The characteristics of the very, very wealthiest Europeans may not be terribly different from the wealthiest Americans, but if you look a little bit below that level, older wealth may matter more than it does in the US.
Is that because they don't have the same estate taxes?
They don’t have the same estate taxes but they do have more progressive income taxation. Depending on the country, there are ways of preserving the wealth of privately owned businesses. Sweden has been most famous for that.
This is maybe more controversial and speculative: my belief is that tax haven issues are a bigger factor in Europe than in the United States. I should clarify that I am not talking about corporate wealth. With respect to corporate wealth, the US is no better than Europe when it comes to [legal] tax havens. But when you think about private wealth, we have not been seeing lots of American money showing up in the Panama papers. Some of it showed up in Switzerland, but not much.
We don’t know for sure, but we don’t have smoking gun evidence that lots of private US wealth sits unreported abroad. But we do have evidence that offshore wealth has been significant in Europe. Does this conclusion come from a lack of data or the truth? My prior is that there is a grain of truth to the notion that wealthy Europeans have more money stashed abroad. Of course, lots of corporate profits sit in tax havens, but that’s not hidden, and it’s legal. If we’re talking about U.S. private wealth hiding offshore, that would often be fraud, not avoidance.
Hiding private wealth offshore is not always tax fraud in Europe, and they have access to various ways to move money abroad. It’s also easier if you are a European to leave your home country—leaving Sweden and going to Monaco is a decision, but not as big a decision as leaving the US.
There are two arguments we often hear supporting the need for wealth taxes.
1. Wealth inequality is such a big problem that we need to use the tax code to lessen it.
2. We need to raise revenue — whether for new entitlement spending like Medicare-for-all or to pay down our now massive debt — and wealth taxes are the best way to do it.
Are there any economic justifications for reducing wealth inequality?
The standard argument is redistributive. Our society may prefer less inequality because of a view that the value of money in the hands of people with lower incomes is higher than in the hands of people with higher income. Society may prefer to redistribute wealth, but that’s a matter of preferences. We might prefer one wealth distribution to another.
There is some research pointing to harmful economic consequences following from too much inequality. They are along the lines of inequality associated with maybe political power, maybe market power. To the extent that you believe that’s true that may take you into considering some types of instruments that target inequality. If you believe in those things, there might be some efficiency gains to be had from lower levels of inequality.
What about the argument that we can increase growth because lower-wealth people spend more?
This type of argument is not always relevant. When you think of a recession and a Keynesian style stimulus, where you think we’d want to boost aggregate demand, then you may want to explore policies that redistribute to people with higher marginal propensities to consume.
Keynesian-style stimulus is appropriate during recessions, but not even in every recession and not at all other times. It’s not the objective to stimulate consumption during boom times. And even if the goal is redistribution, wealth taxes are not the best way to do it. Wealth taxes go after savers and, most of the time, that is undesirable.
The problem I have with the wealth taxes is that it they are not a very efficient way to tax.
Why is that? Why do you not like wealth taxes?
There are three reasons:
One, a wealth tax creates disincentives to save and invest. It has effects on entrepreneurs that force them to reduce their ownership stake and shift it to the government or outside investors. You might think Bezos is important for how Amazon performs. If you diluted his ownership of Amazon in the 1990s, would it be a different company than it is now? These are the types of things I worry about.
Second, there are better instruments that are less distortionary. You can tax capital income or wealth. The distinction between these two is subtle, but immediately comes up when you think about the issues more carefully. The distinction is that a wealth tax is a tax on principal—effectively a tax on the safe rate of return. A capital income tax is much more tilted toward being a tax on extraordinary returns. Now, what’s desirable depends on what you think drives extraordinary returns. If you think they come from taking more risk, maybe you do want to tax that or maybe not— there is good and bad risk-taking. But the other part of extraordinary returns comes from rents; examples are monopoly rents or inside information. It's not clear you want to excuse those things. In fact, the standard argument for taxing capital income is suspicion that high returns reflect rents. A wealth tax excuses rent-seeking because it taxes it very lightly on the margin (say, at 2 percent, or whatever the right rate might be), while a capital income tax discourages it.
The third and strongest argument against a wealth tax is the implementation issue. The wealth tax has in the past been very, very difficult to implement. The reasons, in a nutshell, are that observing wealth is very difficult and that there are many ways to avoid it .
This not just an administrative problem or a problem that results because the government is doing a bad job. It is an objectively hard problem: to measure wealth you have to observe it, and to observe it you need to gather information about assets and evaluate what they are worth. That is fairly straightforward for savings and checking accounts. But other types of asset—especially business assets—are very difficult to value. One relevant anecdote is that the Forbes list reported that Bloomberg’s wealth doubled from 2007 to 2008. This happened because he decided to buy back some of his company from Merrill Lynch. This transaction gave an observable price of his business, and it was significantly higher than Forbes’s previous valuation. Absent a market price, even in the case of a very visible company, Forbes made a mistake of 50 percent.
Now we are talking about the government dealing with tax payers who have every incentive not to disclose this information. And dealing with companies that are not regularly valued. Coming up with an evaluation is not an easy or cheap process. When 10 years ago IRS researchers compared estate tax returns with what Forbes does, there were big discrepancies there, by a factor of two.
Consider all we know from evaluating estate taxation, a once in a lifetime—or after a lifetime—tax. It’s imposed under very, very specific circumstances when assets are changing hands anyway, yet it is still difficult, contentious, time-consuming and costly. Wealth taxes ask for something like that process to happen annually. It’s very hard for me to see how that could happen
Alternatively, you could base wealth estimates on some proxy like revenue or profits. But those things are only indirectly related to the value of a company. You aren’t taxing wealth, but only some multiple of turnover or profits. You are imposing another layer of tax on top of corporate taxes.
Do you expect wealth taxes to alter risk-taking and how high net worth people invest? Can we expect more investment in risky or less risky assets? And would that impact asset prices?
I would expect people to shift to different types of investments and, naturally, to see lower after-tax rates of return. This would mean lower asset prices.
There is a grain of legitimate disagreement here on the way these things cut. But a wealth tax goes after savers, and I don’t think that is desirable.
Would a one-time wealth tax be different? Could this be a good way to pay down debt or finance a recovery program?
The big problem [with wealth taxes] is they are not a very efficient way to redistribute wealth on a permanent basis. They impose strong disincentives to save and invest. It is different if it is truly a one-time tax and it has been used before, as in times of dire need like war. To the extent that this particular moment in time is like that, and to the extent policymakers could commit, which is a very, very, very big if, to an ad hoc one-time way of taxing wealth, it’s possible that this policy instrument could be on the table.
But this needn’t be an explicit wealth tax. Suppose we could inflate, it seems implausible at the moment, but suppose we could inflate away debt. That’s effectively a tax on wealth in the form of short-term, unexpected inflation. That would not necessarily be extremely inefficient because it goes after wealth that has already been accumulated. And if it’s short-term and we agree it won’t happen again, it is not necessarily a bad form of taxation.
But there are big issues with implementing that policy on a permanent basis. It is a conceivable policy for short-term budgetary needs, it could be on the table, but as a permanent policy over the long haul I have not changed my mind. It’s a pretty bad policy.
What do you make of proposals to tax unrealized capital gains?
I am not completely unsympathetic to these ideas. We don’t treat all types of capital income the same way; for example, we treat capital gains differently from interest income. There’s a distortion there that pushes us in the direction of holding onto existing investments so that the investor can benefit from deferral. And, no doubt, the way we tax capital gains now is deficient and somewhat broken.
The easiest thing to do if you want to tax capital gains better, is not to tax it mark-to-market (taxing unrealized gains), but rather to eliminate distortions that encourage deferral of taxation.
The most obvious way to do this is to get rid of Step-up in Basis at death. If you hold on to your appreciated asset until you die the capital gains tax is effectively forgiven at that time. This presents a very strong deferral problem, especially when you can borrow against appreciated assets. There is no good economic justification for Step-up in Basis. Eliminating this would make capital gains taxation work better.
There are others things that are asset specific, especially for commercial real estate, that allow for shifting from one type of investment to another without realizing capital gains. This also creates incentives to defer tax realization of gains. There are a number of things like this which all open up possibilities for making existing capital gains taxes work better than they do right now.
Mark-to-market would tax capital income upon accrual rather than realization. One line of thinking is that that’s better because there’s no benefit to holding onto your existing investment to avoid taxation. There’s an argument that it would be more efficient; we don’t want people locked into investments. If you hold a stock for 10 years, you might want to sell it to diversify your portfolio or simply because you see another investment opportunity. But then you’re hit with a large capital gains tax liability. So holding on to an asset means deferring tax.
Arguments against this relate to liquidity. Taxing unrealized capital gains forces people to pay taxes on something they haven’t realized. Then the question is how are you going to pay for it? In case of publicly traded stocks, this is not an issue: you can sell it. In the case of all other assets it becomes more problematic—if you have a business or even a piece of art, you can’t just sell it easily or you may not want to because you have to let in outside investors.
These liquidity problems are aggravated because asset prices fluctuate. If we take this particular crisis, suppose the tax due was based on the value of assets in December. The stock market was its peak and the value of businesses was high. The tax liability today would be based on those values. But right now, after everything has declined in value, paying the tax based on December would be problematic.
Also, let’s assume assets don’t recover by next December. How do you handle the losses across the board? You should do something about those losses. You could refund them, but we know that creates lots of tax arbitrage opportunities, so it’s hard to do it in practice. If you are not going to refund those losses, you can think about carryforwards or carrybacks, but that’s complicated and does not really compensate you for the full value of the loss in practice. Effectively you don’t refund the whole loss, so you incur a tax when you have gains, but not a full refund when you have losses, leading to heavier taxes than intended. That creates a lot of issues.
You have interesting alternatives in the literature. Alan Auerbach and David Bradford have a better alternative—retrospective capital gains taxation. That means taxing things when they are sold, but adjusting for the holding period. That would correct for the deferral incentives.
If I were asked in what direction we should go, fixing the deferral issues relating to capital gains taxes is how I’d do it.
If inequality is a concern and/or we need to raise revenue what should we do?
Fix the existing distortions in the tax code. I am not taking a stand on the rates we should have, but the reason we have low rates on capital gains is because realizations are very responsive to the tax rate. The reason they are so sensitive is that we have a deficient way of taxing. If we reduce those deficiencies, capital gains will be less responsive to taxation, and that opens the possibility of increasing the rate. And that would be better than a wealth tax in my view.
A wealth tax is an outdated instrument. I think it’s useful to think about why some taxes were used in the past and why they’ve gone away. Administration is crucially important.
Historically, some societies taxed wealth—even going as far back as the Roman Empire—not income, because it was very difficult to observe income. It was easier to observe how much land people owned or how many windows their houses had. We moved forward and now we are able to better observe income. Income is a better proxy for economic circumstances and an ability to pay. That change took a lot of time. The modern tax system is able to do withholding and the evolution of the banking and financial system has allowed us to collect information on income. It’s no accident that we did not have widespread income taxes until the mid-20th century: it is simply owing to the fact that our ability to collect information on income has improved over time.
This is in contrast to the wealth tax, for which our information has improved somewhat but not dramatically.
Would wealth taxes increase the incentives to keep companies private? If so, could that worsen inequality since the average investor wouldn’t be able to own some of the most successful companies?
Oh, yeah. A wealth tax would increase incentives to shift into assets that are harder to value. When you think about that, it probably means keeping businesses private. As a side effect, it would likely shut out many types of investments from small individual investors. To some extent we are already seeing that in the context of private equity and hedge funds, which are the domain of higher net worth and institutional investors. That type of disparity in access to investments could make inequality worse.
A more subtle thing is that it would make inequality less visible. Right now, we know how much Jeff Bezos is worth. We can look at the share price of Amazon and see it. If we didn’t have the stock market valuation of those assets, you’d have less information about what they are worth, because there would be much stronger incentives to keep things private. This might cause us to think there is less inequality than there really is. My countryman Lech Walesa once quipped, “Break the thermometer and you won’t have a fever.”
Maybe that’s desirable. My suspicion is that the lower levels of observed inequality we see in Europe are due in part to the fact that there are stronger incentives to keep wealth private in Europe, which makes observing it harder. My suspicion is that there is more actual inequality there then what see in the data. Shifting in that direction may make the discourse better, but the economic substance… that’s a different story.
Allison Schrager is a senior fellow at the Manhattan Institute. Follow her on Twitter here.
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