Consuming wealth without spending a dime

"It is a great comfort to have you so rich" - Jane Austen, Pride and Prejudice.

Stripped down to the barest essentials, taxation works like this:

taxes owing = tax rate * tax base + lump sum taxes - income guarantees and tax credits.

The appropriate tax base, rate and income guarantee are the three fundamental issues in tax design. 

Many economists believe that consumption is the best possible tax base (see this post, and the comments). Consumption is the best measure of what a person takes, consumes, and enjoys; consumption measures her welfare, how well off she is. It is thus the fairest basis for taxation. Moreover, these economists argue, taxing consumption has desirable incentive effects: it encourages saving; it discourages excessive, wasteful, environmentally destructive spending. 

Consumption taxation could be achieved by allowing individuals to make unfettered contributions to registered retirement savings plans (RRSPs in Canada, IRAs in the US) and taxing all withdrawals from those accounts. Or relying more on sales taxes like the GST and HST. 

There are well-known limitations to our ability to tax all consumption. What is produced and consumed in the home, for example, falls outside the tax system - something which is a problem for income taxes also. It can be hard to distinguish between business expenses, such as home offices or travel, and personal consumption.

Less often observed is that wealth itself generates consumption benefits, even if one never spends a dime of it.

I own a 12 year old Toyota Matrix. The front fender has collided with one too many snow banks, and is now held together with string. The exhaust system has seen better days. It breaks down occasionally. But overall it's very cheap to run.

If I was poor, it would be tough having an old, unreliable car. The unexpected, yet inevitable, major repairs would be a financial nightmare. $750 to repair the clutch. $200 to fix the axel seal. If the car broke broke down, and I couldn't get to work, I might lose my job.

But because I'm financially secure, I can afford a cheap car. I can self-insure against financial risks: unexpected repair costs, taxi fares, rental cars, and so on. I can afford to get my car towed. If it was beyond repair, I could get another car tomorrow.

The real value of having $10,000 in the bank isn't $200 in interest income, or the stuff $200 in interest income might buy. $10,000 in the bank creates a little bit of room to take risks. One could call it the "implicit value of self-insurance generated by own capital." It's the comfort of being rich (or having rich relatives). It's real. It's valuable. But it wouldn't be taxed if Canada had a consumption tax.

Admittedly, the insurance value of having wealth isn't taxed under an income tax either. But at least under an income tax some of the return on wealth is taxed, so there is, at least potentially, some shifting of the tax burden onto those with wealth.

The greatest freedom money offers is the freedom to walk away. Your bank doesn't offer you unlimited everything with no monthly fees? Walk away. There's always someone else who wants your money. Your phone plan is too expensive? Walk away (o.k., that may not be the best example). 

People with money have alternatives, which makes their demand for goods and services elastic. Food may or may not cost more in poor areas. But a rich person can shop at Value Village if he chooses. A poor person may not be able to afford expensive purchases which save money in the long run, like bread machines or high efficiency appliances or pressure cookers. Consumption taxes aim to tax the amount of stuff people actually consume. But if poor people pay a higher price for their stuff than rich people, is a system that taxes only consumption spending, without taking into account the ability to command consumption wealth conveys, fair?

There is a more subtle benefit to having wealth: the power it gives in social interactions. Becker's Rotten Kid Theorem explains how those how have wealth can control the behaviour of others by giving or withholding transfers. Shakespeare's King Lear is a vivid example. As long as King Lear has wealth, his two eldest daughters flatter him and treat him with loyalty and devotion - because they hope their obsequious behaviour will, in time, be rewarded. Once King Lear gives over his kingdom to them, Regan and Goneril cast him out. 

Some might argue that taxing consumption taxes capital - once that capital is spent. But wealth generates benefits for the holder even if the holder never spends a cent. Canada has relatively low taxes on capital - we do not have an inheritance tax, do not tax capital gains on principal residences, provide dividend tax credits to offset corporate tax paid, and provide room for tax-free savings within pension plans and tax free savings accounts. 

The noted economist Tony Atkinson has recently made the case for introducing an annual tax on wealth. His argument is that taxing wealth would reduce inequality.  

Even those who find Atkinson's argument for wealth taxation on purely distributive grounds unconvincing, and believe that consumption is the most equitable basis for taxation, should still be open to the idea of wealth taxes - because such a tax would recognize the comforts of being comfortably off.

Comments

[Trevor Adcock]

Aren't all of these just arguments for a more progressive consumption tax. Or perhaps regulations or subsidies designed to deal with the problem of liquidity constraints amongst the poor. I fail to see how this relates to wealth taxes.

[Stephen Sachs]

I'm a nonexpert, but I'm not sure how this can be right.

Suppose the consumption tax is structured as you say, taxing income minus net contributions to a savings account. Say I've got $10,000 in my account, and the tax rate is 33% (inclusive); every time I ask to withdraw $100, they withhold $33 of it first and send that to the government. Of the nominal $10K in my account, I can't actually spend more than $6.7K of it -- unless I give it to charity, do something else tax-deductible with it, etc.

So, if we say that I'm "consuming" my ability to spend $10K in the future, isn't the government taxing that, too? Don't I only get to consume an ability to spend $6.7K -- to buy $6.7K worth of bread machines, take $6.7K worth of risks, play $6.7K worth of King Lear? Don't I enjoy exactly as much security and power as someone else who has $6.7K in a special account from which withdrawals are tax-free? In other words, isn't the government successfully imposing its 33% rate on these forms of consumption too?

If there's some cognitive illusion here, so that I get the good feelies of $10K-in-the-bank even if I can't actually spend that much, that seems like the sort of interpersonal utility comparison that can't possibly be dealt with in the tax code. (Person A enjoys free things like sunsets and long walks, while Person B only likes things that can be bought as taxable consumption, etc.)

Where am I going wrong?

[Frances Woolley]

Trevor, "Aren't all of these just arguments for a more progressive consumption tax."

If you reject my premises that wealth conveys power and provides implicit income in the form of self-insurance they, yes, you'll reject my conclusion too (the goods being cheaper for the rich phenomenon could possibly be addressed with a more progressive consumption tax).

But if you accept my premises that simply owning wealth provides benefits that *cannot* possibly be taxed through a consumption tax, then there is a case for a wealth tax.

Consumption taxation and wealth taxation are not equivalent. A consumption tax only taxes wealth when it spent. A rich person can avoid paying consumption taxes by shopping at Value Village, wearing old clothes, driving an old car and repairing it themselves, and never going out (yes, there are rich people who do these things). One can't avoid a wealth tax by shopping at Value Village. A wealth tax taxes wealth regardless of whether or not its spent.

Even from a lifetime perspective, the two are not equivalent for anyone with a non-trivial amount of assets, because lots (most?) people don't spend their wealth during the course of their life.

[Frances Woolley]

Stephen -

The easiest one to understand is the ability to self-insure. Suppose you have a car worth $10,000 and has an accident and gets written off tomorrow. If you have $10,000 in the bank (or $15,000, if you need $10,000 after paying tax on withdrawals from registered accounts), then you can absorb that lost. You don't have to buy insurance to cover the cost of that loss, you can self-insure.

This means that you don't have to pay for the administrative etc costs of insurance, i.e. the difference between the cost of buying insurance and the expected loss, i.e. the probability of having the car written off times the value of the car. That's a potentially really big saving. It's a value of having wealth that's often ignored.

And, sure, no one is going to be nice to you just because you have $10,000 - that's not enough money to grovel for. But if you think that the ability to control money doesn't give power, you haven't seen how fast some people walk out of my office once they realize I'm not the Associate Dean who gives out travel grants.

[Frank Restly]

Frances,

The problem with taxing wealth is that taxation itself may force the liquidation of assets. That forced liquidation may negatively affect the market value of those assets and similar assets. Tax man goes to Joe and taxes his 10,000 acres of land. Joe must sell 2,000 acres of land to pay the taxes on it. That sale of 2,000 acres drives down the market value of land. Tax man then goes to Sam and taxes his 10,000 acres of land. Sam must sell 2,200 acres of land to pay the taxes on it further driving down the market value of land.

This would not be a problem if taxation was done on real terms (government accepts land as payment) instead of nominal terms (government accepts currency as payment).

"Moreover, these economists argue, taxing consumption has desirable incentive effects: it encourages saving; it discourages excessive, wasteful, environmentally destructive spending."

I disagree entirely. When a government receives taxes in any form, does it save them or turn around and spend them? If taxes received by a government are spent by the same government you have not reduced excessive, wasteful, environmentally destruction spending. All that you have done is shifted consumption from the private to the public sector and likely increased the waste and destruction.

[Stephen Sachs]

No one's disputing that it's nicer to have an extra $10,000 in the bank. The dispute is the extent to which a consumption tax affects *how much nicer* that is.

My claim is that a consumption tax reduces the niceness of the money in the bank in exact proportion to the tax rate. I may be misunderstanding you, but your claim appears to be that the consumption tax diminishes the niceness of the bank account not at all -- that the money in the bank escapes scot-free, simply because it happens not to be included in the annual tax base for the current year. But isn't the point of tax incidence theory that the burden of taxation doesn't necessarily fall in the same place -- or at the same time -- that revenue is collected?

Suppose that, due to some strange legal loophole, Person A is subject to the 33% consumption tax while Person B is not. Both have $10K in the bank. Are you arguing that A and B are equally wealthy, or derive equal benefits from their bank accounts? I'd think it clear that A has less wealth, less ability to self-insure, etc., than B -- 33% less, to be precise. The reason that his money in the bank is valuable at all is that it might be *used* in the future, at which point 33% of it will automatically disappear; ignoring that 33% misvalues his assets. So A may have to buy more insurance than B, take on extra administrative costs, and so on. The greater the tax rate, the less wealthy A is. In other words, A's wealth *is* being taxed -- it's just being taxed at the point of exit, but that fact filters back to affect its value all the way through. (How much would *you* be willing to pay, today, to take ownership of A's account?)

A ought to be indifferent between holding his dollar bills and swapping them each for 67-cent notes that can be withdrawn tax-free -- or, to put it another way, between standing pat and prepaying $3.3K in order to be free of taxes later. (This is just the equivalence of traditional and Roth IRAs in the US.) If he did prepay, it'd be obvious that his future consumption had been burdened, relative to a regime without the consumption tax. So what consumption is the consumption base missing?

[Frances Woolley]

Stephen: "but your claim appears to be that the consumption tax diminishes the niceness of the bank account not at all"

From the point of view of a consumption tax, the following two individuals are identical:

Individual A: Earns $40,000; spends $40,000, assets of zero.

Individual B: Earns $100,000; spends $40,000, assets of $1 million.

Under a purely consumption-based tax system, they pay the same tax. You may be attempting to make the point that the assets of $1 million are eventually subject to consumption tax *when they're spent*. Yes, that's true - Michael Smart argues in the comments in the post linked to above that a consumption tax is not equivalent to an earnings tax precisely because it taxes capital when it is spent.

The point I'm making here is that *even in the here and now* individual B is better off than individual A, because there are all sorts of benefits generated by having $1 million in the bank that are not taxed under a consumption tax.

On the equivalence between traditional and Roth IRAs - it's not quite as simple as that. First, there's the issue of super-normal returns - Roth IRAs are awesome for anything that generates a super-normal return. Second, switching to an entirely consumption based tax system would change the tax rate on the pre-existing capital stock.

"ignoring that 33% misvalues his assets" - that's a question about the *rate* at which a wealth tax should be set. Right now in Canada we don't have a wealth tax at all - only some taxes on capital income. The tax on registered plan withdrawals isn't a tax on wealth, as I'm sure you know. It's an attempt to tax money when it's consumed (though, of course, one could argue that people are forced to withdraw money from their RRIFs even when they don't need that money for current consumption, so the rrsp/rrif system isn't really a consumption tax system - that's a different debate).

"So what consumption is the consumption base missing?" The consumption benefits from self-insuring i.e. not paying having collision insurance on your car, the consumption benefits from having your kids be nice to you because they're hoping to inherit one day, and, to some extent, the greater value rich people can potentially obtain from a dollar of consumption spending.

[Frances Woolley]

Frank: "I disagree entirely." It's the argument Robert Frank makes for consumption taxes. I'm also not entirely convinced that switching to consumption taxation would save the earth.

"The problem with taxing wealth is that taxation itself may force the liquidation of assets."

That's a serious objection. Also there's the problem of taxing paper gains that might not exist in a year's time, given how bubbly the stock market is.

[louis]

One cool thing about taxing wealth as opposed to capital income is that it doesn't discourage risk-taking.
One a component of the return on capital is a return on assumed risk, and the higher the taxes on dividends and capital gains, the less incentive there is to take on that risk. By taxing wealth at a constant rate, regardless of how it is invested, you eliminate that disincentive.

[Frances Woolley]

Louis - this is a very good point. It depends, of course, on how capital income is taxed. Some ways of taxing capital income effectively allow the government to become a shareholder/own a portion of the investor's wealth. IIRC a corporate income tax which allows for immediate 100% write-offs of capital investments works like this - by allowing an immediate write-off of investment, the government is effectively buying a share of the investment. In this case capital income taxation dampens out both losses and gains, and can actually encourage risk taking.

[Lord]

Basic consumption isn't really consumption at all. We are all our own business, generating incomes and incurring expenses to do so, and basics, food, clothing, shelter, and the like, to some extent at least, are among these, which is the reason for exemptions. Then one enters the morass of just what is consumption and what investment, what is necessary and what luxury. Perhaps progressive exemption levels would be a better choice.

While wealth is more skewed than income in nominal terms, if one considers it in terms of income it generates, it is less, so a more progressive income tax, or more progressive benefit levels, are preferable to taxing wealth which suffers from circularity in that the value depends on level of taxation among other things being difficult to assess, collect, or even identify.

[baconbacon]

Bastiat would roll over in his grave.

The $10,000 in the bank insures BOTH the poor person and the holder of wealth, because it ensures that either can afford a new car on the spot (though not both simultaneously). The wealthier person can pay cash, but the poor person has $10,000 availible to borrow. The more you strip away wealth in the form of savings the more you reduce the ability of the poor to tap their most valuable resource, their expected income stream. But it doubles, because the more you tax wealth the more you interrupt the information stream between rich and poor. Savers and wealth holders will, in general, have made more and/orbetter financial decisions, and by putting conditions on loans will tramsmit information about what spending decisions are better than others.

Don't believe that last sentence? How many people propose lending tens to hundreds of thousands of dollars to high school graduates with no strings attached? How many propose to lend them money on the conditional that they spend it on furthering their education? High school grads are "poor" by your standard, they have low earnings and few assets, the willingness to conditionally loan to them carries terriffic infomation about the value of education.

Your analysis only holds if wealth is distributed entirely randomly and only benefits the holder. Since neither of these are remotely true it is meaningless.

[Frances Woolley]

Baconbacon: You make a number of good points, but they do not invalidate the basic argument made here.

"The wealthier person can pay cash, but the poor person has $10,000 availible to borrow. "

But the poor person is a lousy credit risk, so has to pay an exorbitant interest rate when borrowing the $10K, if he or she is able to borrow it at all.

"the willingness to conditionally loan to them carries terriffic infomation about the value of education."

Or about the profitability of loaning out money at prime plus 2.5% with no possibility of the loan being wiped out by the borrower declaring bankruptcy. Yes, it's true that "people propose lending tens to hundreds of thousands of dollars to high school graduates with no strings attached". The thing about education is that it's a good investment, but it's one heck of a risky one. Like so many things on offer in life, individual results may vary. I for one worry that people have been far too enthusiastic about embracing the idea of student loans on the basis of information about the *mean* return to education, without thinking seriously about the *variance* in the return to education. And even those estimates of the mean return are based on historical experience, and may not hold true in the future. Also estimates of the return to education may not fully adjust for selection effects.

[Frances Woolley]

Lord: "so a more progressive income tax, or more progressive benefit levels, are preferable to taxing wealth"

Sure, I'd go for that. I'm not strongly convinced of the desirability of taxing wealth. The point here is that there are serious problems with using nominal consumption as the tax base. Many of the arguments against consumption taxes go like this: "let's measure the progressivity of the tax system looking at how taxes/income changes as income rises. Consumption taxes aren't as progressive as income taxes." The problem with this argument is that it essentially assumes that income is the appropriate way of looking at things. I wanted to get away from that and say "o.k., let's accept that real consumption is the appropriate measure of welfare. We still don't want to use nominal consumption as the tax base."

[Joshua A. Miller]

I don't understand your response to Stephen Sachs. It seems to ignore the relevant margins because in your example you're comparing a millionaire to a regular person. Unsurprisingly, the millionaire is better off. The way to do it is to compare the behavior people would undertake in similar situations under different tax regimes.

Individual A: Earns $40,000; spends $40,000, assets of $10,000; pays tax on income of $4,000.
Individual B: Earns $40,000; spends $40,000, assets of $10,000; pays tax on consumption of $4,000.
Individual C: Earns $40,000; spends $40,000, assets of $10,000; pays tax on assets of $4,000.

As I read it, the first situation discourages market-based (and thus taxable) work; the second situation discourages market-based spending; the third situation discourages market-based savings and investment. So over time we'd expect A to make less, B to spend less, and C to save less.

In your example, Individual C might have less of an option value to own a cheap car, but he has more money to spend on car maintenance every year, which he can save or spend from year to year. So he probably has an incentive to buy a new car sooner just because if he saves the money it'll be taxed. But I don't quite know why that's a better thing than making his old car last longer.

Whereas B has good reason to keep that car in good condition as long as he possibly can so he can avoid both the price of a new car and the taxes that will bring.

[eightnine2718281828mu5]

---
It's the comfort of being rich (or having rich relatives). It's real. It's valuable.
---

Political (and other forms of) influence also flows from wealth.

[Stephen Sachs]

I don't mean to press this further than is useful; I fear that we're talking past one another. Let's take your two individuals, and assume the 33% tax rate from before.

Individual A: Earns $40,000; spends $40,000, assets of zero.
Individual B: Earns $100,000; spends $40,000, assets of $1 million.

Of course I agree with you that A and B pay the same tax in the current year, and that B, as a millionaire, is obviously much better off than A. We also agree that B's assets will be taxed in the future, when they are spent; that consumption taxes differ from wage taxes in their timing and treatment of existing assets, and so on. What we disagree about is the significance of those future taxes, and whether the benefits B currently enjoys by having $1 million in the bank are somehow "not taxed under a consumption tax."

Consider three more individuals:

Individual C: Earns $40,000; spends $40,000; assets of $1 million subject to a special 100% tax when withdrawn.
Individual D: Earns $100,000; spends $40,000; assets of $1.33 million subject to a special 50% tax when withdrawn.
Individual E: Earns $100,000; spends $40,000; assets of $1 million subject to a special 0% tax when withdrawn.

It seems clear to me that A and C are equally well off, even though C ostensibly has $1 million in the bank while A doesn't. If C can't access his money at all, if the government will take it from him as soon as he tries to withdraw, what good is it? How can he use it to self-insure, or to persuade his kids to be nicer, or whatever?

For the same reasons, D is no better off than B, even though his account is larger; both can look forward to only $667K of future consumption, whether for themselves (eg, self-insuring for car repairs), or for their children, or whatever. What matters isn't the nominal value of the bank account, it's what that bank account can actually buy you, whether in the future or today. And both B and D are substantially worse off than E, the only one who really gets to enjoy the self-insurance or other present benefits of having a million bucks in the bank.

If B's assets will be taxed when spent, then the current-day benefits of his having $1 million in the bank are smaller -- 33% smaller -- than they'd be in the absence of the consumption tax. Isn't that enough to show that his benefits don't escape taxation? What else would you need? Sure, the 33% chunk that the government takes out of his self-insurance ability might not show up in this year's revenue totals. (Though it would if the government sold a bond based on the future taxes that he'll pay.) But why should that matter?

The tax burden regularly falls in ways that don't track the language of the code: the economic burden of a tax on employers might actually fall on employees, etc. And the economic burden of a tax levied on future spending might actually fall on present asset holders. If it does, what tax-free benefit is B actually enjoying?

(On a separate note: I'm not sure why Roth accounts would reward supra-normal returns, at least ones that haven't yet been earned. Suppose the tax rate is 33%, I have $10K of income, and I have a special way of doubling my money in a year. With a traditional IRA, I'd put all of my income in the account and pay no taxes right now. The account would grow to $20K at the end of the year, I'd pay $6.7K in taxes, and take home $13.3K after tax. With a Roth IRA, I'd pay $3.3K in taxes right now and invest the remaining $6.7K, which would then double in a year to $13.3K. Either way, I have $13.3K a year from now, meaning both strategies would have the same net present value regardless of the current discount rate and regardless of whether my returns are above or below normal. The only difference is that current US law happens to use the same nominal contribution limit for both accounts, meaning that I can effectively contribute more to the Roth because I'd be contributing after-tax dollars.)

[Frank Restly]

Louis,

"One cool thing about taxing wealth as opposed to capital income is that it doesn't discourage risk-taking. One component of the return on capital is a return on assumed risk, and the higher the taxes on dividends and capital gains, the less incentive there is to take on that risk."

I don't agree with the proposition that the taxation of capital income reduces risk taking since losses that may occur can be deducted as well. In essence, government offers insurance on investment projects by taxing gains on successful investments to fund losses on unsuccessful investments. This may seem "unfair" to use Frances's terminology, but this in fact encourages risk taking.

[baconbacon]

"But the poor person is a lousy credit risk, so has to pay an exorbitant interest rate when borrowing the $10K, if he or she is able to borrow it at all"

Why is a poor person a lousy credit risk? If we go by the definition of poor as someone with low earnings and low wealth then the statement is false. As I said 18 year olds get cheap loans for tens of thousands of dollars all the time, with little prospect of earning significant money for 4+ years. Even "for real" poor people don't pay outrageous interest rates for secure loans, it is unsecured loans that carry high default rates (and hence high interest rates).

The problem for "poor people" is frequently that they have little in the way of savings. If the problem is savings, why in the world would you want to tax them and thus lower the incentive to save?

For more detail see my reply on Kevin Erdman's blog- http://idiosyncraticwhisk.blogspot.com/2015/05/our-discomfort-with-reward-from-risk.html

[Frances Woolley]

baconbacon: "Why is a poor person a lousy credit risk? If we go by the definition of poor as someone with low earnings and low wealth then the statement is false. As I said 18 year olds get cheap loans for tens of thousands of dollars all the time, with little prospect of earning significant money for 4+ years"

18 year olds only get cheap student loans because (a) the federal and provincial governments are prepared to step in and pay the interest on the loans if necessary (see, e.g., http://www.canlearn.ca/eng/loans_grants/repayment/help/repayment_assistance.shtml) (b) it's really hard to deafult on student loans by declaring bankruptcy.

Anyone who can't get a loan without serious financial guarantees from two levels of governments plus special rules regarding loan repayment looks like a lousy credit risk to me.

"The problem for "poor people" is frequently that they have little in the way of savings. If the problem is savings, why in the world would you want to tax them and thus lower the incentive to save?"

Let's imagine moving from our present world to a world of consumption taxation while keeping government revenues the same. Unless the consumption tax had a more steeply progressive tax rate than our current income tax, high income individuals who save a good part of their income (and it is pretty much exclusively high income individuals who save a good part of their income) would see their tax liabilities fall. The only way to keep revenues the same, is to increase the average rate of tax on consumption - which would - again, unless we could make that consumption tax rate schedule more sharply progressive than the existing income tax rate schedule - make these poor people worse off.

[Joshua A. Miller]

Could you say more about why a consumption tax has to be more progressive than an income tax? Is it because the rich can afford to be more responsive to consumption taxes than the poor?

If so, is a VAT-funded Basic Income Guarantee progressive enough?

Also, as a matter of fact are most asset taxation systems very progressive? The emphasis on capital income among the very rich always seems to lead to relatively low capital gains taxes.

[JKH]

OT-LOL:

http://krugman.blogs.nytimes.com/2015/05/18/tyrannical-canadian-initiative/?module=BlogPost-Title&version=Blog%20Main&contentCollection=Opinion&action=Click&pgtype=Blogs&region=Body

[Avon Barksdale]

Frances,

You are advocating the use of wealth as a tag to tax other things that you would like to tax but are less observable. OK, fine, but let's follow the logic. The question is: Are there more efficient tags for what you want to tax? The answer is, of course, yes. Height, physical attractiveness, gender, and race all correlated strongly with the potential to generate wealth and given the “fairness” and “equality” goals you keep mentioning, perhaps a more honest position would advocate using all efficient tags. If you find using efficient tags based on race or facial symmetry distasteful, perhaps advocating wealth taxes is a bit misleading. Let's think like economists here; take Chamley-Judd as a serious background theorem for a starting point. Let's think about ways to lower the rate and expand the base, hence the appeal of consumption taxes. If you think about it, the plethora of special accounts (RRSPs, TFSAs, RESPs, RIFs, etc.), is a tacit admission that the rate is too high, and tax arbitrage is a monster of inefficiencies!

Furthermore, what are we trying to do with taxation? The answer should be to pay for public goods, but for the toe-of-frog/eye-of-newt-economist-turned social-engineer, public goods are not enough. Somehow, taxation now is supposed to address the lottery of life under some misguided notion of Rawlsian social justice – to correct the “cosmic wrong” that some are born smarter than others, with more wealth than others, more attractive that others, and perhaps with better genetics than others. Sorry, but that's not economics, it's economists playing at being political philosophers. Using economics as a discipline to correct all ills, to usher in utopian solutions, is not only misguided, but dangerous. There is no sense in which economists are social engineers – it's bad story telling at best.

[Frank Restly]

Avon,

"Furthermore, what are we trying to do with taxation?"

Good question.

I think the closest answer to being economically correct is stated simply by the MMT guys: A government taxes to create a demand for it's currency.

"The answer should be to pay for public goods..."

A government that is free to create it's own currency (fiat) or to borrow from a central bank / the public doesn't need taxation to pay for public goods. It needs taxation to ensure that the currency it creates will maintain it's monopoly status as a medium of exchange. People faced with the choice of carrying multiple currencies (one to pay taxes with, one or more to conduct trade) or a single common currency in their wallet will eventually settle on a common currency to perform both functions with some caveats.

Without taxation denominated in a government's currency, the public will be free to create it's own currency / currencies.

[Kaleberg]

It's good to see an economist who understands what James Clavell, the potboiler novelist, used to call "f--k you money". Not only did money let you walk away, it let you say "f--k you" while doing so. Clavell also pointed out that no one ever got f--k you money out of cash flow.

Right now, the developed world has a massive capital glut and insufficient spending. Return on investment has been falling for decades because of this. Taxing consumption is exactly the wrong thing to do. This would just further cut consumption and further lower investment returns. We need higher taxes on capital. If there were a tax on owning 10,000 acres of land or a $150M painting, then we would see more spending and higher investment returns on productive capital.

The philosophical argument for such a wealth tax would flow from the fact that private property is a valuable government service and people with wealth should pay for it. Most wealth is in the form of government issued money, government money backed financial instruments, shares of government chartered collectives or government allocated real estate. (Alternatively, the government could only provide protection for the first $1M or $10M of one's private property. Anything over that amount would require private security services and good luck.)

[Avon Barksdale]

Kaleberg,

"Right now, the developed world has a massive capital glut and insufficient spending. Return on investment has been falling for decades because of this" Really? How do you know this? The world stock market has returned about 10% per annum over the last 6 years. It looks like the return for holding risky assets is actually quite high.

Need more taxes on capital? Really? What part of Chamley-Judd fails in your opinion such that we need more taxes on capital right now? Do you have a full solution to a dynamic program of stochastic equilibrium? But I glad you got it all figured out - that you know the exact amount of incentives, which freedoms to take away, and how to organize society.

I find it so ridiculous that people think it's so easy to engineer society, that there are no second order effects or unintended consequences to policy. Honestly, engineering society makes building the space shuttle look like a child's lego set. I am willing to bet that you have no opinion on the best way to implement a dynamic program for a hydrazine reaction control system for space flight manoeuvring, but that problem is infinitely easier than top down design of economic systems. Let's have some Hayekian humility, shall we?

[Bob Smith]

Frances,

A couple of observations.

First, I think the claim that a tax on registered plan withdrawals is not a tax on wealth is highly contestable. Granted, it isn't in our existing system (since some wealth is held outside a registered plan, so would only be taxed on a gain). But if we were to adopt a true consumption tax (i.e., with a form of unlimited RRSP contribution), taxable on withdrawal or death, the tax payable on death would be a tax on wealth (i.e., your accumulated savings - you wealth - is taxed).

(Query whether in a true consumption tax, taxation on death is justified. One the one hand, one could argue that your wealth should only be taxed in the hands of those who inherit it, so should not be taxed at death. Rather it should be included in the income of your heirs and, to the extent save, deducted. Conversely, one might argue that the act of gifting it to your heirs (or charities, or whatever) is a form of consumption, from which you derive benefits in your life and should be taxed. I'm agnostic as between the two, but I'd say that your concerns are greatly minimized in the latter regime.)

Second, there is no doubt that wealth generates all sort of intangible benefits. When your mechanic tells you that your car needs a new Johnson rod, life is a whole lot easier if the first question you ask is "when can you fix it?" instead of "how the hell am I supposed to pay for that?".

But wealth isn't the only attribute for which that is true. Life is much easier if you're smart, then if you're dumb. Quite apart from the pecuniary benefits, smart people tend to work in more interesting and less dangerous jobs. They tend to be more influential then dumb people. They have more options in life. So the case for taxing wealth is much the same as the case for taxing IQ. After all, at the end of the day, IQ is just another form of wealth.

That isn't to say we shouldn't tax wealth (or IQ) maybe we should, but if we're going to go down that path, we need to consider where we draw the line.

[louis]

Avon: "The world stock market has returned about 10% per annum over the last 6 years. It looks like the return for holding risky assets is actually quite high."
The return on holding risky assets from the trough in 2009 was indeed high, because in the midst of a great financial crisis, multiples contract and anyone with the capacity to hold risk does great. Your statement is a total non sequitor to the question on what the return on investment (the IRR of the marginal investment in real capital projects) is today.

[Frances Woolley]

Bob: "First, I think the claim that a tax on registered plan withdrawals is not a tax on wealth is highly contestable."

Bob, thanks for putting it like that. It expresses the views of other commentators very neatly.

Anything can be contested, but in this case, I'm pretty sure I'm right.

If the RRIF/RRSP rules were changed so that there were no required withdrawals, then people would only make withdrawals from RRIFs/RRSPs when they actually wanted to consume the money. If there were unlimited RRSP contributions, then anyone with money to save would put it into a RRSP (unless they wanted to do some lifetime tax averaging). Remember I did say "unfettered" RRSP/RRIF contributions.

A tax system that taxes money when it's spent and doesn't tax it when it's saved looks an awful lot like a consumption tax to me.

"But wealth isn't the only attribute for which that is true." This is absolutely for sure true. It's human capital and social capital, as much as physical capital, that allows me to have an old car. A couple of times the Matrix has broken down just as we were about to head down to Toronto. One time Nick came over when the car had broken down, lent us his car to drive to Toronto in (yes, that one), and moreover rode in the tow truck as the car was taken to the dealership, and handled the repairs. Yes, Nick is a totally amazing human being, and the best friend anyone could ever have.

[Bob Smith]

"A tax system that taxes money when it's spent and doesn't tax it when it's saved looks an awful lot like a consumption tax to me."

Except that's only half the system. It also taxes savings on death. Now that is a consumption tax (if one treats bequests as a form of consumption), but it's also a wealth tax (in that your unconsumed income - your wealth - is taxed on death). A consumption tax = a wealth tax if we treat bequests as a form of consumption (as, implicitly,the existing RRSP regime does).

[Frances Woolley]

Bob, agreed, and this is definitely going to be one of the hot issues in tax policy going forward, especially if the RRIF withdrawal rules are eased.

[Avon Barksdale]

Bob Smith,

"So the case for taxing wealth is much the same as the case for taxing IQ. After all, at the end of the day, IQ is just another form of wealth."

That's the point I made about tags. Frances' argument boils down to using wealth as a tag for other things she would like to tax, but can't easily observe. But there are better tags than wealth if you want to tax these other "assets". You can tax height, IQ, physical attractiveness, gender, and race. All of these tags are more efficient than wealth because it is hard to shirk these taxes. Using the tax system, I can disguise my wealth, but I cannot disguise my height.

This is the problem with all utilitarian arguments. Stretched to it's logical limit, the argument justifies slavery provided that society's joint utility function more than makes up for the utility loss of the slaves. Instead of trying to use economics to right cosmic wrongs according to some imagined joint utility function, let's just figure out how to pay for public goods and leave it at that.

[louis]

Bob - by that logic, it's an income tax, too. Your income is taxed at some point, either when you consume it, or when you die.

As I see it, a wealth tax is levied every year on your assets. If you earn a million dollars this year and save it for 5 years, then spend it, you pay tax each of those five years. If you spend it after 2 years, you only pay 2 years of taxes on the wealth. Basically, it's like the effect of inflation on savings kept in cash.

[Avon Barksdale]

"Your statement is a total non sequitor to the question on what the return on investment (the IRR of the marginal investment in real capital projects) is today."

Louis, returns above the riskless rate are generated from holding risk - that is true for all assets. You might complain that the riskless rate is low, but that is not the issue about investing in capital projects. It's always the nondiversifiable risk that gets compensated. The risk premium varies over time.

[Bob Smith]

"Bob - by that logic, it's an income tax, too. Your income is taxed at some point, either when you consume it, or when you die."

Well, it's not quite like an income tax, because a consumption tax doesn't distort the consumption/savings decision, whereas an income tax does. A consumption tax is only like an income tax if there are no savings (which would make a discussion of wealth irrelevant). In a world with savings (and therefore investment income), the two are not equivalent.

Remember, consumption and income are both annual flows of different things, so only in exceptional circumstances, is a consumption tax equal to an income tax (i.e., when savings equal zero). On the other hand, wealth is a stock that is a function of the annual flows of both income and consumption. So both income and consumption taxes can be thought of as different forms of taxation on wealth (particularly if you treat gifts or bequests as a form of income, which admitedly the Canadian tax system does not).

"As I see it, a wealth tax is levied every year on your assets. If you earn a million dollars this year and save it for 5 years, then spend it, you pay tax each of those five years. If you spend it after 2 years, you only pay 2 years of taxes on the wealth. Basically, it's like the effect of inflation on savings kept in cash."

Why does a wealth tax need to be imposed on an annual basis? That seems to be an arbitrary way to define a wealth tax. I would have thought that a wealth tax is, by definition, any tax levied based on wealth. You're proposing one version of a wealth tax (one that I suspect many would find problematic, because it discourages savings, raises liquidity concerns, etc.), whereas I'm proposing another version which doesn't have any of those issues (and indeed, one that fits nicely within our existing tax system).

[Bob Smith]

"Bob, agreed, and this is definitely going to be one of the hot issues in tax policy going forward, especially if the RRIF withdrawal rules are eased."

Well, they've been eased (to better reflect the realities of current life expectancies and interest rates), but I don't see anyone getting rid of the deemed disposition on death. That's not in the cards.

The one upshot of a "super RRSP" is that it might make it easier to tax bequests in the hands of the recipients (which, if you want to prevent the accumulations of concentrations of wealth, would be a good thing).

While a good case can be made for treating an inheritance as a form of income, the political opposition to doing so (giving rise to a hefty tax hit for the recipient in the year of death) is significant (as the ongoing US battle over the "death tax" illustrates). On the other hand, under a consumption tax regime, while bequests will ultimately be taxed, they're taxed when they're consumed, not received. The bequest would ultimately be taxed (probably at an appropriately lower rate, reflecting the recipient's lifetime consumption, rather than their one-off income in a year), but because the big tax bill doesn't arise with the receipt of the gift, the political opposition is likely to be both smaller and less effective (i.e., people will kick up much more of a fuss over something that imposes a tax liability now then on one that increases a tax liability in 40 years, when they die).

[Majromax]

Extremely relevant: The Million Pound Note. As a comedy, it touches upon precisely the "is wealth only useful in its expenditure?" question.

[Frances Woolley]

Bob: " On the other hand, under a consumption tax regime, while bequests will ultimately be taxed, they're taxed when they're consumed, not received. "

Bob, the issue here is that inequality in wealth is such that most wealth is held by people who are so rich they're unlikely ever to consume that wealth within their lifetime. Not obvious their kids will ever consume that wealth either.

"I don't see anyone getting rid of the deemed disposition on death. That's not in the cards." Once upon a time, no one would ever have thought that TFSAs were in the cards, much less a doubling of them. Or income splitting. I hope you're right, but I'm not convinced.

[Majromax]

@Bob Smith:

> Why does a wealth tax need to be imposed on an annual basis? That seems to be an arbitrary way to define a wealth tax.

It makes perfect sense.

The idea is that wealth, simply in its possession, acts as insurance against destitution and ill fortune. It relieves its holder of a liquidity crisis.

In certain limited respects, we can put a value on this. This is the same sort of insurance as banks offer in "balance protection" plans, although there the benefit is in not being limited by current outstanding debt rather than continued-financing of the same level of consumption for the medium-term future.

We can also get at this another way, by looking at the risk premium on debt-financed consumption, multiplied by an estimated probability that such a thing would happen. The RBC insurance offers a maximum payout (over 10 months) of 100% of a card's outstanding balance at a premium of 1% average daily balance per month. If the plan breaks even (hah), that means that they estimate a ~10% chance per year of some qualifying event, or a greater chance of a lesser payout.

Applying that logic, we get a back-of-the-envelope estimate that an average person has a 10% chance of needing to finance on year's spending on short notice. If doing so on credit carries a 7% risk premium (somewhere between a cheap line of credit and the credit card interest rate), then having equivalent savings provides 10%*7% = 7‰ annual benefit.

Taxing that imputed benefit as if it were consumption would then give a 1-2%permil; wealth tax.

Perhaps the biggest question is whether such a wealth tax should cap. The self-insurance benefits of wealth have diminishing returns: having $10bn in the bank does not provide better insurance for a $30k/yr lifestyle than having $1bn in the bank does. On the other hand, other benefits of wealth (such as power, from control over voting shares) do scale with asset size.

[Bob Smith]

"Bob, the issue here is that inequality in wealth is such that most wealth is held by people who are so rich they're unlikely ever to consume that wealth within their lifetime. Not obvious their kids will ever consume that wealth either."

Right, but recall, if we're talking about a proper consumption tax, all receipts are either consumed (and taxed) or saved and consumed (and taxed) in the future or taxed on death (just as, in the current RRSP regime, all registered wealth is taxed on death). So, in that world, whether or not you actually consume your wealth, you're going to be taxed on it. My only point is that it's much easier to tax that wealth on death than on receipt.

In many respects, a properly designed consumption tax could be far more radical than the ill-conceived notions that pass for progressive tax policy in Canada today ("let's tax corporations", "let's tax the "rich""). One of my pet peeves with the Canadian left is that their conception of tax policy is so primative and ill-informed that they reject the sort of well-designed tax policies which would allow them to efficiency fund their spending agenda's in favour of populist pap which won't raise a dime in revenue.

On your other point, I'm not sure that TFSAs are that far fetched, given their equivalence to RRSPs (and the existence of similar regimes in the US). They're not really that radical a change from the prior RRSP regime, they're just a different way of skinning the same cat.

[Frances Woolley]

Bob: "Right, but recall, if we're talking about a proper consumption tax, all receipts are either consumed (and taxed) or saved and consumed (and taxed) in the future or taxed on death (just as, in the current RRSP regime, all registered wealth is taxed on death)."

If we're agreed on taxing all registered wealth on death, we're good. But I'm hearing rumblings on that subject.

[Bob Smith]

"The idea is that wealth, simply in its possession, acts as insurance against destitution and ill fortune. It relieves its holder of a liquidity crisis."

On that logic, we should have a marriage tax, or a children tax, since they serve a similar role. Also, I'm not sure the comparison with balance protection insurance, since that's one of the greatest scams out there, purchased only by the truly gullible or bad at math.

On the "power" point, that actually illustrates the inefficiency of a "wealth" tax at taxing power. Consider the following examples. Person A has a net worth of $100M which she invests in a broad portfolio of public companies/bonds/etc. Person A is quite wealthy, but has little power over any of the issuers of the securities she owns.

Person B is highly levered and owns a chain of car dealerships. The dealerships have a value of $20M, but Person B has debt of $15M. The dealerships employ hundreds of people and are major players in their local economies.

Now, in these examples Person A is far wealthier than person B (i.e., A has a net worth 20 times that of B). On the other hand, Person B is arguably far more influential (given the role his dealerships play in the lives of their local communities). Certainly, in our political system where parties are elected on the strength of local consituencies, the car dealer who owns dealerships in four different communities is likely to have significantly more sway than my hypothetical rentier.

[Frances Woolley]

Bob: "On that logic, we should have a marriage tax"

Actually the Carter Commission did suggest that a marriage tax would be a good idea.

[Too Much Fed]

Frank Restly, would you be willing to post something for me at David Andolfatto's blog? Thanks in advance.

[Frank Restly]

TMF,

What are you looking for in particular?

[Too Much Fed]

Frank, David talked like he would turn on "anyone can comment" on his blog. I am going to post the link in my next comment or what to google if the link will not post.

[Too Much Fed]

https://support.google.com/blogger/answer/42063?hl=en

"If you choose to enable comments, visitors to your blog will have the option to respond to your published posts. Blogger supports threaded commenting which means we display comments such that a reader can more easily differentiate between whether someone is making a general comment on the thread, or responding to another comment on the thread. Single-level comments will always be displayed chronologically.

Enabling comments

To enable comments, click on Settings from the drop-down menu on your Dashboard, then go to the area for posts and comments."

Next, there is a picture.

And, "1.Comment location: Select "Embedded" if you'd like to enable threaded commenting.
2.Who can comment?: Here you can specify who can comment on your posts. The options range from anyone (which means that anonymous users can comment without having to sign in to any type of account first) to only members of the blog (if it's a team blog)."

[Frances Woolley]

Too Much Fed, Frank - could you please keep your comments here focused on the topic under discussion? Thanks.

[Too Much Fed]

Sorry. I had no other place for this.

I tried the link under Nick's post.

The link would not display.

[Frances Woolley]

Too Much Fed - no worries. Hope you manage to get this all worked out.

[BC]

Consider two people A and B with zero initial wealth and equal lifetime earnings. They are equally wealthy in present value terms. A consumes all his earnings immediately while B saves some and, hence, gains some insurance value from his savings. I believe that Frances's argument boils down to saying that a consumption tax will tax all of A's consumption but will not tax the self-insurance value that B consumes because such insurance is home produced. (If B purchased such insurance from an insurer, then the insurance premiums would be taxed.)

While I would concede that point, I don't see how B's home-produced insurance is any different from other home production that is also left untaxed. A handy person benefits not only from (untaxed) self-repairs of home appliances but also an insurance value that derives from the ability to fix appliances during times when no external handyman is available for hire. Similarly, a home cook or gardener derives (untaxed) insurance value from being able to satisfy hunger during hours and holidays when grocery stores and restaurants are closed. The insurance value described by Frances seems to be a special case of home production rather than a separate and different benefit associated with financial wealth per se.

The King Lear presumed social benefit of wealth also seems to result from cognitive illusion. True, King Lear can gain his daughters' flattery with the promise of wealth transfer. However, he is not able to gain the promise of more wealth (or anything else) by flattering his daughters. (Presumably, his daughters do not value his flattery or else he would have been able to use it to avoid being cast out.) The exchange of wealth for flattery is a symmetric one. One could just as easily use the example to argue for a charisma tax as a wealth tax.

[Frances Woolley]

BC - "Consider two people A and B with zero initial wealth and equal lifetime earnings. They are equally wealthy in present value terms. A consumes all his earnings immediately while B saves some and, hence, gains some insurance value from his savings."

Overwhelming majority of variation in wealth comes from variation in lifetime earnings and variation in inheritance. Family structure (which influences consumption patterns) and return on saving also explain some differences in wealth accumulation, but most of it is earnings and inheritance.

I'm not sure how much insight one can get into this issue by assuming away the stuff that matters empirically.

"I don't see how B's home-produced insurance is any different from other home production that is also left untaxed"

It isn't any different from other home production: for all untaxed good and services there is generally some possibility of increasing the efficiency and/or the equity tax system if one can find some way to tax them either directly or indirectly. For example, the reason that a tax on earnings distorts labour supply is that leisure and household production is untaxed - if one could tax the value of leisure and household production, then a tax on the value of earnings+leisure+household production would be close to a non-distortionary lump-sum tax on ability. Which is an efficiency and equitable way of designing a tax system.

[pamela rogers]

The collapse of marriage in our poorest communities -- and its tragic impact -- is a familiar story. But increasingly, marriage is becoming a marker of class privilege in America, something increasingly reserved for the affluent. If progressives want to tackle the scourge of inequality, then the retreat from marriage is an issue they can't ignore.

[BC]

FW: "Overwhelming majority of variation in wealth comes from variation in lifetime earnings and variation in inheritance."

Yes, but much of the variation in earnings and inheritance is already captured by variation in consumption (plus consumption that one leaves to heirs). Thus, those variations are already captured by a consumption tax. Considering the merits of a wealth tax in addition to or as an alternative to a consumption tax requires examining what a wealth tax does that consumption taxes do not do. That's why one needs to look at the differential impact of a wealth tax on two people with identical lifetime consumption. Controlling for lifetime consumption, differences in wealth are primarily due to timing of consumption, i.e., decisions to save vs. consume immediately. A wealth tax is (differentially, relative to consumption tax) a penalty on savings.

FW: "It isn't any different from other home production..."

My point was that you were trying to give a good reason to tax wealth but ended up giving a good reason to tax home production. But, the wealth tax is not a tax on home production. It's not clear that self-insurance is even a significant fraction of home production compared to cooking, home repair, etc. It's also not clear that taxing wealth is a particularly good way to tax home-produced insurance. Two people with identical wealth could face very different actuarial probabilities of the insured events that you mention, and the wealth tax makes no attempt to account for that (which is required for determining what fraction of wealth goes to producing insurance and what fraction is merely delayed consumption, which will be captured by consumption tax). If one sought to design a tax on home production, it seems unlikely that one would end up with something that looks very much like a wealth tax.

[Avon Barksdale]

BC,

Great points.

I might also add that Frances is arguing the use of wealth as a tag for other things that she would like to tax, but which are hard to tax directly. This is a strict utilitarian approach to redistribution and thus any information (in this case wealth) that makes the redistribution more efficient must necessarily be optimal. But we run into thorny problems with this line of thinking. Why stop at wealth as a tag and not tags of ability? The center of the shrubbery maze is that Frances wants to redistribute from high ability to low ability. Taxing any tag that correlates with the ability generate wealth must also increase the efficiency of the tax policy. Thus, if Frances wants to use wealth as a tag, why not use race, height, religious affiliation, or genetic markers? Strictly, Frances' application here does not allow for horizontal equity as a consideration, and from a consistent utilitarian perspective, nor should it. The thinking that says "hey, let's tag that [X,Y,Z] because it's more efficient" is actually a very questionable approach to taxation. In my view it's outright dangerous. Just think of how ugly the end point of that logic gets - you tax Jews and people of strong Protestant work ethic more, you tax taller and more attractive people more, you tax men more, you tax white people more, etc. and you do this regardless of actual market outcomes because all these groups had the potential or ability, on the average, to generate more wealth. Strict utilitarian approaches force you into this very ugly box.