The crowded Democratic primary field managed to reach a consensus on at least one issue — to raise taxes — with disagreements only over which taxes should rise and by how much. Senators Elizabeth Warren and Bernie Sanders staked the most radical ground with proposals to impose wealth taxes, going after the assets (not just the income) of successful entrepreneurs, investors and business owners.
The most important thing to know about wealth taxes is that they are a tax on savings and investment. Even a seemingly small tax on someone’s assets can equate to a tax exceeding 100 percent of income, thereby drastically discouraging investment at the expense of jobs and U.S. economic competitiveness.
Nevertheless, polls at the time showed most Americans were open to the idea of taxing wealth. That’s why my organization, the Center for Freedom & Prosperity, asked John Diamond and George Zodrow of Rice University to model the economic effects of one of the proposed wealth taxes.
Their computer model of the U.S. economy has been used by the Joint Committee on Taxation to provide a dynamic model of tax proposals, and it is particularly well suited for understanding the complex effects of large changes like the imposition of a wealth tax. What they found from the wealth tax was significant economic pain.
In a paper published by CF&P, “The Economic Effects of Wealth Taxes,” Diamond and Zodrow look specifically at the Warren proposal of a 2 percent annual tax on household wealth above $50 million and a 6 percent tax on household wealth over $1 billion. The model assumes that any revenues raised would be directed toward transfer programs, i.e. the welfare state, which matches the rhetoric of the various Democratic candidates — including Joe Biden.
Diamond and Zodrow find an average initial loss of $2,500 to household income. The distributional effects also fail to support the oft-asserted notion that those losses come solely from the top. Those that could be categorized as ranging from lower-middle class to upper-middle class would suffer losses from $440 to almost $50,000, respectively. Per-household wealth at the very top would fall by $3.7 million.
Households up and down the economic ladder suffer because taxing wealth reduces the supply of savings and investment, which are the keys to economic growth. That’s why long-run GDP projects to fall by 2.7 percent, labor productivity declines, and the economy loses the equivalent of 1.8 million jobs in hours worked. The only supposed good news is that additional redistribution spending counteracts the economic pain for the lowest earners, though making people more dependent on government is hardly a step forward.
Interestingly, the top rates proposed by Warren and Sanders are much higher than those used elsewhere in the world. As previously mentioned, and stressed by the paper, the income tax equivalent of a wealth tax is much higher than the statutory rate. So, while Warren and Sanders propose rates up to 6 percent and 8 percent, even socialist nations in Europe have never tried to impose such punitive tax rates.
Indeed, many other OECD nations have abandoned wealth taxes over the years, finding them extremely complex administratively, and the revenues lower than expected. Given the economic damage shown by Diamond and Zodrow’s simulation, it’s not hard to see why politicians tend have inflated expectations.
Biden ultimately came away with the Democratic nomination as the standard bearer of the establishment faction after fighting off a left-wing insurgency, but he has since joined forces with Sanders to produce a policy platform aimed at appealing to the far left. It’s easy to imagine the inclusion of a wealth tax becoming part of his pitch to progressive voters, and it’s even easier to imagine a hard-left Congress pushing this destructive tax next year.
At the risk of understatement, higher taxes to fund a larger welfare state is not what America needs. That would amount to a disaster for workers and the economy.