The Wealth Tax: Could It Fix Our Current Economy?

The Wealth Tax: Could It Fix Our Current Economy?

The fiscal cliff is fast approaching, and with tax cuts for affluent Americans set to expire, many of our nation’s richest citizens could face a significant tax hike.

From the perspective of President Obama and many Democrats, the way to decrease our deficit is to significantly increase the tax rate for high earners, so many of their proposed solutions call for tax changes based on income.

But are they focusing on the wrong thing? Is income really the best basis for deciding on tax hikes?

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Recently, some economists have come forward to suggest that the key to fixing our country’s long-term economic woes is to start taxing wealth, not income. In the United States, the distribution of overall wealth--this includes an individual’s investments, savings and other assets--is highly imbalanced: The top 1% of Americans possess nearly 50% of total wealth in our country.

But are economists unfairly targeting the rich? Probably not. It turns out that wealth inequality adversely affects economic growth, and harms our country's chances for success, according to research conducted by the International Monetary Fund, which focuses on securing financial stability around the globe.

We’ll take a closer look at how wealth inequality can hurt us all economically, and how our nation would change if we focused more on solving the inequality gap.

The Real State of Wealth Inequality in the U.S.

Simply put, wealth inequality is exactly what it sounds like: an unequal distribution of assets among a group of people. Even in a country in which the recent election was dominated by the concept of the 99% vs. the 1%, few Americans really understand the scope of wealth inequality in the U.S.

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A recent survey conducted by Michael I. Norton and Dan Ariely—professors at Harvard Business School and Duke University, respectively—showed that most Americans greatly underestimate the state of inequality in the United States. The majority of respondents estimated that the wealthiest 20% of Americans owned only 59% of total wealth in this country.

The reality is starker: Recent data has shown that the top quintile owns as much as 84% of total wealth. In the below graph, taken from Norton and Ariely's paper, you can see just how little wealth is owned by the four lower quintiles.

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When asked how they'd want wealth distribution to look in an ideal scenario, the majority of respondents recommended that the top 20% own only 32%--that's much closer to the distribution of wealth seen in Sweden.

Why Is Wealth Inequality Such a Concern?

The current state of inequality in the U.S. is at the highest point since the Great Depression—and it’s no coincidence that steep inequality is associated with one of the rockiest economic periods in our nation’s history.

While one economic theory holds that the gains made by the rich trickle down to boost the economic well-being of those on the bottom, the IMF has shown that greater inequality translates into less stable economic expansion and a slower rate of growth. Joseph Stiglitz, a Nobel Prize winner in economics, told The New York Times: “Increasing inequality means a weaker economy, which means increasing inequality, which means a weaker economy. That economic inequality feeds into political economy, so the ability to stabilize the economy gets weaker.”

Additionally, the I.M.F. found that great wealth inequality can also lead to political instability, citing revolutions in Arab Spring countries, like Egypt, as an example.

 

Lastly, research by the I.M.F. and the Brookings Institution also supports the argument that wealth and income inequality actually played a significant role in bringing on the recent recession. Starting as far back as the 1970’s, when income growth slowed for lower and middle class earners, many people decided to borrow in order to buy homes that were more expensive than they could afford, believing that real estate would prove to be a reliable asset. They also started to rely more on consumer credit, masking the fact that incomes and buying power were shrinking.

From the 1970s to the early 1990s, inequality in the U.S. was rated in the low 40s, based on a 1 to 100 scale used by economists and statisticians. When the housing bubble popped, the assumptions made by many Americans proved to be faulty, and their wealth was diminished. As a result, inequality is now rated around 80.

How Would Taxing Wealth Change Our Society?

In a recent op-ed for The New York Times, NYU adjunct associate professor of economics Daniel Altman wrote that taxing wealth—rather than income—would go far to improve the current state of inequality in the United States.

Given that wealth is comprised of accumulated assets, he argued that wealth inequality will increase over time, even if income inequality stays the same. So those earning more will continue to put away more money each year, and invest more funds, than those earning less.

By taxing wealth (financial assets like housing, cars, business ownership, etc.) at a flat rate of just 1.5%, the IRS would take in as much as they do with income, estate and gift tax revenue combined. Creating a bracket system in which those with wealth of up to $500,000 paid 0%, those worth $500,000 to $1 million paid 1% and those with fortunes of over $2 million paid 2% would have the same effect.

For example, Altman compared two families: one that had $500,000 in wealth and $200,000 in annual income, and one that possessed $4 million in wealth and earned the same annual income. Under the current system of taxation, the first family would pay $50,000 in federal income taxes; if we were to have a wealth tax system, they would pay nothing. In contrast, the second family would pay $65,000 under the wealth tax. In short, people who use their accumulated wealth to support themselves financially would pay more in taxes, while those who depend more directly on income would pay less. This would effectively slow the trend of growing wealth inequality--if not turn it around altogether.

However, Altman also points out that implementing a new wealth tax system would face issues. For instance, people who already paid income tax on the money used to purchase assets would be taxed twice. To solve this, Altman suggests starting the highest bracket at a smaller tax percentage.

How Would Americans React to a Wealth Tax?

Given that a wealth tax could help create a more equitable society, and help improve long-term stability and growth, why wouldn’t it be implemented?

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Well, aside from the logistical issues mentioned in part by Altman, many Americans are scared of the concept of “redistribution,” even though they'd like to see a fairer society, as evidenced by the Norton/Ariely survey.

Why?

Norton, in an op-ed roundtable for The New York Times, diagnoses the issue as being tied to poorer Americans’ unfounded belief in the concept of social mobility.

While the facts show that 43% of Americans born into the lowest economic class remain there—and 40% of those born into the highest economic class also stay—many citizens unrealistically believe that they will one day be rich. And, when that happens, they wouldn’t want to be taxed more on their wealth, either.

In the same roundtable, Scott Winship, the research manager of the Pew Economic Mobility Project, writes that many people feel strongly that it's important to ensure that opportunities to become wealthy remain open--rather than immediately reduce inequality through actions like taxing the wealthy. And since many of them still believe in the American Dream, it doesn't seem pressing to change the system.

What do you think: Should there be a wealth tax?

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