The Unique Evils of the Wealth Tax

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I am dedicated to an ideologically pure form of anarcho-capitalist thought in the libertarian style, following the mold of great thinkers like Murray Rothbard.

Politicians have floated around the idea of a tax on unrealized capital gains for a long time. This is sometimes called a wealth tax, though it is important to note that there are other similar taxes that could also be called wealth taxes—and all of them share key detrimental effects.

We will have to examine some economics to understand what these are, but the key points that need to be addressed are:

1)     The consequences of a wealth tax are disastrous, even if government applies it narrowly

2)     The effects a wealth tax has on economic behavior and productivity

3)     The reasons a wealth tax will create horrifying outcomes and state overreach

For the moment, I will set aside my usual screed that taxation is theft and that government is a gang of bandits. Populists of both left and right stripes seem to believe that the hyper-rich cause many of our social ills, and they’re not entirely wrong about this, but they also believe that these elites will be the ones the tax hurts.

They will not. A simple political realism would remind everyone that the fat cats in DC and the fat cats in New York are basically the same ruling class. The ruling class does not target itself with legislation.

What a Wealth Tax Is Not

Now, many people will say that we have had wealth taxes in the past—this is true if you enjoy using the Holodomor as the model for your system.

But practically a lot of the things that people think of as historical wealth taxes are not.

From an economic perspective, no tax is neutral, but some taxes distort the market more than others. While the concerns about the market may seem to be the distant concerns of bespectacled and pimply pencil-necks or amoral capitalist pigs, the fact remains that the market is how we get our food.

Playing too many games with the economy—especially when even the people in charge admit that we will see food shortages—is a spectacularly foolish idea. Those who interrupt the patterns of investment and production must reckon with the reduced productivity.

Since economics is value free, the Austrian perspective I favor can only claim to seek a maximal productivity. It is up to the listener to decide whether they wish to distort markets via intervention to achieve a greater goal. But the wealth fat is the trans fat of taxes. There is no healthy amount of wealth taxation precisely because it operates on a crucial part of the market.

Let us look at what a wealth tax is not, to clear some things up before we get into this economic analysis.

Progressive Income Taxation

First, progressive taxation is not inherently a wealth tax. Now, progressive taxation may be a feature of a wealth tax, but the two are distinct.

Progressive taxation simply refers to how a tax scales relative to another metric. Typically, this has always been a quantity of money, and we see this in the income tax system in many countries.

The poor are exempt or pay a lesser share of their income in taxes. As individual incomes rise, the tax liability relative to the individual’s income rises with them.

This taxation scheme seems “fair” since it does not threaten to take away an individual’s last money and is supposed to leave the necessities of life for individuals.

It simply means that the highly productive do not satisfy their marginal demands. Since the state wastes money, whether this would be a net benefit for society relative to the ultimate effect of taxation is unclear. If the marginal demand of the income earner would be the psychic profit they could achieve by philanthropy, the state will probably be inferior.

And even if the taxed individual were simply to purchase consumer goods, this may create jobs and have a larger positive effect than the government’s spending—especially when we consider the undesirable social effects of many welfare programs.

However, the important thing about progressive income taxation is that it targets assets that are already liquid—money floating around, not investments with a particular cash value. While this has a long-term negative effect, it does not evoke a short-term crisis.

Sumptuary Taxation

There is also a consumption tax, which I will refer to as a sumptuary tax to distinguish it from tariffs, sin taxes, and sales taxes.

Sumptuary taxation targets the use of money on luxury goods or other “frivolous” expenditures and is part of a larger class of sumptuary laws.

The goal of sumptuary taxation is not to prevent these behaviors (as some sumptuary laws and sin taxes aim to do) but to turn them into state financing.

For instance, the government may levy a tax on pleasure boats, or a tax on windows in houses (since large houses are likely to have more windows), or so forth.

These have largely fallen out of favor because the relative cost of enforcement is high, the ease of finding loopholes is inescapable, and bureaucrats love the nice things of life and don’t enjoy taxing themselves.

In short, most sumptuary taxes don’t pay for themselves. They are interesting in historical case studies, but in a free market where the average consumer purchases things that could qualify as luxury goods and the sheer number of goods and services is astronomical, it would be hard to use this as a serious source of income.

Note that we still see some sales taxes and other fees (such as for cell phone service) levied by the government, but these are largely bereft of the sumptuary element because the goal is mass taxation rather than specifically targeting the elite.

There is also a constitutional limit on sumptuary laws because they belong to status law, something which the American legal system supposedly abolished (though it has been resurgent in the form of civil rights legislation and other transplants on the common law tradition through the legislative process).

Estate Taxes

Estate taxes are the closest thing we have to a wealth tax, and the populists rightly consider them abhorrent. They’re not technically a wealth tax in the way unrealized capital gain taxes are.

We know the effects of estate taxes: family businesses destroyed, homes sold off to pay the tax man, and the liquidation of generational wealth.

There are some differences here. Estate taxes typically cause the liquidation of investments. But they do not mandate it. For instance, cash in an account that is confiscated in an estate tax may go to waste instead of going to its original purpose (say, supporting survivors) but in this case it has the normal effects of redistributing money (akin to the income tax system) rather than the particularly dangerous effects that come when government liquidates investments.

The Economics of Investment

The simple nature of the unrealized capital gains tax is that it is a tax on investment. We already tax the wealthy on realized capital gains—that is, when they sell their assets to get money to spend.

So what’s special about unrealized capital gains taxes?

Unrealized capital gains taxes require an individual to sell all or part of something they’ve invested in to pay the tax.

The function of this varies depending on the taxed individual’s investment structure—obviously with the example of the estate tax we saw before, the owner of a building or other large indivisible piece of property may have to sell a property entirely, leaving them with nothing but cash.

This is the largest and most obviously disruptive example, at least for the individual involved. However, discouraging investment is a bad idea.

A Crash Course in Time Preference

It is imperative to understand time preference as it applies to economic action, especially when looking at investment.

High time preference reflects a desire to consume immediately as opposed to saving for later. The counter-part, low time preference, involves a willingness to save for greater returns in the future.

Time preference is both a personal trait—some individuals have more propensity to delay gratification—and a consequence of social and environmental factors. Risk and uncertainty elevate time preferences, since there is a logical case to consume now when goods may not be available in the future.

Investment results from low time preference. It represents an individual’s ability to assess and find courses of action where they can apply what they own to get a greater result later.

Taxation has a general effect of raising time preference since it strips owners of their property, as do social welfare programs and regime uncertainty surrounding regulatory structures.

Wealth as Competence

One thing that is important to remember is that accrued wealth is a measure of competence. We can lament “unearned” wealth all we like, but there is a sufficient correlation that one cannot use the outlier of wealthy heirs who are entirely unproductive (many of whom are actually productive, but don’t have the reputation a rags-to-riches story brings) to muddy the waters.

The fact is that all wealth comes from an economic process of investment—either of time and labor or of capital as producers’ goods.

Those who accurately satisfy market demands with their investments, and do so more efficiently and accurately than their competitors, will earn a profit. Those who fail will operate at a loss.

Wealth concentrates in the hands of the most efficient in a free market, which we unfortunately do not enjoy in the United States. Despite this, we still have a sufficiently free market that those who do not operate too heavily under the coat-tails of lucrative government contracts can be judged to be more competent than others, and as a political realist I do not believe that any government-aligned individuals will be subject to these taxes (at least, subject to them in a way that is not repaid out of the general purse).

In short, the unrealized capital gains tax is likely to be targeted in such a way that it takes money away from those most capable of satisfying consumer demands and toward those who the government likes.

Liquidation and Disinvestment

The problem with the wealth tax is that it requires the liquidation of property, which will often involve some disinvestment.

Disinvestment is not always a natural market process. Investments that have paid off reward investors with yields, which take the form of increased value of the capital invested in a firm (e.g. on the stock market) or consumer goods sold at market. The former is driven by a venture’s capacity (or perceived capacity) for the latter.

Some disinvestment will occur because of unforeseen circumstances, time preference shifts, or other reasons for immediate consumption. This means that the investment will either be sold off or liquidated.

In the event of sale, the new investor must decide whether to continue the current course of action or re-allocate the existing capital to a new purpose.

Liquidation involves selling the producers’ goods currently in use for a direct cash payment.

Now, in practice this doesn’t need to involve a loss, since one investor could simply pass along a functioning enterprise to another.

But this is not guaranteed. With an unrealized capital gains tax, the market incentive is to get out of taxable assets. Investors who are already wealthy may choose not to invest, since they would be losing a significant portion of their investments to the government, and instead apply more of their wealth to consumer goods.

While this is not in and of itself bad—production must precede consumption and the resources will still eventually wind up invested in capital—it means that any enterprise too large to avoid the tax thresholds will break up.

The popular idea of the economy of scale is not an iron law, but investment leads to efficiency because otherwise investment would be a sub-optimal strategy. Disrupting investments, as forcing the sale of assets can do, means that these efficiencies disappear from the market.

Avoiding Disinvestment

Of course, there is a way to avoid disinvestment from the existing lines of production when paying a wealth tax, and that would involve taking a private property or business public and selling shares of it.

However, let us examine some of the associated effects of this.

With a private business, its current owner may be the best-suited to operate that venture. Further, there are advantages to private ownership, such as the ability to decide unilaterally during uncertain situations. Though publicly owned corporations use a CEO in this position, the CEO has incentives for a higher time preference than an owner, and is ultimately beholden to board politics.

At the very least, taking a business public involves legal and operational overheads that make it less efficient, even if the new operating structure leads to better decision-making.

“Taxing Money”

Socialists and the economically illiterate (but I repeat myself) often believe that wealth functions in reality like we depict it in cartoons and hip-hop videos. However, nobody is swimming in a pool of gold coins or walking around with a million dollars in high-denomination bills.

This is posturing and ostentatious display, and it is the sort of high time-preference behavior that actively militates against acquiring much wealth at all. Sure, the occasional fool may decide to buy a multimillion-dollar sports car instead of wisely investing their money, but this is simply the old adage about the fool and their money parting ways in real time.

In practice, people generate wealth through investment toward ends. This may be an investment for efficient consumption, as with home ownership—one reason the welfare state has ruined entire communities—or an investment toward efficient production.

There is a reserve demand for money, an amount of money which someone will hold ready, but the point of this money reserve is to hedge against uncertainty and permit action on the market. This is the money that would be in cash under a mattress or in checking accounts, and represents a tiny amount of the “saved” money in the economy.

Further, this is unlikely to be where wealthy people keep a significant amount of money because they could always secure short-term credit at agreeable rates because of their low credit risk and ability to put up existing assets as collateral.

The wealthy do not hoard away their money like a dragon’s loot. It is at the ready to be invested when an opportunity arises.

Some may object that there are the highly affluent who desire to live off savings instead of investing their money. But this both reflects a reward for prior investment at some point and a very rare case.

Usually those living off their savings still have their money managed—even a relatively impecunious retiree with a 401k is not sitting on cash but usually holding bonds or other investments which they will cash out when ready—so this is not a removal of money from the economy into some inert stockpile.

In fact, even an apparently inert bank deposit is likely stored in a fractional reserve bank—the money is not in the bank’s vaults but is used to extend credit. This is how banks wind up paying interest instead of charging fees to maintain accounts.

Money Supply Hazards

Let’s assume, however, that there is a large static collection of money somewhere that is just sitting around doing nothing and that this wealth tax finds it.

In an inflationary environment, taking this money out of reserves and into the market is a recipe for doubling down on inflation. The effect of this is to push marginal consumers out of the market by bidding up the cost of goods.

In fact, let us assume that we are able to take the investments of the wealthy and turn them into immediate benefits for the less wealthy through welfare payments without decreasing the supply of goods. Here, because the actual quantity of goods remains unchanged, all that has happened is that the relative advantage between middle and lower classes has closed, while the upper classes still possess greater assets.

In short, the effect is to let the unproductive enter the consumer goods market at the expense of the productive blue-collar and petite bourgeoise classes. Investors, the upper class.

Since the wealthy have an incentive to liquidate assets to avoid taxation (or to achieve optimal deals if the best buyers would offer a price on more of their assets than the tax required them to sell), they may actually enter the competitive market for goods they would not have otherwise bought, so that the threshold for the marginal consumer increases. This would mean that more people suffer a lack of resources, rather than fewer, as investors transition to consumers.

The Ultimate Conclusion of the Wealth Tax

A wealth tax, carried to its logical conclusion of rendering all property subject to seizure regardless of if it is on the market, would be a prerequisite of a great economic reset.

When all property is fair game for state seizure, there is only one outcome:

You will own nothing, and you will be unhappy.

If this is not reason enough to oppose the tax on unrealized capital gains, then it is important to understand that it will have two outcomes.

First, it will make private business-owners form corporations to divide up their companies, enabling takeover by government-aligned entities like Blackrock and Vanguard. This will involve selling some of their company in a fire-sale below market value to pay for whatever arbitrary assessment the government sets for the property.

Second, it will generate less income than expected, because of the natural loopholes and ways to avoid the plan, discourage investment, and move money out of America.