Tax luxury, not wealth or income

Another FYI article.

"...You don’t want a punitive tax on income or wealth; you want a punitive tax on very high consumption—say beyond $50,000,000/year. Gates and Buffett would still be able to use their income for charity and investment purposes, with no almost deterrent effect from high taxes. They’d only be punished for an excessively lavish lifestyle. Now admittedly there might be a few billionaires that would be deterred by a high consumption tax, say Larry Ellison. But even there, the deterrent effect would be less than you might think. That’s because a lot of the high-end consumption is positional goods.... The high tax rates would not just apply to Larry Ellison, but to all the superrich. Thus if Larry had to scale back from a 500-foot yacht to a 400-footer, his closest rival would scale back from a 400-footer to a 320-footer. The relative ranking of consumption would be roughly unchanged. Ditto for real estate, where the exact same people would still live on the ocean in Malibu, but the price of land would fall to reflect the lower consumption of the superrich. Ditto for fine art. Larry Ellison can enjoy parties on a 400-foot yacht surrounded by young Ukrainian beauties just as much as he can enjoy parties on a 500-foot yacht, as long as his closest rivals only have 320-foot yachts. That’s how human brains work, and that’s why even a 70% or 80% tax on consumption doesn’t really deter work effort from the superrich, or at least not as much as conservatives fear...."
Scott Sumner, "Tax luxury, not wealth or income,"The Money Illusion, February 16, 2019, https://www.themoneyillusion.com/tax-luxury-not-wealth-or-income/

The Money Illusion: Tax luxury, not wealth or income

I favor very high marginal tax rates on the super rich, say 70% to 80%. But I am also opposed to all income taxes and all wealth taxes. Why?

Let’s start with the conservative argument that taxes on the super rich will deter work, saving, and investment, by reducing the incentive to build more wealth. Is it true? The answer will depend on the type of tax.

If you look at the behavior of superrich people like Bill Gates and Warren Buffett, they tend to spend only a few extra pennies on consumption, for each extra dollar they earn. Thus it does not seem like extra consumption is an important motivation for the superrich, beyond a certain point. So perhaps high taxes are not a disincentive.

Ah, but you might argue that they have other motivations. They like to be big time philanthropists, or they like to build their business empire up to greater and greater heights. That’s their real motivation, and a punitive tax rate would therefore discourage them from putting in the extra effort that we want to get from talented people. I agree.

But that proves my point! You don’t want a punitive tax on income or wealth; you want a punitive tax on very high consumption—say beyond $50,000,000/year. Gates and Buffett would still be able to use their income for charity and investment purposes, with no almost deterrent effect from high taxes. They’d only be punished for an excessively lavish lifestyle.

Now admittedly there might be a few billionaires that would be deterred by a high consumption tax, say Larry Ellison. But even there, the deterrent effect would be less than you might think. That’s because a lot of the high-end consumption is positional goods.

Let’s suppose that currently the biggest yacht is a 400-foot monster, and Larry Ellison wants a 500-foot one—to impress his friends. Also suppose that a steep consumption tax prevents Larry from getting this mega-yacht. You might argue that this reduces his utility, and would discourage his effort to make Oracle the best company it can be.

But here’s what you are missing. The high tax rates would not just apply to Larry Ellison, but to all the superrich. Thus if Larry had to scale back from a 500-foot yacht to a 400-footer, his closest rival would scale back from a 400-footer to a 320-footer. The relative ranking of consumption would be roughly unchanged. Ditto for real estate, where the exact same people would still live on the ocean in Malibu, but the price of land would fall to reflect the lower consumption of the superrich. Ditto for fine art.

Larry Ellison can enjoy parties on a 400-foot yacht surrounded by young Ukrainian beauties just as much as he can enjoy parties on a 500-foot yacht, as long as his closest rivals only have 320-foot yachts. That’s how human brains work, and that’s why even a 70% or 80% tax on consumption doesn’t really deter work effort from the superrich, or at least not as much as conservatives fear.

I’m not sure the best way to implement a progressive consumption tax. One could imagine two systems, one for employees of companies and one for the self-employed. Company employees would simply pay a progressive payroll (FICA) type tax. Very simple—no forms to fill out, even for LeBron James. A wage tax is identical to a consumption tax, in the long run.

The self-employed would pay an income tax with unlimited 401k privileges (which is effectively a consumption tax). So they’d only be taxed when they consumed their income. Income from any shares you own in your own company would be viewed the same as income earned by the self-employed—i.e. “wage income”.

The heirs of the rich would receive their inheritance in 401k-type accounts, and they’d pay taxes as they pulled the money out of those accounts to consume it.

There’s a difficult issue in determining how to tax existing stocks of wealth, at the point the new system goes into place. Perhaps a compromise where existing stocks of wealth above a certain threshold are put into a 401k-type structure, but taxed at a lower rate—in recognition of the fact that a part of the wealth has already been taxed.

If your country needs to raise large sums of money (and it shouldn’t-see Singapore), you need multiple tax systems; otherwise there will be too much evasion. These might include VATs, property taxes and carbon taxes. The property tax is a sort of tax on housing consumption, to make up for the fact that VATs don’t include housing. Currently, the superrich in places like New York pay a far lower rate of property tax than average homeowners, whereas they should pay a far higher rate. The fact that even liberal cities like New York are this regressive is an indication of the confused nature of our debate over taxes. Commenter “dtoh” has proposed a VAT where the poor are rebated what a poverty line person would spend on consumption, so that the tax is not regressive.

Read the debate in the blogosphere and you’ll see that people are horribly confused by taxes; they aren’t even debating the right issues. They talk piously about the need to tax capital income, which is the worst possible way to think about taxes. Meanwhile Larry Ellison will continue to enjoy his 500-foot yacht, with the extra 100 feet made of steel and employing labor that could have been used to provide dozens of cars for average people.

Sad!

PS. Some people like the following analogy. On Christmas Eve, people bring presents and put them under the tree. The next morning, people show up and grab presents from under the tree. Should we tax those who put them under the tree, or those who take them away the next morning? Based on how much you produce or how much you consume?

PPS. This post is on the superrich. I’m not sure how to handle the far more numerous ordinary rich-perhaps a 50% MTR on consumption. That sounds bad, but don’t forget the unlimited 401k privileges for the rich self-employed. That sort of tax would actually be less than 50% of one’s income. If they are rich wage earners, you can view the system as unlimited Roth IRA privileges.

PPPS. This post was a bit unfair to Larry Ellison, as he sold his 453-foot yacht to David Geffen and bought a smaller one, which could access more ports. And he has far more sophisticated taste than Trump. But I still maintain that high-end consumption is largely about positional goods.