A Wealth Tax Might Be Moral But It Would Be A Disaster In Practice
There’s an idea going around that perhaps we should have a one off wealth tax to restore the public finances. The rich bastards have oodles of cash so if we demanded that they paid over 10% of it all then all would be fine. It’s even being said that this would be a moral solution: but it would work out appallingly in practice:
Should advanced countries implement wealth taxes as a means of stabilising and reducing public debt over the medium term? The normally conservative International Monetary Fund has given the idea surprisingly emphatic support. The IMF calculates that a one-time 10% wealth levy, if introduced quickly and unexpectedly, could return many European countries to pre-crisis public debt/GDP ratios. It is an intriguing idea.
The moral case for a wealth tax is more compelling than usual today, with unemployment still at recession levels, and with deep economic inequality straining social norms. And, if it were really possible to ensure that the wealth levy would be temporary, such a tax would, in principle, be much less distortionary than imposing higher marginal tax rates on income. Unfortunately, while a wealth tax may be a sound way to help a country dig out of a deep fiscal pit, it is hardly a panacea.
Here’s what the problem is. Sure, those rich bastards have lots and lots of stuff. But they ain’t rich bastards because they keep 10% of their stuff in cash under the mattress. No, their money is in buildings, stocks, bonds, antiques and leggy Russian models.
So, we now demand 10% of all they have (this is what a wealth tax means, we tax everything, not just earnings in any one year) and then what happens? Well, every rich bastard now needs to start selling some of his bonds, stocks, houses, antiques or leggy Russian models. To the extent that those last don’t depreciate fast enough on their own. So what happens to the prices of all of these things? They fall. And they don’t just fall they plummet: for who the hell can the rich bastards sell to if all rich bastards are selling?
Excellent, so, we’ve just engineered a collapse in asset values. And there’s a problem with that. There’s something called the “wealth effect”. If asset prices plummet then we all feel less wealthy (yes, not just the rich bastards) and when this happens then we get a recession. Actually, this is what happened a few years back: even if the financial system had not fallen over we would still have had a bad recession in the US because housing wealth fell by $8 trillion. That drop in wealth will indeed, through that wealth effect, lead to a recession.
So maybe it might indeed be moral to have a wealth tax. But do we really want to have another recession if we have one?