Why a “wealth tax” is terrible public policy (and this is not even a controversial observation among economists)

The trouble with Socialism is that eventually you run out of other people’s money.

Margaret Thatcher

For months now, Democratic presidential candidates have proposed a litany of new spending proposals to woo the electorate into voting for them.

These include:

  • Medicare for All, which has a $32 trillion price tag – assuming it is extended only to US citizens, though most Democratic candidates have suggested also extending it to tens of millions of undocumented immigrants. I am not sure this additional cost has ever been scored, and any number would also be dependent on changes to immigration policy. For example, if crossing the border were made into a civil offense *and* immigrants qualified for entitlement programs, there would likely be an unprecedented number of border crossings. This would, in turn, significantly increase the cost of Medicare for All.
  • Forgiving trillions of dollars in outstanding student loan debt.
  • “Free” postsecondary education at public institutions.
  • A “Green New Deal,” which has not exactly been well-framed. The legislation introduced by Representative Ocasio-Cortez has been estimated to cost over $90 trillion. Presumably, the candidates want something a little more… modest… than replacing or retrofitting every building in the country. But after Medicare for All for anyone on the planet who wants to enter the country, who knows.
  • Universal pre-kindergarten.
  • Universal child care.
  • Universal raises for child care professionals and teachers.
  • Hundreds of billions of dollars to combat the heroin crisis.

I’m sure there are many more that I did not list here. Basically, so long as you are not a member of the dreaded “1%,” the federal government is going to assume all of your household’s ordinary expenses.

Nevermind that our existing entitlement programs are going broke, and no one is even trying to solve that…. Let’s add more!

This also does not take into account the fact that America’s existing entitlement programs are all headed for insolvency with no current plan to shore them up.

I’m impressed that Millennials think they are going to get Social Security, let alone free health care. Lol.

And let’s not even talk about how many public pensions are underfunded, which will be the next big generational pissing match to get lobbed toward the federal government. If you think student loans are a problem, wait until you see what California, Illinois, New Jersey, Connecticut, Kentucky, and Puerto Rico owe their workers that they’ve only saved pennies to pay out.

There is not enough money in the United States to fund Democrats’ spending proposals. Literally.

The obvious problem is how to pay for any single one of these proposals, let alone several of them. I think they are well over $100 trillion in spending proposals at this point. No kidding. According to the Federal Reserve, the aggregate net worth of U.S. households and non-profit organizations is barely $100 trillion, a record level both in nominal terms and purchasing power parity. This means that even if the federal government confiscated every single last dime from American households and every charity in the country, Democrats could still not pay for their spending proposals. That’s how batshit these people have become.

Of all the socialist-chic candidates, Bernie Sanders is at least approximating honesty when he tells people that he’s going to raise their taxes dramatically to fund his vision of universal health care. You won’t be paying health care premiums; you’ll be paying taxes. A lot of taxes. (In exchange for health care from the same geniuses that have veterans blowing out their brains in the parking lot of VA hospitals. But I digress.) Perhaps you won’t notice that he’s only changing “pay to the order of” on the check you write.

But let’s ignore the headline numbers and talk about a wealth tax anyway

The Hot New Thing among Democratic candidates is now a “wealth tax.” It’s not a hot new thing elsewhere in the world. In fact, a dozen other countries have already tried the wealth tax concept and promptly dumped it:

While as many as a dozen countries in Europe had a wealth tax in the early 1990s, that number has dropped to three as of 2018, according to an Organisation for Economic Co-operation and Development report. (In 2018, France replaced its net wealth tax with a new real estate wealth tax.)

So why are Democratic candidates proposing an idea that everyone else in the world has considered but rejected?

I imagine there are two reasons. One, the idea of a wealth tax is included in Thomas Piketty’s tome on income inequality, Capital in the Twenty-First Century. This made a bad idea trendy again. Two, they have nothing else. They are proposing an obscene amount of new spending and are hoping the electorate’s economic resentments will cancel out numeracy. Polls suggest they might be right, particularly among highly innumerate younger generations.

Since some Americans seemingly have to re-discover why socialist concepts of governance necessarily and inevitably fail in the real world, here’s why a wealth tax is a terrible idea.

(1) A wealth tax will not generate as much money as Democratic candidates suggest.

Let’s bracket off the fact that Democratic candidates’ wealth tax projections are insufficient to pay for their proposals in the first place. Even liberal economists acknowledge that the projections they have made are grossly inflated.

This is why the idea of a wealth tax was never seriously considered by the Obama administration. Obama’s policy advisors thought it was laughable when he was in office, and they are trying to communicate that is laughable now.

There is a reason why Elizabeth Warren et. al. have chosen policy advisors that do not have experience in government scoring budget measures. Anyone with experience observing how wealthy people skirt the estate tax understand that people wealthy enough to have tax advisors will understand how to shelter their wealth from taxation. It would do Warren well to take a vacation in the Cayman Islands sometime. Extreme wealth is extremely portable.

(2) “Wealth” is not “cash.” The assets of America’s wealthiest families can fluctuate dramatically day-to-day and can be extremely difficult to value.

What’s the daily mark-to-market value of Zuckerberg’s modern art collection? How much does a $200 million yacht depreciate when you sail it away from the yacht broker? How often are you going to value a privately held company?

Every country that has ever implemented a wealth tax has discovered that it is an administrative nightmare to enforce. It’s not as simple as asking “ultra-millionaires” to check their bank account.

You’d think Warren, an expert in bankruptcy law, would understand this. There’s a reason bankruptcy proceedings can drag on for years. You can dispute the valuation of illiquid assets until the end of the republic.

(3) Contrary to what Warren claims, her proposed wealth tax is not at all like paying property taxes on real estate.

I almost can’t believe Warren is dense enough to make a claim like this. But here we are explaining how taxing unrealized gains in Facebook stock is not like taxing a home on a cul-de-sac in Phoenix. And why she’d essentially be taxing the same assets several times. And why she’d kill the market that state and local governments use to fund infrastructure projects, like roads and schools.

First, traditional property taxes have a comparatively efficient tax base. Traditional property taxes fall on both the building and the land underneath. Land is thought of as a very good tax base because its supply is fixed—individuals and businesses cannot avoid a tax on land by producing less of it. Because of this, economists generally think that land taxes are very efficient taxes. In many jurisdictions, the land is a significant portion of the total value of real estate. As a result, a meaningful portion of real property taxes share this positive characteristic with a land tax.

Warren’s wealth tax would apply to land, but it would also fall on many other types of assets, some of which are much more responsive to taxation. For example, Warren’s wealth tax would fall on the ownership of financial assets such as corporate stock or bonds. A wealth tax would reduce, sometimes significantly, the return to these assets. For example, municipal government bonds, which have interest rates around 2 to 3 percent, would face effective tax rates higher than 100 percent. This would make it much less likely that individuals would hold on to these assets. This could have several negative effects on the broader economy, including a reduction in national saving.

Another virtue of the traditional property tax is that the taxable asset isn’t particularly hard to value. While there can be controversy over the value of property in a given year, localities are pretty good at determining it. One reason is that there is a lot of property to compare to and homes are sold frequently in many places. There are companies that can tell homeowners what their house is worth at any given time.

The wealth tax would fall on many assets that are very hard to price. For example, a closely held business—one that is not traded on the market—does not have a known value, and the value can change significantly from one year to another. As a result, it would be very challenging to apply the wealth tax. Tax authorities would either need to guess or use some sort of formula to impute the value—a process taxpayers would be unlikely to trust.

For homeowners, there is another important distinction to consider. Under current law, the returns to homeownership are mostly exempt from the income tax. Under current law, the first $250,000 ($500,000 for married couples) of capital gains on the sale of your primary residence are exempt from the income tax. In addition, the imputed rental income (the rent you, as a homeowner, pay yourself) is exempt from the income tax. The CBO shows an effective rate close to zero. As a result, the state and local property tax is usually the only tax that falls on real estate for homeowners.

In contrast, a lot of the wealth under Warren’s wealth tax is already taxed under the income tax before it’s hit by the wealth tax. For example, dividends from corporate stock are subject to the individual income tax. Then the value of the stock would be taxed under the wealth tax. The assets subject to both taxes would face significant effective tax rates—a combined tax burden that homeowners don’t face.

(4) A wealth tax will be an economic drag. Not just because it’s going to move wealth away from the country, but because it will influence major investment decisions.

I often say that I would rather get a root canal than talk to a Democrat about economics. Democrats tend to assume that their fellow citizens are not rational economic actors. You create a new tax, they think, and people just roll over and pay it. In reality, people change their behavior in response to ordinary activity suddenly becoming a tax penalty. In policy circles, these behavioral shifts are called unintended consequences.

This means a tax that Warren bills as forcing the wealthy to pay for everyone else to carry less household expenses will actually impact what the latter earns. Or even if they have a job at all. (But, hey, at least that would cut down on child care expenses.) Wealth taxes reduce investment, wages, employment, incomes, and output. They depress financial holdings, which most Americans store their own wealth in.

This also means that this tax, which takes so many government resources even to enforce, reduces tax revenues to the federal government, state governments, and local governments through lost economic activity.

Before you pull a lever for a charlatan selling you on ideas that other countries have already tried and rejected as abysmal failures, ask yourself this question: Will I ever see any of this free shit they promise? Or will I actually be worse off economically than I am now, just like every socialist experiment that has taken place in the history of human civilization? If there is a consensus among educated people that these policies fail, why are they centerpiece of these candidates’ campaigns?

Bernie Sanders has no clue how student loans work

This is not a post about politics. This is a post about basic economics. I really don’t care about your politics.

First of all, let’s talk about where student loans come from and how financial bubbles are created. We can all agree that younger generations are getting absolutely fucking screwed when it comes to obtaining an education. But not everyone who believes this understands the mechanics. And that leads them to support objectively insane public policy positions.

Wall Street is responsible for many yards of bullshit, but they are not even remotely responsible for the student loan crisis. Two other forces in American society are: (1) the federal Department of Education, and (2) postsecondary institutions with bloated administrations and ridiculously lavish capital construction programs.

In the immediate wake of the financial crisis, a lot of legislation was passed, among it the Affordable Care Act (colloquially known as Obamacare). The ACA did not just pertain to health care, however. It was what is known in government as a “Christmas tree,” as lawmakers’ and lobbyists’ every desire was dangled from it. This included higher education. A significant provision of that legislation was that the federal government assumed responsibility for substantially all student lending in the country. The federal government actually took over the books of a lot of state-operated nonprofits, which were far more generous than the federal government in terms of servicing loans and turned a lot of their own investment profits into loan relief.

Student loans do not materialize from nowhere. Someone has to provide the funds. To make funds available for student borrowers, the US federal government issues Treasury bonds, which is essentially borrowing a ton of money from places like China and Japan. (And Wall Street! The federal government relies on borrowing money from Wall Street to cash flow.) US taxpayers borrow that money, and the proceeds from those loans are then turned into loans to student borrowers. Make no mistake: These are very generous, taxpayer-subsidized loans. If you walked into Bank of America as an 18-year-old and told the loan officer that you wanted a low interest rate loan for $50,000 with zero regard for your credit history or employment or future earnings, so you could study accounting or philosophy or religion or gender studies, and please pay for your housing and meal plan while they are at it, Bank of America – a Wall Street institution – would laugh you out of the bank. Because to them you are an objectively bad bet on loan performance. And they are not wrong. Most of the student borrowers that have taken out such loans have either defaulted or are in one of the federal government’s very generous forbearance programs (forbearance means you aren’t paying, but the government’s loan servicer is agreeing not to destroy your life just yet). Because their earnings do not match the cost of their education. If they did, there would be no problem here.

So if the federal government suddenly decides to tell you that you do not have to repay your loan, what happens to those Treasury bonds that the government issued to borrow money from China and Japan to fund your education? Nothing. Nothing at all. American taxpayers must still repay those funds at the barrel of a gun (or, let’s be honest, in the path of a nuke). The federal government would never entertain the idea of not returning $2 trillion plus interest to China. That is the stuff of world wars and not the silly swatting at unmanned drones that is happening these days.

Enter Bernie Sanders’ “financial transaction tax,” which Bernie Sanders says will tax Wall Street to pay for the education you received. Bracket off the fact that, again, the federal government makes student loans and not Wall Street. He instead is going to tax a fixed percentage of stock, bond, and *gasp* derivative transactions.

Bernie Sanders is either colossally stupid, or he wants to buy votes and he’s betting that younger generations do not understand a few things: (1) that the people who participate in the financial markets are not an exclusive group of Gatsby-esque assholes in New York, but every person in the US who has set away money for retirement, for their kids’ education, for a down payment on a new home, or pretty much anything that requires saving; (2) that “derivatives” are not just interest rate swaps used to manage portfolios of mortgages and other financial products, but also the options that are used to mitigate risk in, say, the mutual and index funds that almost every American owns, (3) that there’s not going to be fat cats rolling over and accepting the political resistance affecting their bottom line, but that a financial transaction tax is actually a TAX ON CONSUMERS. It’s regressive, not progressive. It hurts the little guy more than the big guy as a matter of fact, not theory. And even the transactions that are institutional, like interest rate swaps used to hedge mortgages, will only make financial products more expensive to consumers, as the cost of hedging the risk will just be passed on to consumers in higher lending fees.

His plan might help the sliver of younger generations who (1) borrowed an epic ton of money for an education they cannot use, and (2) have no income / are trying to fend for themselves in one of the US cities that is experiencing a massive real estate bubble right now (which the federal government is also propping up – noticing a pattern?). But it’s going to be a wash for the people who borrowed within their means and while experiencing loan forgiveness are going to see its long-term impact on their savings. Only Washington can take your money to give you money back and think you’ll be delighted with that outcome. Because they think you are an idiot pawn, and for a lot of people they aren’t wrong.

Which brings us to the other culprits in this situation: universities. It’s not an accident that a young adult in the 1960s (Bernie’s generation) could afford college by working during the summer while younger generations now have educations that cost a quarter of a million dollars and compete with mortgages for their chunk of the American Dream.

College administrators understand this one important point: That young adults can borrow virtually unlimited money from the federal government (ultimately from China and Japan) to pay for their education, and this means that colleges can charge virtually unlimited amounts for an education. The dynamic here is not at all that different than the liar loans of the mortgage crisis and the financial bubble that ensued. Bankers understood that if they were originating mortgages to sell to investors and not holding them on their books, they could lend virtually unlimited amounts of money with no concern over whether the debt could be repaid. Same with colleges. They have no skin in the game financially.

Higher education is an antisocial enterprise now, and they have created a debt-fueled financial bubble in higher education. They sell the idea that younger generations will be ruining their future financial lives if they choose to do something that does not require a degree, but after you buy a degree from them, your financial life is immediately ruined. They’ve turned college into a second infancy, with luxury suites and student centers with rock walls and restaurants – just some warped hyper-materialistic perversion of education in the place of building skills and making an effort at job placement.

The federal government does not have to absorb trillions of dollars in cost now (and pass those costs on to consumers) and trillions of dollars going forward (who knows where those funds will come from) to break this miserable cycle. They can demand that colleges have financial skin in the game for the graduates they have released into the world to fail. They can strip colleges and universities of their nonprofit status and start clawing back some of these multi-billion-dollar endowments that universities hoard while bankrupting their raison d’etre.

This dynamic needs to change by holding the people who are actually responsible responsible. Not by milking narratives of resentment from 2008 that have literally nothing to do with the problem.

What Bernie Sanders is proposing is just going to enrich the people responsible yet again.