Wealth Tax in 2021: Scheuer and Slemrod's Analysis PDF

Journal of Economic Perspectives—Volume 35, Number 1—Winter 2021—Pages 207–230 Taxing Our Wealth Florian Scheuer and Joel Slemrod A primary reason for imposing a wealth tax is to shift the tax burden toward the most affluent households. This goal is evident in the choice of wealth as a base for the tax, given that wealth is considerably more unequally distrib- uted than the most common tax bases—income and consumption. In 2016, for example, the top 1 percent of households ranked by net worth held 40 percent of US wealth, while the top 1 percent ranked by income earned 24 percent of income (Wolff 2017). In addition, wealth taxes typically have high wealth thresholds before any tax is due and may also include a graduated structure of tax rates that apply above the thresholds. Heightened consideration of a wealth tax is almost certainly tied to the increase in inequality over the past four decades: although the details of this increase are disputable, in our view the conclusion that it has increased non- trivially is not (for discussion, see the “Symposium on Rising Inequality of Income and Wealth” in the Fall 2020 issue of this journal). The wealth tax has had some prominent academic adherents: for example, Kaldor (1956) called for a wealth tax for developing countries, Allais (1977) proposed to replace most direct taxes with a 2 percent wealth tax in France, and Piketty (2014) called for a global progressive wealth tax. But even some of those who are concerned about rising economic inequality raise questions about whether a wealth tax is the appropriate policy response. Measuring some forms of wealth Florian Scheuer is the UBS Professor of Economics of Institutions, University of Zurich, Swit- zerland. Joel Slemrod is the Paul W. McCracken Collegiate Professor of Business Economics and Public Policy, Stephen M. Ross School of Business, and Professor of Economics, Univer- sity of Michigan, Ann Arbor, Michigan. Their email addresses are [email protected] and [email protected]. For supplementary materials such as appendices, datasets, and author disclosure statements, see the article page at https://doi.org/10.1257/jep.35.1.207. 208 Journal of Economic Perspectives on an annual basis is very difficult: for example, how does one value pension accounts, life insurance, trusts, or closely held family corporations? Heteroge- neous measurability of assets could cause horizontal inequity, a flight to more easily undervalued assets, and consequent understatement of net wealth. Recent experience is not encouraging: while a dozen high-income European countries levied wealth taxes in the recent past, now only three retain them, which suggests that the other nine countries determined that any benefits associated with such taxes do not justify their costs. In addition, there are a range of other policy options to tackle inequality. In this essay, we begin with a basic conceptual discussion of the base and tax rates for a wealth tax. We then provide an overview of the recent wealth taxes in European countries. The United States has never levied an annual wealth tax, but during the 2019–20 contest for the Democratic presidential nomination, wealth tax proposals were put forward by Senators Bernard Sanders (D-VT) and Elizabeth Warren (D-MA). As we will see, none of the European wealth taxes either applied rates anywhere near the 6 or 8 percent top rates in these proposals nor established such a broad base, and only Switzerland raises a level of government revenue compa- rable to these US proposals. However, the United States does have experience with some taxes that have aspects similar to a wealth tax. As we discuss, the property tax is an annual tax on ownership of immovable property, the estate tax is a wealth tax imposed at time of death, and the capital gains tax is imposed on some increases in the value of some assets—albeit in a haphazard way. We then turn to what we know about the behavioral effects of a wealth tax, including effects on real behavior, financial choices aimed at reducing the burden of a wealth tax, outright tax evasion, and administrative and compliance costs. Studies of the European wealth taxes often, but not always, find a substantial behavioral response, although the nature of the response varies. We emphasize that any lessons drawn from the European experience must be applied to the recent US proposals with substantial caution, because the design features of recent proposals—rate schedule, broadness of the base, and enforcement provisions—are very different from any previous wealth tax.1 Finally, we look to optimal tax theory—should we as a society decide to our tax wealth and, if yes, how so? We point out that the former conventional wisdom— that an optimal tax system would feature no taxes on capital—has been overturned. Instead, we review a series of arguments that justify some form of progressive taxa- tion of wealth accumulation both in the short and long run. We also discuss under which conditions such taxes should take the form of a wealth tax versus alternative policies that have similar objectives. We conclude with an overview of some political economy arguments for taxes on wealth accumulation that go beyond the usual redistributional objectives. 1 We do not address whether a wealth tax would be constitutional in the United States, a subject of some controversy. For the two views, compare Johnson and Dellinger (2018) and Jensen (2019). Florian Scheuer and Joel Slemrod 209 What Is a Wealth Tax? The Base of a Wealth Tax In principle, the base of a wealth tax is net worth—the value of assets minus debts. Like all taxes, in practice, the base to which tax rates are applied could be narrowed by exemptions, deductions, or preferential treatment (for example, discounted valuation) of certain components of net wealth. Determining the base for a wealth tax raises some thorny practical issues. For example, the market value of a closely held, family-run business, or of personal prop- erty perhaps received via inheritance, is difficult to estimate at high frequency. The value of many assets, including firms, consists of a projected flow of future income, which makes valuation highly sensitive to the applied discount rate. Another issue is that wealth and wealth tax liability is not always matched by disposable income in a given year, and, as a result, requiring the tax to be remitted annually may raise liquidity problems. Past and current wealth taxes contain many base-narrowing features. For example, all wealth taxes exempt wealth below a certain threshold, which varies considerably across countries. Some wealth taxes do not apply to wealth held in a pension or life insurance account. Some have exemptions or reduced tax rates for the wealth in one’s primary residence; more generally, wealth tax rules often differ across real estate and financial assets. There are reduced or deferred wealth taxes for certain business assets—for example, to prevent a situation where a family- owned firm would need to be liquidated to satisfy a wealth tax liability. Wealth tax bases often leave out trusts established to pass wealth to later generations. Finally, wealth taxes have not been applied to implicit wealth in the form of an individual’s human capital, although this is sometimes hard to disentangle from the value of business partnerships (such as law firms or doctors’ practices). The Rate of a Wealth Tax It is a useful starting point to think of a wealth tax as a tax on the “normal” rate of return to capital. A wealth tax at a rate of tw is equivalent to a tax rate of tw/r on capital income where r is the interest rate. For an asset whose rate of return is 8 percent, a 4 percent wealth tax corresponds to an annual 50 percent tax rate on capital income and an 8 percent wealth tax (the top rate in Sanders’s proposal) would be equivalent to a 100 percent tax rate on capital income. Thus, the income- tax-equivalent of a given wealth tax rate is smaller, the higher is the rate of return. However, a wealth tax differs from a capital income tax in an important way. For a given amount of wealth, the tax liability of a wealth tax does not depend on the amount of capital income the wealth actually generates: in contrast, a capital income tax liability is related to that flow. For example, if all of one’s wealth were held in a zero-interest demand deposit, a capital income tax would generate no tax liability, while a wealth tax would. If wealth declines in a given year—that is, the return for that year is negative—the wealth tax still applies. Because a wealth tax affects the rate of return to saving, it changes the rela- tive price of consumption across time. For instance, in a world where the rate of 210 Journal of Economic Perspectives return r = 0.07, an 8 percent wealth tax turns a 7 percent rate of return before tax into a negative 1 percent return after tax.2 To put it another way, an initial investment of $1 with a 7 percent return will compound after 30 years to a total of $7.61 (= (1 + 0.07)30). However, with a negative 1 percent return arising from a 7 percent return and an 8 percent wealth tax, $1 after 30 years will fall to $0.74 (= (1 – 0.01)30), or just one-tenth as much. Tax rates that might sound low in the income or sales tax context are actually much higher when they become part of the annual rate of return that is compounded over time. Wealth Taxes: Existing and Proposed European Wealth Taxes In 1990, twelve European countries levied an annual tax on net wealth. By 2018, only four—France, Norway, Spain, and Switzerland—levied such a tax, with Switzerland raising more than three times as much revenue as a fraction of total revenues (3.9 percent) as any of the other three countries (OECD 2018). In 2018, France replaced its annual wealth tax with a tax only on immovable property. Italy levies an annual tax on financial assets in the form of a stamp duty on bank and securities accounts, and the Netherlands has a hybrid system with similarities to an annual wealth tax, imputing an asset-type-specific rate of return to assets and assessing a 30 percent tax on those imputed returns.3 Table 1 provides some summary statistics about wealth taxes in high-income European countries, and then in the bottom two rows compares them to the proposals made by Senators Sanders and Warren in 2019. For the European wealth taxes, the average top rate was about 1 percent. Finland, Sweden, and Switzerland had top rates reaching nearly 4 percent in the past, and the highest current rate is in the Spanish region Extremadura at 3.75 percent. But the Spanish system, certain Swiss cantons, and, in the past, some other countries feature a cap on the sum of wealth and income taxes as a fraction of taxable income. Such a cap limits the liquidity problem of a high ratio of income plus wealth tax liability to disposable income—and has the effect of imposing a zero marginal tax on wealth for those at the cap. The cap also provides an additional incentive to reduce reported taxable income. Many of the wealth taxes described in Table 1 feature exemptions or preferen- tial treatment of some forms of assets, notably one’s main residence, life insurance proceeds, pension wealth, and business assets. The exemption thresholds of these countries’ wealth taxes average about €500,000 for married couples. 2 The real average growth rate of the total wealth held by those on the Forbes 400 list of the wealthiest Americans has been 7.3 percent per year between 1982 and 2018. 3 Several non-European countries have had wealth taxes, including Argentina, Bangladesh (more recently a net-worth-triggered income tax surcharge or net wealth tax, whichever is higher), Colombia, India (repealed in 2015), Indonesia (abolished in 1985), Pakistan (removed in 2003 and reinstated in 2013), and Sri Lanka (1959–1993). Taxing Our Wealth 211 At first blush, it does not bode well for wealth taxes that of the dozen European countries that have had them in the last three decades, only one-quarter of them still do.4 Why did the other three-quarters abandon them? A 2018 OECD report lists a number of concerns: efficiency costs, risk of capital flight, failure to meet redistrib- utive goals, and high administrative costs. In Germany, the Federal Constitutional Court deemed the wealth tax unconstitutional in 1995 on the grounds that the tax’s distinction between property and financial assets was an infringement against the fiscal principle of tax equality (Drometer et al. 2018). In Sweden, it was argued that the special treatment of business equity made the wealth tax regressive—taxing middle-class wealth (housing, financial assets) and exempting the wealthiest individ- uals’ assets (large, closely held firms)—and it was blamed for spurring tax avoidance and evasion, including capital flight to tax havens (Waldenström 2018). The Swiss Example Of the three European countries that still levy a wealth tax, Switzerland raises by far the most revenue as a share of overall tax revenue, amounting to 1.1 percent of GDP in 2018, which is comparable to the revenue projected for the recent US proposals. Hence, the Swiss example is of particular interest for the wealth tax debate in the United States. The wealth tax in Switzerland has a long history, and in fact, predates the modern income tax. The Swiss tax system is generally structured in three layers: the federal, cantonal, and municipal level. There is no federal wealth tax, but all cantons must levy a comprehensive wealth tax, which they have significant freedom in designing. Eight cantons impose flat rates (above some exemption level), and the other 18 feature graduated rate schedules. Each municipality then chooses a multiplier that is applied proportionally to the cantonal tax rate schedule. Hence, an individual’s overall tax liability depends on both the canton and municipality of residence. This highly decentralized system induces local tax competition and migration. In 2018, the combined cantonal and municipal marginal wealth tax rates in the top bracket ranged between 0.1 percent (canton of Nidwalden) and 1.1 percent (canton of Geneva). In 16 of the 26 canton capitals, the annual top wealth tax rate was below 0.5 percent. There is also some variation in the tax-exempted amounts, ranging in 2018 from about $55,000 in the canton of Jura to $250,000 in the canton of Schwyz (for married couples). Hence, even though it raises similar overall revenue as the estimates for the US proposals, the Swiss wealth tax is targeted at a larger share of the population and is substantially less progressive. The base of the Swiss wealth tax is broad: in principle, all assets, including those held abroad, are taxable. Only foreign real estate, common household assets, and pension wealth are exempt. The tax liability is based on net wealth, so taxpayers can deduct mortgages and other debt. The annual reporting requirements for assets 4 The Florida intangibles tax offers a cautionary tale closer to home. It could be avoided by putting intangibles in trust in December and distributing them out of trust in January, to the point that it became commonly known as a voluntary tax; it was repealed in 2007. 212 Journal of Economic Perspectives Table 1 European Wealth Taxes and the Sanders and Warren Proposals Revenue Top marginal rate Exemption level Years of as % of enforcement GDP Most recent Ever Single Married Country/plan [3a] [3b] [4a] [4b] Austria 1954–1994 0.14% 1.00% 1.00% None None Denmark 1903–1997 0.06% 0.70% 2.20% € 320,657 € 641,314 Finland 1919–2006 0.08% 0.80% 4.00% € 250,000 € 500,000 France 1982–1986, 0.22% 1.50% 1.80% € 1,300,000 € 1,300,000 1989–2017 Germany 1952–1997 0.11% 1.00% 2.50% € 61,355 € 122,710 Iceland 1096–2006, 0.48% 2.00% 2.00% € 473,248 € 630,997 2010–2015 Ireland 1975–1978 0.10% 1.00% 1.00% € 88,882 € 126,974 Luxembourg 1934–2006 0.55% 0.50% 0.50% € 2,500 € 5,000 Netherlands 1965–2001 0.18% 0.70% 0.80% € 90,756 € 113,445 Norway 1892–present 0.45% 0.85% 1.10% € 157,833 € 315,666 Spain 1977–2008, 0.18% 0%–3.75% 3.75% € 400,000– € 800,000– 2011–present 700,000 1,400,000 Sweden 1947–1991; 0.19% 1.50% 4.00% € 166,214 € 221,619 1991–2007 Switzerland (1840–1970)– 1.08% 0.1%–1.1% 3.72%* € 25,380– € 51,150– present 116,250 232,500 Sanders n/a 1.56% 8.00% n/a $16,000,000 $32,000,000 Warren n/a 1.34% 6.00% n/a $50,000,000 $50,000,000 (continued) and liabilities allow the cantonal tax authorities to track the year-to-year evolu- tion of wealth and cross-check it against reported income (the so-called “wealth development test”), so the wealth tax serves a supporting role for income tax enforcement. Several aspects of the broader Swiss tax system provide context for the greater role of the wealth tax there. First, there is no capital gains tax on movable assets (for example, shares of stock in a company) unless the owner professionally trades securities.5 Second, almost all cantons have abolished taxes on gifts and bequests from parents to children. The Swiss wealth tax therefore serves as a backstop to at least partly substitute for a capital gains tax and an estate tax, which are common in other countries. Third, due to the institution of bank secrecy within Switzerland, third-party reporting of financial assets is precluded, which constrains enforcement. Fourth, while there are some guidelines for the valuation of privately held busi- ness assets based on a weighted average of capitalized earnings in recent years and net asset holdings (Hongler and Mauchle 2020), it remains subject to considerable 5 As for real estate, there is a special capital gains tax at the cantonal level as well as a property tax at the municipal level. Florian Scheuer and Joel Slemrod 213 Table 1 European Wealth Taxes and the Sanders and Warren Proposals (continued) Treatment of: Estate/ No. of Cap on Main Life Business inheritance/ marginal rates liability? residence insurance Pension assets gift tax? Country/plan [7a] [7b] [7c] [7d] Austria 1 N T T T T N Denmark 1 Y T E E T Y Finland 1 Y TP E E T Y France 5 Y TP T E E Y Germany 1 N T T E TP Y Iceland 2 N T E E TP Y Ireland 1 Y E T E TP Y Luxembourg 1 N T T E TP Y Netherlands 1 Y TP E E TP Y Norway 1 N TP E E TP N Spain 8 Y TP T E E Y Sweden 1 Y T T E E N Switzerland 1–1,000 Y* TP T E TP Y Sanders 8 N T T T T Y Warren 2 N T T T T Y Notes and sources: Countries with currently active wealth taxes are shaded in gray. For inactive countries, the table reports information as of the most recent active year. The Sanders and Warren plans are as shown on campaign websites as of April 20, 2020. Data for Iceland come from OECD 2018, Herd and Thorgeirsson 2001, Krenek and Schratzenstaller 2018, and conversations with Thorolfur Matthiasson. : OECD 2018, p. 76, Table 4.1. France abolished its wealth tax in 2017 and replaced it with a tax based on real estate; in 1096 (not a typo) Icelanders began paying a 1% tax on wealth (in fact, a tithe based on a 10% tax applied to an assumed 10% return on assets); Sweden made a major change in 1991; Switzerland’s cantons introduced the tax gradually, with full adoption by 1970. : OECD Global Revenue Statistics Database, line 4210 (individual recurrent taxes on net wealth). For active countries the value is for 2018. For inactive countries, the value is for the most recent full active year. For Ireland, McDonnell 2013, p. 24; for Iceland and Luxembourg, Krenek and Schratzenstaller 2018, pp. 23–24. : OECD 2018, p. 88, Figure 4.2 and various historical sources (Du Rietz and Henrekson 2014; Kessler and Pestieau 1991; Lehner 2000, Sandford and Morrisey 1985). The Spanish central government top rate is 2.5%; some regions levy higher rates (e.g., Extremadura’s top rate is 3.75%) while others levy lower rates (e.g., Madrid’s 100% credit results in an effective rate of 0%). Rates differ across Swiss cantons. *The average top marginal rate in 1942 across all cantonal capitals was 3.72% (Eidgenössische Steuerverwaltung 1969), which is higher than the cantonal plus municipal rates that we are able to confirm in any other year. : OECD 2018, p. 81, Table 4.2. Austria had no specific threshold but implicitly wealth below € 11,000 was untaxed. Denmark’s exemption levels were provided in Krone by Katrine Jakobsen and converted to Euro at the 12/31/1996 exchange rate. Krenek and Schratzenstaller 2018, p. 23 notes Luxembourg’s € 2,500 exemption per person. Taxpayers are taxed individually in Finland and Spain. The Spanish central government statutory individual exemption is € 700,000; some regions have lower exemptions, including Aragon at € 400,000 and Catalonia at € 500,000. Exemptions differ across Swiss cantons. : OECD 2018, pp. 87–88. The Swiss canton of Basel-Country has a schedule with rates increasing for each CHF1,000 of reported wealth, up to CHF 1 million. : OECD 2018, pp. 88–89, and Silfverberg (2009) (Sweden). *In some cantons, but not all. : OECD 2018, p. 84, Table 4.3. For Denmark, Jakobsen et al. 2019. T = fully taxed, E = full exemption, TP = tax preference. : OECD 2018, p. 24, Table 1.1. Austria abolished its inheritance and gift taxes in 2008, though there is a 2.0–3.5% tax on the transfer of assets with the lower rates for transfers between close relatives. discretion on the part of cantonal tax authorities, which may contribute to an equi- librium where the wealthy are treated rather leniently.6 6 Some cantons offer foreigners who live but do not work in Switzerland an exemption from regular taxation, subjecting them instead to a flat-rate tax based on their living expenses, which has allowed some very rich households to enjoy low tax burdens. The minimum tax rules under this alternative tax regime 214 Journal of Economic Perspectives The Swiss wealth tax enjoys broad political support, as evidenced by the fact that it keeps being reaffirmed by citizens in Switzerland’s system of direct democracy, where most tax policy decisions must be put directly to voters. But its design and the role it plays in the overall tax system are quite different from what is currently discussed in the United States. In particular, it is not geared towards a major redis- tribution of wealth, and indeed, wealth concentration in Switzerland remains high in international comparisons (Föllmi and Martínez 2017). Comparisons with Recent US Wealth Tax Proposals During the 2019–20 Democratic presidential nomination campaign, two prom- inent candidates, Bernie Sanders and Elizabeth Warren, proposed that the United States enact an annual wealth tax. The Sanders proposal featured graduated rates starting at 1 percent on net worth above $32 million for a married couple, rising to a marginal tax rate of 8 percent on net worth above $10 billion, while Warren proposed a 2 percent rate on net worth in excess of $50 million and a 6 percent rate above $1 billion. The candidates claimed these levies would raise $3.75 trillion and $4.35 trillion over 10 years, or approximately, 1.34 percent and 1.56 percent of GDP and 7.9 percent and 9.1 percent of federal revenues.7 As Table 1 details, these US proposals differ quite substantially from the wealth taxes across Europe—past and present—in a number of ways. First, the top marginal rates of both the Sanders and Warren proposals are far higher than any top rate of the European wealth taxes. Second, neither the Sanders nor Warren proposal has a cap on annual tax payments as a share of income. Third, both the Sanders and Warren wealth tax proposals have what is by European standards an exceptionally high exemption level. Under Warren’s plan, 75,000 households would be subject to the tax, while Sanders’s plan would apply to 180,000 households. The very top rates would affect an even smaller group: Warren’s top rate kicks in at $1 billion, applying to about 600 people as of October 2019 (according to Forbes), while Sanders’s top rate begins at $10 billion, applying to only about 50 people.8 Fourth, both Sanders and Warren proposed unprecedently broad bases, including, for example, assets held in trust, and (in Warren’s case) including retirement assets and assets held by minor children. Fifth, the revenue to be raised from these wealth taxes as a share of GDP is one-third to one-half above the Swiss level, which in turn, is substantially higher than the revenue raised in the other countries. Finally, the US wealth tax proposals would be federal, rather than decentralized as in Spain or Switzerland. Supporters of these proposals for a US wealth tax often discount the relevance of European experience with wealth taxes—and the wide abandonment of those taxes—on the grounds that the details of the US plans, especially the high exemp- tion level, rate schedule, broadness of the base, and enforcement provisions, are have been tightened recently, and it currently affects fewer than 5,000 individuals (Federal Department of Finance 2019). 7 Emmanuel Saez and Gabriel Zucman advised Senator Warren regarding her proposal, produced the revenue estimates, and have written a detailed explanation and defense of it (Saez and Zucman 2019a). 8 The extreme targeting of top wealth levels has led some readers of an earlier draft to suggest that a more appropriate title is “Taxing Their Wealth.” Taxing Our Wealth 215 very different than these other systems. This distinction is true, but it is a double- edged sword as these unprecedented design features also make it difficult to learn from experience and to predict its consequences with much confidence. What Other Taxes Does a Wealth Tax Resemble? Although the United States has never had an annual wealth tax, it has long experience with several other related taxes. Property Taxes Local governments in the United States rely heavily on an annual tax on one form of wealth, often called “immovable” property, in the form of property taxes. Property taxes account for nearly half of own-source local government revenues. The rate of tax levied on immovable property varies widely. Harris and Moore (2013) report that, for the period 2007–2011, the mean property tax burden as a share of house prices was 1.15 percent. For a number of reasons, a property tax is not identical to an equivalent-rate wealth tax. First, US property taxes do not allow for a deduction for debt. Second, the Tiebout (1956) theory of property taxes emphasizes that households can choose among many different communities with varying levels of local public goods. In this setting, the property tax, unlike a wealth tax, becomes a non-distorting price for local services, and has much different implications than a broader wealth tax not tied to public services. Third, immovable property is only one component of wealth, and because the relative size of this component varies dramatically across levels of household net worth, a property tax is not well-targeted at the very wealthy. Using the 2016 Survey of Consumer Finances, Wolff (2017) estimates that, while principal residences (the major but not only component of the property tax base) account for 62 percent of the gross assets of individuals in the middle three quintiles of net worth, they comprise only 8 percent of gross assets for the top 1 percent. Fourth, most local property taxes in the United States feature a fixed rate, occasionally with an exempt level of property value. Of course, other rate structures are possible. For example, the “council tax” in the United Kingdom features a graduated rate structure based on the property value. Many US states do levy a surcharge on the highest-value homes or have a progressive bracket structure through their real estate transfer tax system, sometimes referred to as “mansion taxes.” Estate and Inheritance Taxes The US federal government has levied a tax on a base close to net worth since it enacted an estate tax in 1916 and added a gift tax in 1924. This tax requires a valua- tion of taxable wealth at death, coinciding with the probate process, which attempts to locate and determine the net worth of the deceased. The US estate tax has a sizeable exemption level, which as of 2020 is $11.58 million for singles and $23.16 million for married couples and features a flat rate of 40 percent over the exemp- tion. The revenue it generates has eroded over time recently because of legislated 216 Journal of Economic Perspectives increases in the exemption level; in fiscal year 2019 it raised $16.7 billion, or slightly less than 0.5 percent of federal revenues—less than one-tenth of what the Sanders and Warren proposals projected to collect—from about 0.06 percent of decedents. In principle, the estate tax is designed to target the superrich, but in practice many features of the law allow the wealthy to reduce their exposure significantly. Notably, the effective estate tax rate is reduced by extensive undervaluation of wealth transfers via, for example, family limited partnerships, which are holding companies owned by two or more family members created to retain a family’s busi- ness interests, real estate, publicly traded and privately held securities. Due to the lack of control and lack of marketability that limited partners possess, these interests can be transferred to future generations at a discount to market value. What is known about the consequences of an estate tax? Kopczuk (2013) surveys the evidence and concludes that the literature suggests an elasticity of reported estates—which includes changes in real wealth accumulation, avoidance, and evasion—with respect to the net-of-tax rate between 0.1 and 0.2. Eller, Erard, and Ho (2001) analyze estate tax evasion based on data from a stratified random sample of federal estate tax returns as filed and audit assessments, and they estimate the estate tax underreporting gap due to noncompliance to be 13 percent, but this figure may substantially understate the true magnitude of the gap, in part because it does not account for any noncompliance not detected during the IRS examination process. Capital Gains Taxes Any analysis of how the wealthy are taxed must confront how capital gains are taxed. For the superrich, realized capital gains represent a very high fraction of reported income. For example, IRS data shows that in tax year 2014 realized capital gains represented 60 percent of total adjusted gross income (AGI) for the 400 highest AGI Americans. In tax year 2016, those with adjusted gross income over $10 million reported net capital gains corresponding to 46 percent of their adjusted gross income, whereas it is a negligible fraction for those earning less than $200,000 (Scheuer and Slemrod 2020). A capital gains tax is of course not a wealth tax, because it applies to gains rather than to the total value of the financial asset. Under current US law, capital gains are taxed at a lower rate than other income and are taxed upon realization (usually sale) rather than accrual, which generates a so-called deferral (or interest) advantage. Most importantly, capital gains unrealized at death completely escape income taxation. Instead, there is a “step-up” provision under which the value of an asset at the time of death becomes the tax basis for the inheritor, so that if sold the taxable capital gain is calculated as if value at time of inheritance was the purchase price. Even though some of the income that gives rise to the appreciation of assets (such as corporate stock) is subject to taxation at the corporate level, corporate tax rates have come down over time. Taken together with the extreme concentration of capital gains at the top, these provisions have led to concerns that the overall progressivity of the income tax is eroding. There have been a number of proposals to alter the capital gains tax in ways that would restore tax progressivity without resorting to an annual wealth tax. As Florian Scheuer and Joel Slemrod 217 one example, President-elect Joe Biden released a plan during the campaign to tax capital gains and dividends at the same rate as ordinary income for taxpayers with incomes exceeding $1 million and also to tax unrealized capital gains at death. Combined with other proposed changes in the income tax code, Biden’s tax plan would raise the top marginal tax rate for capital gains from 20 percent to 39.6 percent. While Biden’s plan would eliminate two of the preferential tax provisions for capital gains, it would retain the current system of taxation based on realization rather than accrual other than at death, thereby preserving the advan- tage of being able to defer taxes within a lifetime. In view of this, calls for the taxation of accrued capital gains have been made. For example, Batchelder and Kamin (2019) offer a menu of “incremental” revenue options, including an accrual-based capital gains tax consisting of an annual mark- to-market tax on publicly traded assets plus a retrospective accrual tax for illiquid assets. Under a retrospective scheme, the capital gains tax is assessed upon realiza- tion, but the statutory tax rate rises as the holding period lengthens, effectively charging interest on past gains when realization occurs. This eliminates the need to value assets that are not actually being sold while minimizing liquidity problems and the incentive to defer such realization (Auerbach 1991). Consequences of a Wealth Tax Imposing a wealth tax will tend to reduce the amount of taxed wealth, due to some combination of changes in wealth accumulation, shifts in financial choices, and outright evasion. Here, we consider these various consequences, along with some discussion of the administrative and compliance costs of levying such a tax. We focus mostly on evidence from the European wealth taxes, but also consider some evidence from related taxes like the estate tax. Evidence on the Overall Response to Wealth Taxes Empirical studies of the behavioral response to wealth taxes are much sparser than for income taxes, largely because wealth taxes themselves are much rarer than income taxes. Moreover, because tax bases and relevant enforcement details vary widely, applying the evidence on the effect of one country’s tax to another is problematic. Indeed, some potentially critical enforcement instruments, such as cross-country information exchange agreements that are designed to constrain tax evasion using foreign accounts, postdate essentially all of the studies. We begin with a number of recent studies that find taxable wealth to be highly responsive to its tax rate. Brülhart et al. (2019) take advantage of variations in the Swiss wealth tax rate across cantons and over time and find that a 1 percentage- point decrease in wealth taxes increases reported taxable wealth after six years by at least 43 percent (and by 96 percent for the subset of large reforms). Comparing administrative tax records from two cantons suggests that about one-fourth of the effect comes from taxpayer mobility and another one-fifth from house price capi- talization. They argue that savings responses cannot explain more than a small 218 Journal of Economic Perspectives fraction of the remainder, suggesting sizable evasion responses in this setting with no third-party reporting of financial wealth. Jakobsen et al. (2020) examine changes in the Danish wealth tax that was cut back beginning in 1989 and abolished in 1997, taking advantage of two design aspects of this tax: a doubling of the exemption threshold for married couples and a cap on the ratio of income, payroll, and wealth taxes as a fraction of income that renders the marginal wealth tax equal to zero for those at the cap. For the very wealthy, they conclude that reducing the wealth tax rate by 1 percentage point would raise taxable wealth by 21 percent after eight years. Because the estimated effect grows over time, they argue that it could not be all a one-time avoidance effect. Instead, half of the long-run effect is mechanical since a higher wealth tax reduces wealth even when behavior is unchanged. Also sizeable are the estimated elasticities of Durán-Cabré, Esteller-Moré, and Mas-Montserrat (2019) based on an analysis of the surprise reintroduction of a wealth tax in Catalonia in 2011. They find no evidence of it reducing wealth accu- mulation, but find that the tax triggered substantial tax avoidance via taxpayers changing their asset composition toward exempt assets (mainly company shares) and also that the return of the tax induced taxpayers to reduce taxable income to take advantage of an income-related cap on the sum of income and wealth tax liability. They find that a 1 percentage point reduction in the average wealth tax rate would lead to an increase in taxable wealth of 32 percent over four years. Agrawal, Foremny, and Martínez-Toledano (2020) look more closely at the migra- tion response, focusing on the fact that all Spanish regions levied positive wealth tax rates except for Madrid. They conclude that, by five years after the reform, the number of wealthy individuals residing in Madrid for tax purposes increased by 10 percent relative to other regions, but conclude that misreporting rather than physical location change is likely the main factor. As in Brülhart et al. (2019), this applies to sub-national variation in wealth tax rates, where migration (or reported migration) is likely to be large relative to cross-national migration. Zoutman (2018) studies a major reform to wealth and capital income taxation in the Netherlands that occurred in 2001. Comparing households that were similar in wealth and income, but treated differently by the reform, he concludes that a 1 percentage point decrease in the wealth tax rate leads to a long-run increase in accumulated wealth of 14 percent. On the other side, Seim (2017) finds considerably smaller effects. Exploiting bunching around a kink in the Swedish wealth tax rate schedule where the rate changes from 0 percent to 1.5 percent, he estimates that a reduction in the wealth tax rate by 1 percentage point increases reported wealth by 0.10 to 0.27 percent. He concludes that the elasticity mainly represents reporting responses, and finds no evidence of households changing their saving or portfolio composition.9 9 In a recent study of Colombia, Londoño-Velez and Ávila-Mahecha (2019) find evidence of bunching responses of reported wealth below notches in the tax rate structure and estimate that, in the short run, a 1 percentage point wealth tax cut increases reported wealth by 2 percent. They conclude that these Taxing Our Wealth 219 In sum, recent studies of the European experience suggest that the behav- ioral response to wealth taxation can be substantial, but that the anatomy of the response—real versus avoidance versus evasion—varies a lot, in large part because of differences in the broadness of the tax base. Advani and Tarrant (2020) offer a comprehensive review of these empirical studies and attempt to explain the varying results based on design features, contextual factors, and methodological differences. There is an important interaction among these behavioral reactions. As Slemrod (2001) details in a more general context, the tax disincentive to real behavior depends on how the marginal cost of avoidance and evasion interacts with the real decision. In the extreme, a tax that can be costlessly evaded will provide no disincentives for real behavior. This insight suggests that when estimating the effects of a wealth tax, it is essential to understand how design differences might affect the costs of evading the tax. Indeed, supporters of the prominent US wealth tax proposals have suggested several reasons why it might be harder to evade than the European experience would indicate: for example, the United States is a much larger country, its tax system is citizenship-based rather than residence-based, the proposals involve much higher exemption thresholds, they are accompanied by plans to enhance tax enforcement, and their implementation would post date the adoption of the Foreign Account Tax Compliance Act (FATCA) in 2010. We take up some of these issues below. Real Behavioral Responses A wealth tax reduces the after-tax return to saving. The most important poten- tial real behavioral response is in terms of reduced saving and capital accumulation. This effect is qualitatively the same as under other taxes on capital accumulation, such as a capital income tax (for an overview, see Bernheim 2002). As seen above, though, one difference is that a wealth tax can translate into higher capital income tax rates than are commonly imposed (potentially exceeding 100 percent), which presumably leads to larger effects. Taxes that appear to be levied on the wealthy may instead be borne by others via tax-induced changes in pre-tax prices. For example, if a wealth tax reduces capital accumulation, in the long run it may reduce average wage rates. Such an argument figured prominently in the debate preceding the Tax Cuts and Jobs Act of 2017, when supporters argued that the proposed cut in the rate of corpo- rate income tax would, via increased business investment and eventually a larger capital stock, increase average annual wages by as much as $9,000; this suggests an avenue through which taxing “their” wealth ends up affecting “our” wealth. This conclusion is highly controversial, however (for an overview of the arguments made at this time, see Slemrod 2018 in this journal). responses reflect predominantly avoidance and evasion, such as misreporting wealth items subject to less third-party reporting. They also find that wealthy taxpayers increased compliance in response to incen- tives for the disclosure of previously hidden wealth as well as in response to an exogenous increase in the risk of detection and punishment due to the publication of the “Panama Papers.” 220 Journal of Economic Perspectives A wealth tax could also affect work effort, but there is no consensus on the relevant labor supply elasticity. Notably, a substantial fraction of the very wealthy are either themselves or descendants of principals in a rather successful business venture: for example, of the wealthiest Americans on the 2018 Forbes 400 list, 69 percent were “self-made” founders of their business (Scheuer and Slemrod 2020). As a result, the relevant margin is probably not hours of work in the narrow sense. Instead, the key effects may be on the incentives for entry into entrepre- neurship (Cullen and Gordon 2007; Scheuer 2014; Shourideh 2014)) and on the ownership and control structure of business enterprises. Due to the highly progressive nature of the wealth tax, it could, for example, discourage entrepreneurial risk taking. Hall and Woodward (2020) document that entrepreneurial risk is highly skewed, with most venture-capital backed start-up companies faring poorly and a few performing exceptionally well. Due to incentive problems, this risk cannot be diversified, which limits the attractiveness of entre- preneurship under reasonable risk aversion, so further reducing entry might seem like a bad idea. However, because a risk-averse individual will have relatively low marginal utility in case of very good outcomes, the effect on decisions to participate in entrepreneurship of a wealth tax that applies only in those low-probability states of the world could be modest. Another concern is that a wealth tax might force entrepreneurs to reduce their ownership in a company whose valuation increases over time in order to pay the tax liability. Even if such founders are not primarily motivated by monetary incentives, but instead are mostly interested in being able to realize their ideas, such an antici- pated dilution of control rights could have discouraging effects on entrepreneurial activity. Might a US wealth tax induce some people to move out of the country? Because the US taxes on the basis of citizenship rather than residence, moving does not relieve an American citizen of any tax obligations—instead, citizen- ship renunciation is required. There are some prominent examples: Facebook co-founder Eduardo Saverin dropped his US citizenship in favor of Singapore just prior to the Facebook initial public offering in 2012. But overall, US citizenship renunciation by the wealthy has been very small. Between 2005 and 2017, more than 30,000 individuals dropped their US citizenship, of whom fewer than 100 reported net worth greater than $100 million (Organ 2020). Overall, however, about one-third of those dropping citizenship were millionaires in terms of wealth, compared with only about 5–6 percent in the US population. An increase in renunciations in the 2010s was probably due to increased enforcement of tax evasion using offshore accounts, prompting renunciation by dual citizens already residents abroad. However, there is no historical precedent to help gauge the renunciation response to a wealth tax at rates far above existing levels.10 10 Senator Warren proposed a 40 percent exit tax on the net worth above $50 million of any US citizen who renounces their citizenship, while Senator Sanders proposed a 40 percent exit tax on the net value of all assets under $1 billion and a 60 percent exit tax for those with wealth exceeding $1 billion. If enforced, these measures might greatly limit any potential exit responses. Florian Scheuer and Joel Slemrod 221 Avoidance One way to reduce wealth tax liability is to substitute assets that face lower tax rates, or to hold assets for which the value is harder to monitor and thus easier to understate successfully. Spain offers a stark example: when it exempted some forms of closely held businesses from its wealth tax base, the share of the exempted stock as a share of all closely held businesses increased from 15 to 77 percent (Alvaredo and Saez 2009). In a US context, a wealth tax might lead some high net-worth individuals to shift into assets that are harder to value, such as keeping businesses private rather than going public. Start-up firms might forego equity infusions to avoid new valu- ation rounds, which could constrain their expansion, or they could start issuing non-standard, less transparent types of stocks. Hemel (2019) offers the example of companies deciding not to offer their shares on public equity markets, even if a public offering would be the most efficient means of raising capital, because a more transparent valuation will lead to a larger wealth tax liability for its shareholders. Much wealth of the Forbes 400, for example, is currently held in publicly traded stock, but this feature cannot be taken as unresponsive to a potential wealth tax. This is an example of a potentially substantial and distorting behavioral response of which there is no trace in existing data; how likely it is to occur and what enforce- ment responses might constrain it are very hard to know. Such shifting into less visible assets would also have repercussions for our measures of wealth inequality: it might look like a wealth tax reduces concentration when in reality it partly shifts top wealth into forms that are less susceptible to accurate measurement.11 Evasion Government auditors typically lack the resources to trace sophisticated means of wealth tax evasion—say, methods that work through layers of financial interme- diaries. High-profile leaks from these intermediaries, such as the 2007 leak from HSBC Bank in Switzerland and the 2015 “Panama Papers” from the firm Mossack Fonseca, have allowed researchers to gain insights into these forms of tax evasion. Alstadsæter, Johannesen, and Zucman (2019) link the account names from the HSBC leak with individual tax data for Norway, Sweden, and Denmark and find that 95 percent of these foreign account-holders did not report the existence of the account to the tax agency. They show that evasion rates rise sharply across the income distribution and conclude that the top 0.01 percent in the income distri- bution evade about 25 percent of the income and wealth taxes they owe. Guyton et al. (2020) combine random audit data with data on offshore bank accounts and show that tax evasion for US taxpayers through offshore financial institutions is highly concentrated at the very top of the income distribution, and that random audits virtually never detect this form of evasion. Despite this new evidence, we do not yet know the extent to which a wealth tax at much higher rates would be susceptible to evasion, although some of the studies 11 Another avenue of wealth tax avoidance is inter vivos gifts. Research suggests that these gifts are tax- sensitive (for example, see Bernheim, Lemke, and Scholz 2004; Joulfaian and McGarry 2004). 222 Journal of Economic Perspectives of European wealth taxes suggest substantial evasion. Its extent will certainly depend on the enforcement environment, which is evolving. The Foreign Account Tax Compliance Act (FATCA) of 2010 set up third-party reporting requirements based on existing tax information exchange agreements. Through threat of a punitive with- holding tax for non-complying foreign financial institutions, FATCA provides US tax subjects with strong incentives to report to the IRS the value and income generated by their foreign accounts.12 Both the Sanders and Warren wealth tax plans would expand enforcement further, proposing significant increases in the IRS enforcement budget and a minimum audit rate for taxpayers subject to the wealth tax. How effective such expanded enforcement would be in restraining evasion has been controversial. Saez and Zucman (2019a) claim that evasion would shrink the wealth tax base by just 15 percent. Kopczuk (2019) expresses skepticism, noting that the most effective tax enforcement relies on market transactions reported by third parties, which would be absent for much wealth. This is not purely an enforcement problem because, as mentioned, the valuation of many assets is objectively hard. Clever ideas have been put forward to address this problem; for example, Allais (1977) proposes that wealth owners self-report the value of their assets but then the government (or any other private bidder) could acquire these assets at a surcharge of 40 percent (respectively, 50 percent). Such schemes come with their own difficulties, though, especially with opaque assets, not to mention the political concerns about the government owning a large share of businesses in the economy. One difference between the wealth tax and the estate tax is that the former requires reporting at a much higher frequency. While this potentially raises compli- ance costs, the upside is that any evasion strategy must engineer an entire path of reports that is plausible on a yearly basis, notably relative to yearly income, rather than just one end-of-life snapshot. This may make it harder to conceal wealth systematically than in the case of the estate tax, which allows for decades of planning without generating much data for tax authorities. Administrative and Compliance Costs A wealth tax imposes costs of collection, including the compliance costs borne by taxpayers and third parties and the administrative costs borne by the government. Leiserson (2019) extrapolates from experience with the US estate tax to estimate the ratio of private compliance costs to revenues from a 2 percent wealth tax at 19 percent, which is approximately double the conventional wisdom about the US income tax; he estimates government administrative costs to be just 0.6 percent of revenue. Troup, Barnett, and Bullock (2020) estimate the compliance cost to be 1 to 1.5 percent of total wealth in the first year based on the legal costs of the probate process in the United Kingdom, which (depending on the tax rate) would 12 The international version of FATCA, known as the Automatic Exchange of Financial Account Infor- mation in Tax Matters (the AEOI Standard), began in September 2017 and, by 2019, 94 countries had exchanged information. Johannesen et al. (2020) provide evidence on the impact of pre-FATCA enforce- ment policies aimed at foreign accounts held by US taxpayers. Taxing Our Wealth 223 mean costs roughly equivalent to tax revenue. However, the compliance costs would fall in subsequent years due to repetition effects. Moreover, due to the fixed-cost nature of valuation and reporting efforts, the compliance cost relative to revenue declines if a higher wealth tax rate is applied. Are Wealth Taxes Part of an Optimal Tax System? We now turn to the normative question whether wealth accumulation should be taxed and, if so, the extent to which a wealth tax should be a preferred mechanism for doing so. A growing literature in public economics has started to incorporate more realistic labor markets into models of optimal tax policy, accounting for phenomena such as rent-seeking, skill-biased technological change, and superstar effects, to name just a few advances (for an overview, see Scheuer and Slemrod 2020). This line of work has focused on the optimal design of labor income taxes in static models that capture recent trends in occupational sorting and wage inequality. Because a growing concentration of earnings can affect, through savings, the degree of wealth inequality down the road, this raises the question whether these trends also affect the optimal taxation of capital or wealth. The Atkinson-Stiglitz Benchmark Suppose first that all wealth inequality is driven by inequality in labor incomes. In this case, the Atkinson-Stiglitz (1976) theorem provides a classic benchmark. It states that, if a nonlinear labor income tax is available, any distortion of savings is Pareto-inefficient whenever preferences satisfy two conditions: (i) they are separable between consumption and labor; and (ii) all individuals have the same utility over consumption across time. In other words, if individuals only differ in their labor productivities, and the recent rise in wealth inequality is the result of changes in labor markets, then the policy response should be to adjust the progressivity of labor income taxes. The taxation of capital income or wealth on top of that is not justified. This theorem is a conceptually useful baseline, but the underlying assumptions are not realistic. First, Saez (2002) has suggested a positive correlation between labor productivities and savings propensities. This violates the Atkinson-Stiglitz condition (ii), because individuals will differ in their discount rates in a way that is related to earnings abilities. Similarly, when individuals differ in their rates of return on their wealth, this lends support to the additional taxation of capital (Gerritsen et al. 2020). Second, disentangling labor and capital income can be challenging in practice, so capital income taxes may be needed to minimize revenue-losing tax- base shifting from labor to capital income (Christiansen and Tuomala 2008). Third, when agents face uncertainty and are risk averse, taxing capital income can improve incentives for labor supply (Golosov, Tsyvinski, and Werning 2006). Fourth, current policymakers do not face a blank slate, but instead face a situation with preexisting wealth inequality. Individuals already differ in the wealth they own, either because they have inherited it from previous generations or because they themselves have saved in the past. 224 Journal of Economic Perspectives A One-Time Tax on Existing Wealth In principle, preexisting wealth inequality could be alleviated in a lump-sum fashion through a one-time, unanticipated wealth tax. Indeed, historically, various countries have used one-time wealth taxes to deal with revenue shortfalls, such as wartime spending shocks. In 1999, Donald J. Trump, then a candidate for the Reform Party presidential nomination, proposed a 14.25 percent one-time “net-worth tax” on individuals and trusts worth more than $10 million in order to eliminate the US national debt. More recently, calls have been made for a time-limited, progressive wealth levy to stem the fiscal burden arising from the coronavirus pandemic (for example, Landais, Saez, and Zucman 2020). From an optimal tax perspective, such policies are attractive because they avoid behavioral distortions by only touching wealth that has already been accumulated.13 But this appealing feature critically hinges on the ability of policymakers to imple- ment such policies on short notice and on their commitment not to make such taxes permanent or to reintroduce them periodically when similar times come about in the future, which would lead to reputational damage. In the past, originally one-off war taxes have often turned into long-lasting tax policies. Taxing Future Wealth Accumulation If an unexpected, distortion-free redistribution of existing wealth is not feasible, one policy option is to adjust the labor income tax going forward. If initial wealth and earnings abilities are positively correlated, a more progressive labor income tax could be used to target both determinants of inequality, at least indirectly. The alternative is to introduce a tax on future wealth accumulation, which will of course distort the savings incentives of individuals. In the online Appendix available with this article at the JEP website, we provide a formal demonstration that a tax on wealth accumulation will be part of the optimal tax mix, even if preferences satisfy conditions (i) and (ii), and that the optimal schedules of the wealth and labor income tax are closely linked. For example, if the importance of initial wealth relative to labor income inequality increases toward the top of the distribution, then the wealth tax should be more progressive than the labor income tax (and vice versa). Moreover, we show that the optimal marginal wealth tax is decreasing in the intertemporal elasticity of substitution (because the savings distortions increase) and increasing in the Frisch elasticity of labor supply (because this increases the distortions from the labor tax, making the wealth tax relatively more attractive). We also provide a sufficient-statistics formula for the top marginal wealth tax that can be calibrated using the shape of the income and wealth distribution. In sum, unless there is already a fully equalized wealth distribution, it is gener- ally optimal to introduce progressive taxes on future wealth accumulation on top of labor income taxes, despite their distortive effects, at least for some amount of time. In the long run, of course, the effect of initial wealth on overall inequality 13 Taxes on existing wealth can be replicated, in principle, by consumption taxes coupled with subsidies on labor income. Moreover, even though taxing preexisting wealth has no incentive effects, it has redis- tributive effects across age cohorts because those who are older tend to have more wealth. Florian Scheuer and Joel Slemrod 225 will diminish. Indeed, the influential Chamley-Judd result argued that zero capital taxation is optimal in the long run; Judd (1985) argues that this result holds even in the face of extreme wealth inequality, while Chamley (1986) instead considers long-run capital taxation in a representative agent framework. However, Straub and Werning (2020) have recently demonstrated that Judd’s result is invalid whenever the intertemporal elasticity of substitution is at most one—which seems the empiri- cally relevant level—and the long-run tax on capital should in fact be positive and significant. For higher elasticities, it converges to zero but possibly at a very slow rate—for decades, or even centuries.14 Wealth versus Capital Income Taxes We conclude that the modern theory of optimal taxation lends support to taxing wealth accumulation. However, the existing literature does not pin down the appropriate tax instruments to use for this purpose. As discussed earlier, in standard models, the wealth tax is equivalent to a tax on the returns to capital income. Given that most countries already have progressive capital income taxes, for instance, what might justify levying a wealth tax instead, or in addition? When individuals differ in the rates of return r on their wealth, there is a tradeoff between wealth taxes and capital income taxes that depends on the source of these differences. Because the capital-income-tax equivalent of a given wealth tax rate tw is given by tw/r, Allais (1977) points out that a wealth tax favors wealth- holders with high rates of return relative to a capital income tax. Hence, relative to a capital income tax, a wealth tax encourages the reallocation of capital from “idle” wealthholders to productive entrepreneurs. In a quantitative model, Guvenen et al. (2019) find significant efficiency gains from this effect compared to a uniform capital income tax. There is, however, an opposing effect. If heterogeneous returns reflect heteroge- neous windfall gains, rents, or excess profits (perhaps due to market power or inside information), rather than actual productivity differences, then taxing away such gains has well-known efficiency benefits (Rothschild and Scheuer 2016). But a wealth tax gets this exactly reversed—it taxes the normal rate of return and leaves the excess returns untouched. For example, if all investors have a real rate of return of 3 percent, but some earn additional excess profits on their investments, then a 3 percent wealth tax would not target any of those rents, whereas a capital income tax would. A related issue is that much of what shows up as return to capital on the tax reports of the superrich (for example, in the form of realized capital gains) is argu- ably compensation to labor from the work that went into building a successful company or picking high-performing assets. In Scheuer and Slemrod (2020), we argue that the ability to convert this kind of labor income into preferentially taxed capital gains is a key margin of behavioral response to taxes at the top, which we 14 Chamley’s (1986) model imposes an upper bound on capital taxes, and Straub and Werning (2020) provide conditions under which this bound is binding forever at the optimum, also implying positive long-run capital taxes. Saez and Stantcheva (2018) show that when wealth enters utility directly, in addi- tion to the consumption it finances, the optimal long-run capital tax is also positive. 226 Journal of Economic Perspectives refer to as the “plasticity” of the tax base. A wealth tax only taxes some normal return, whereas a capital income tax hits the full extent of such shifted labor compensation. Some progress has been made in measuring the extent and nature of return heterogeneity (for example, Fagereng et al. 2020). However, a comprehensive decomposition into actual productivity differences versus differential rents or shifted labor compensation has not yet been accomplished. Political Economy The case for a wealth tax often reaches beyond specifically economic questions of tax incidence and redistribution and is based on a concern that rising inequality of income and wealth may lead to adverse political outcomes. As one example, excessive inequality might allow the rich to capture the political system and tilt it in their favor. Concerns from a somewhat different angle go back to Karl Marx, who predicted that an increase in the concentration of wealth would lead to a revolution and to radical redistribution. We briefly consider both perspectives and the extent to which they can justify a wealth tax. Wealth and Political Power Even in a “one-person, one-vote” democracy, the superrich can affect politics more than others through campaign contributions, ownership of media outlets, or lobbying activities. Gilens (2014) and Bartels (2016) collect evidence that political decisions often are more sensitive to the preferences of the rich than those of the median voter. Accordingly, proponents of a progressive wealth tax have argued that reducing the wealth of the superrich is a desirable objective in itself, beyond the revenue it could raise to effect redistribution. Indeed, Saez and Zucman (2019b) propose setting wealth tax rates above the revenue-maximizing rate, expressing a willingness to reduce the wealth of the superrich in the interest of preventing an “oligarchic drift” that would otherwise undermine democracy. Of course, there is some tension between enacting a wealth tax to fund redistribution initiatives (such as “Medicare for All” in some recent US proposals) and enacting a wealth tax with the goal to reduce top wealth rather than collect revenue. Even if concerns about an extreme concentration of wealth and political power are warranted, the jury is still out on the extent to which a wealth tax is the appro- priate tool to address the problem. Other instruments may be better targeted at ensuring a more equal political representation, such as regulating campaign contri- butions and public financing of political campaigns. Some European countries offer examples of democracies where money plays a smaller role in politics than in the United States, and Brechenmacher (2018) concludes that wealthy elites exerting disproportionate political influence is a distinctly US phenomenon. One particular concern with the wealth tax is that it might encourage the wealthy to become more politically active, in an attempt to reduce their wealth tax liability through, for example, political donations. Taxing Our Wealth 227 Politically Sustainable Tax Policy One can argue that the primary role of a wealth tax is to make tax policy and the resulting inequality more stable, so that it can resist the threat of political upheaval (Farhi et al. 2012; Piketty 2014). Such threats were important drivers of tax and welfare state policies in 19th- and 20th-century Europe, when the socialist move- ment gained momentum (Esping-Andersen 1990), and they are palpable today in many South American countries. If political instability is an urgent problem, annual wealth taxes are able to compress the wealth distribution relatively quickly compared to, say, taxes on bequests or capital income. One approach to modelling this question is to focus on tax policies that will maintain the support of a majority of citizens over time. Scheuer and Wolitzky (2016) show that the optimal sustainable tax policy involves a positive marginal tax on the wealth accumulation of the rich, while subsidizing that of the middle class. At any given time, there is always a temptation to impose wealth taxes, because at this point, wealth accumulation is sunk. However, if the future is likely to bring near-confiscatory wealth taxes, then individuals anticipating this outcome would save very little in the first place, leading eventually to a poor outcome for everyone. Hence, it is better to tax the savings of the rich at least to some degree and create a middle class that accumulates enough wealth to successfully oppose more extreme redistribution in the future. Of course, if the issue is reducing the impetus for political disruption based on tensions related to economic inequality, the wealth tax needs to be compared to a range of other political alternatives: for example, a combination of a progressive increase in income tax rates, more tax audits, expanding the estate tax, reforms to capital gains taxation, refocusing government spending on those with lower income levels, or an expansion of social insurance programs. Conclusion In recent years, many European countries decided that a wealth tax did not belong in their armory of tax instruments. Although the United States has never had such a tax, perceptions of unacceptably high income and wealth inequality have recently galvanized support for one, and two prominent US senators have produced detailed proposals. These proposals differ quite substantially from the experience of their European counterparts. Thus, the evidence about the conse- quences of wealth taxation in Europe is in any event of limited usefulness. On one hand, the broader base along with promised expanded enforcement will limit the revenue leakage and distortion from avoidance and evasion, while exacerbating real behavioral responses. On the other hand, the higher top rates and targeting of the superrich will concentrate the revenue pressure on those taxpayers with the best means and strongest incentives to avoid the tax. Hence, when evaluating these US wealth tax proposals, one can at best hold one’s breath and extrapolate broadly from the European wealth tax experience and the US experience with similar taxes, and gain insight from optimal tax reasoning about whether to tax capital via an 228 Journal of Economic Perspectives annual wealth tax. Given rising economic inequality in the United States, proposals for taxes on wealth accumulation in some form are likely to remain an ongoing subject of debate. We are grateful to Alan Auerbach, Marius Brülhart, Leonard Burman, Reto Föllmi, Gordon Hanson, Janet Holtzblatt, Bas Jacobs, Katrine Jakobsen, Louis Kaplow, Beth Kaufmann, Paul Kindsgrab, Matthias Krapf, Greg Leiserson, Isabel Martinez, Enrico Moretti, Raphael Parchet, Sarah Perret, Dina Pomeranz, Anasuya Raj, Casey Rothschild, Kurt Schmidheiny, Kent Smetters, Timothy Taylor, Uwe Thümmel, Daniel Waldenström, Iván Werning, Heidi Williams, and Gabriel Zucman for valuable comments and to Paul R. 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