Saving the Income Tax with a Wealth Tax
Posted: 17 Jul 2000
The income tax has been criticized for, among other things, largely failing to tax the return to capital despite an extraordinarily complex statutory scheme designed to do so. Recent literature has shown the only thing on which an income tax is able to impose a burden that the consumption tax does not is the risk-free return to capital. Scholars have used this relationship to support a consumption tax. I use it as the basis of support for supplementing an income tax with a wealth tax.
I first defend the model demonstrating the relationship between income and consumption taxes against criticisms that it fails to take into account real-world variations from a normative income tax and likely taxpayer behavior. I argue that if it is impossible for a normative income tax to impose a tax burden on the return to risk (where taxpayers make the appropriate portfolio adjustments), it is inappropriate to do so only in the limited cases where taxpayers are unable to deduct losses, for example, or where taxpayers do not make portfolio adjustments. The current income tax imposes a burden on the return to risk in a completely arbitrary way.
The burden imposed by an income tax on the return to capital is equivalent to an ex ante wealth tax levied on the taxpayer's wealth at a rate equal to the nominal income tax rate times the risk-free rate of return. I argue that it would be simpler and more equitable to append this low rate wealth tax to a consumption tax. I rebut several criticisms of an ex ante wealth tax and discuss several implementation problems. I consider the possibility that valuation and liquidity problems would plague a wealth tax as they do the income tax and therefore evaluate two realization-based wealth taxes. I conclude that an income imputation method based on historical costs sacrifices too much accuracy for simplicity. A wealth tax using a retrospective approach, however, is equivalent to a normative income tax.
Finally, I explore the case for supplementing a consumption tax with a wealth tax. I reject the equality-versus-savers argument as being dispositive, particularly where the saver dies without spending or transfers the consumption. I argue that the value of wealth beyond consumption creates an additional ability to contribute to the fisc that could be captured by a wealth tax. I also examine whether under civic republican theories, there exists a responsibility to pay taxes and the implications of this for a consumption tax.
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