GRAPE

Today: California billionaire wealth tax prop 40. Throwback: One of the papers I most enjoyed writing some 15 years ago (with Farhi and later Sleet, Yeltekin) was on Wealth taxation, nonlinear in a political economy with no commitment. Let me explain what we did. I am not trying to take political sides really or advocate one thing or another. Enough of that and it is good to think of the economic logic in a basic way. As you see, the paper is more subtle. The paper modeled a situation where you (e.g., voters, on average) want to do a "one time" wealth tax and promise never to do it again. The incentive to do so is increasing in the amount of wealth inequality. You have nonlinear taxes on wealth and income, so you have rich tools. However, you can't bind future politics or policies. Every now and then you reevaluate (vote). Sounds familiar? Indeed, various basics of the real world tradeoffs are present. Obvious: this is a time-consistency problem that leads to a 3rd best (third world?) outcome (not your standard optimal tax one, where you assume you can commit). Well known and studied. At its most basic, the temptation is confiscation (slogans: robin hood, socialism), but the expectation of this happening in future is of course a problem (slogans: capitalism, property rights). Less obvious: what it is the best you can do today if you with your tax tools, given the situation and constraints. AGAIN: you are not allowed to say "I promise never to tax again". ALSO NOTE: the options are also not necessarily just a choice between taxing wealth now or never doing so. (As the debate on this oversimplify.) Logically: taxing never may just not be feasible/credible. Equally important: you may come up with a different more intermediate plan. Let's see... Indeed, the model spits out something subtle. You actually declare a more moderate but progressive nonlinear tax on wealth that will be in place permanently. It is progressive with rising marginal tax rates: indeed, you subsidize savings for the poor (!) but tax the rich. In fact, you want to promise this tax today for the future, even if inequality is zero today. Why? The credibility problem depends on the amount of wealth inequality. That is what affects the incentive to renege on promises and tax away wealth. The solution tries to deal with this by creating an environment that will lower or keep inequality in check, to avoid a temptation to fall into the time inconsistency revision. A progressive tax goes in that direction both mechanically and in terms of saving incentives. (BTW, the fact that the tax comes out progressive is very clean and surprising, given that the optimal tax literature rarely obtains such results.) Insight: By keeping inequality in check, it makes policy more credible, avoiding falling into a much worse 3rd best. At the time, we called it a "compassionate conservative" solution: even if you want zero taxes, you compromise and do some progressive taxation, to avoid more radical taxes later. Metaphorically, the best way to deal with a tide is not by ignoring it, denying it or swimming frantically, you may have to float with it, adapt and swim moderately finding the right moves. Links: (older ungated): crei.cat/wp-content/uploads/… published: academic.oup.com/restud/arti… Footnote: We titled it capital taxation, but in reality it is more exactly about wealth taxation, e.g. it holds even in a world without capital, where people hold assets against each other etc.