The real economic question about Elizabeth Warren's wealth tax
It might be a risk, but not for the reasons that most critics cite
Sen. Elizabeth Warren is swinging for the fences with her policy platform. The Democratic presidential contender from Massachusetts has a sweeping agenda to deal with things like student debt, affordable housing, child care, the racial wealth gap, and more. It also includes taxes levied on the richest Americans: a big new wealth tax, a new corporate profits tax, and a hike in the estate tax.
Of course, any genuinely ambitious agenda is also going to attract a swarm of mainstream worrywarts. Various experts told The Washington Post they're concerned the rich will evade Warren's taxes, that her plans will balloon the debt, and that her taxes will slow economic growth.
None of these concerns are particularly persuasive. And ironically, they completely miss the one big macroeconomic issue that could trip Warren up.
According to conventional market economic thought, taxing the wealth people build up is something you should do as little as possible. "If you tax savings, you'll get less savings," Michael Strain, an economist at the right-wing American Enterprise Institute, told the Post. "That will hurt investment, which will hurt productivity. And that will hurt wages." But the standard economic story is wrong: The connection between savings and investment is actually extremely tenuous.
Most of the money businesses use to grow comes from either their own revenue or from bank financing. Now, you might argue that bank loans are provided by other people's bank savings, but that's not right either. When a bank makes a loan, it's creating the money out of nothing. We talk about the government's money-issuing powers as residing with the Federal Reserve, but it's more accurate to say the central bank manages national money creation, most of which is undertaken by the private banking system. Banks are profit-driven firms that make loans based on how much revenue they think they'll get back on the loans — which is determined by the potential of the investment in question. When banks take savings in from customers, that alters their portfolio, which can marginally increase their profits. But they don't need customers' money to make loans.
The mainstream argument that investment, not consumption, is the core driver of economic growth — and thus should be taxed less — is backwards. Without consumption, there is nothing for investment to pursue: and the stronger consumption is, the stronger investment will be. Thus, Warren's taxes will not hurt economic growth.
What about the national debt? As I mentioned, the U.S. government is the source of all dollars. Even mainstream economists acknowledge this, but they tend to avoid fleshing out the consequences. If the U.S government can never run out of dollars, it can never suffer a debt crisis; it can always pay its debt obligations, and those payments will never crowd out other government programs. Interest payments on government debt are themselves spending into the economy, which could be inflationary in theory. But in practice, the distribution of who actually owns most government bonds makes this possibility highly unlikely. Even if Warren's plan does add to the debt, that's not a big deal.
Next are the concerns with tax evasion, which have more bite to them. Tax evasion by the wealthy is a real problem, and wealth taxes like Warren's are much more vulnerable to it. Wealth involves a lot of assets like stock, real estate, and ownership stakes in private businesses that fluctuate with the market, and don't really have a defined dollar value until they're sold. Assessing that potential value on a year-to-year basis is a lot more conceptually complicated than measuring people's income.
At the same time, there isn't really a "policy fix" for this problem. The two main challenges are lack of enforcement and the tendency of politicians to give into lobbyists and blow new holes in the tax code. The solutions to both problems are really just political will from Congress and the president, sustained over time. The best Warren can do is create as tight a tax proposal as possible in the here and now. Gabriel Zucman, one of the foremost experts on tax evasion by the wealthy, told the Post that Warren's plan "is specifically designed in a way that limits tax evasion — allowing no exemptions, increasing enforcement by the IRS and imposing heavy fines on people who try to skirt the tax by undervaluing assets, hiding their wealth abroad or renouncing their U.S. citizenship."
Also, the underlying reason people worry about tax evasion is that Warren would bring in less revenue than she predicts, and thus the national debt would increase. But as we've already noted, more government debt is basically a non-issue.
Finally, what's the other problem that could be a real issue for Warren's plan?
It takes us back to that point about the U.S. government being the source of all U.S. dollars. The assumption is that taxes need to match spending dollar-for-dollar, because the money from the first flows into the second. That is indeed how it works for state or local governments, but not for the federal government. It doesn't need to "get" the money from anywhere. What the federal government needs to do is manage the economy: make sure it doesn't overheat it or leave us in a permanent semi-slump. The purpose of federal taxes is to remove demand from the economy, and make room for more spending, to keep the economy on an even keel.
The wrinkle is that the wealthy spend way less of their income than the poor and the middle class. Therefore, one dollar taken from or given to the poor and the middle class removes or adds significantly more demand than the same dollar taken from or given to the wealthy. Taxing the wealthy still removes demand from the economy, but not as much per dollar. Because Warren's taxes are focused on that population, but her spending is much broader, even if she matches both dollar-for-dollar, she still might not remove enough demand, and wind up driving the economy closer to overheating.
But then, that could also be a good thing. Despite our low unemployment rate, most indicators from the economy suggest we're still a ways off from full capacity. Warren has room to maneuver, demand-wise. And after decades of semi-slumps leading to wage stagnation and rising inequality, a bit of overheating could be just what we need.