Critics have assailed Sen. Elizabeth Warren's (D-Mass.) proposed wealth tax as an anti-American assault on economic dynamism that would hurt growth. This week, they seemed to get a boost from The New York Times, which reported that the first independent analysis of Warren's tax found it would indeed slow investment.
Or did it?
The fact is, the analysis cited by the Times is riddled with problems, from its practical assumptions to the entire economic theory behind the model.
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First off, the basics: The projection came from the Penn Wharton Budget Model — basically a computer model of the economy that takes something like a new tax and tries to game out how the economy would react. In this case, they modeled Warren's call for a 2-percent annual tax on all stocks of wealth — a person's total bundle of real estate, corporate shares, yachts, etc — above $50 million, and a 3-percent annual tax on all wealth over $1 billion. (Incidentally, Warren wants to hike the latter charge to 6 percent to help finance her Medicare-for-All proposal, but that wasn't modeled.)
The result? "Annual economic growth would slow from an average of 1.5 percent to an average of just over 1.3 percent over a decade," the Times reported. "Wealthy Americans would consume more and save and invest less in order to avoid accumulating wealth that would be subject to the tax. The resulting drop in investment reduces economic growth."
Even on the face of it, you might not consider that drop a huge deal. But it did seem to confirm the general story that high taxes on the wealthy erode the engine of U.S. job creation. It was also effectively a knock on Sen. Bernie Sanders (I-Vt.), who's also in the race for the Democratic presidential nomination along with Warren, and who has proposed an even more aggressive version of Warren's idea.
Okay, so why was this analysis bunk? Why is the story it told not actually true? Three overlapping reasons.
First, the analysis assumes Warren will use the revenue from her tax to pay down the deficit. But Warren has explicitly said she wants that tax to offset new spending on things like student debt cancelation and a universal child care system. Those sorts of broad-based programs are going to put more money into everyday people's pockets. And those people will be more likely to spend that extra money into the economy than a small number of very rich people are likely to spend less because we taxed them — being rich, you have to cut into a lot more of their wealth before you seriously affect their spending habits.
Another recent modeling run from the Levy Institute looked at what would happen if Warren's wealth tax was combined with new government spending equal to the tax's revenue. (Like, you know, Warren actually wants to do.) "A 1 percent of GDP increase in tax revenues from the richest households, paired with an equivalent increase in public spending, generates a 1.7 percent increase in GDP," Levy found. In other words, economic growth picks up.
But let's set that aside. The Penn Wharton analysis, however clunky, was presumably trying to nail down the effect of Warren's tax in isolation from anything else. So let's focus on the tax in isolation.
That brings us to the second problem: Historical evidence doesn't bear out the idea that taxes on wealth actually reduce investment or growth.
For instance, in 2003, America cut tax rates on dividends to corporate shareholders, from 38.6 percent to 15 percent. This isn't exactly equivalent to raising or lowering taxes on wealth stocks, but all things considered, it's also a tax that will discourage investment — in theory. But a 2015 study found zero effect from that tax cut on business investment and wages. Nothing; nada. Moreover, we've been cutting tax rates on capital gains and corporate profits — the two most obvious money flows that grow wealth portfolios — for decades now. Over that same time frame, business investment has slowed way down, and wages have stagnated.
How that could be the case brings us to the third point.
As the Times implies, the logic behind the Penn Wharton model's projection is that the savings of the wealthy (or of anyone) are the source of the money that drives investment: new jobs, plus purchases of vehicles, computers, buildings, factories, or any of the other physical capital that keeps the economy humming. "Savings equals investment" is a ubiquitous accounting identity in economics. But as the aforementioned tax history implies, it doesn't appear to describe how the real world actually functions. In fact, even on its own terms, it's incoherent.
Practically speaking, money from people saving is redundant, in that it's only one of several possible ways businesses can get the financing to fund real-world investments. There's also retained earnings — i.e. revenue. And there are bank loans, which are money created out of thin air. (Banks like to get deposits from savers to improve their profit margins, but they don't need the deposits to create loans.) The latter two sources, in other words, don't require anyone to save at all. And the latter two sources are where businesses actually get most of their financing. The vast majority of the buying and selling in financial markets doesn't go into any real-world economic activity. It just bids up the prices of already existing financial assets. In other words, wealthy people's savings portfolios are largely just holding tanks for money that isn't doing anything at all.
That's why, when taxes on the wealthy have been cut in the past, the economy treated it as a nonevent. The extra money added simply didn't matter for growth. Despite the endless repetition that "savings equal investment," it's not the way the engine of American prosperity actually works. And that's why the Times analysis of Warren's wealth tax is bunk.
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