I think the obsession with capital income is really misguided here, and the proposed fixes are a bad way to achieve the ultimate goal (increased social welfare via redistribution of income).
Argument against special treatment of capital income
First, capital income is not the primary driver of inequality, labor income is. When a CEO gets 100 million stock grant, that is part of compensation — e.g. labor income. The fact that they are given stock doesn’t make it capital income. Dispersion in wages is where there has been the biggest change driving inequality. Therefore if you give labor income a free pass, you are going to need to make extreme measures in capital income to achieve the broad inequality reduction you want.
Next, any time you have different tax treatments, this creates the opportunity for loopholes and distorts the economy. Right now, capital income is taxed at a lower rate than labor income, which is bad. Taxing capital income at a higher rate would also be bad. Why not tax all income equally, regardless of source, and use the proceeds for purposes of public works spending and redistribution?
While its true that most people have only a small amount of their wealth in the form of insurance, pension fund claims, and personal retirement savings, nevertheless increasing a tax on these will still hurt them disproportionally because a loss of $100 per month in their pension fund, or a higher insurance premium, is a big deal to a working class person. On the other hand, if the tax is based on the amount of income, rather than the type of income, then you can minimize the pain of the tax and make the tax more efficient from a social welfare point of view.
Argument against complex financial engineering solutions instead of taxes
There have been many convoluted ideas that try to think that money can be gotten for free somehow instead via a progressive tax:
- Have the central bank mail create money and mail out checks
- Have the central bank buy stocks and mail out dividend
- Have the Treasury buy dips and sell bonds — e.g. trade against the private sector — and so accumulate a fund from “nothing” which is then distributed to poor households
The problem with all of these approaches is that they are basically shell games that will incur high transaction costs, are not broad based, incur both financial as well as economic risks, and end up costing more than a simple broad based progressive income tax.
For example, for 2, the CB is owned by the Treasury, in the sense that all CB profits are remitted to the Treasury and thus lower the need for taxes. Therefore there is no advantage to having the CB mail out a check from interest income versus having the CB turn that income over to the treasury (what happens now) which then allows for a lower level of taxation or fewer bond sales. The issue is really of what is targeted. We need a progressive income tax across all income.
For 1, you can argue that the CB will do more than mail out checks from the interest income, that it will print money and then mail that out. But then the CB will either drain the money with bond sales to support a non-zero rate, or it will pay interest on the excess reserves (effectively the same thing). The money for the interest of either the reserves or the bond sales will need to come from the Treasury, so this is no equivalent to the treasury selling bonds and mailing out checks, except that the CB is now conducting fiscal policy, which is against it’s Charter and is also undemocratic.
For 3, this assumes that the Treasury can successfully trade agains the private sector, which is not clear. It will certainly result in a lot of trading fees to brokers. This is because the private sector, once it knows that the Treasury will step in and buy stocks during crashes, will avoid the crash. But crashes play a useful price setting role as well as booms. Now the Treasury needs a model for the fair value of the stock market, and this model will be biased upwards. In other words, this ends up as a subsidy to asset holders and a distortion of the pricing mechanism. But let’s suppose that the Treasury knows what value the stock market “should be”, and let’s suppose that the private sector doesn’t — even though all these documents are public knowledge. So the private sector continues to trade agains the Treasuries fair value model, even once it knows this model. All you are doing now is lowering returns from capital income, which is equivalent to a special tax on capital income. This is less efficient than an overall broad based tax on all income, because it will hit small savers worse than if the tax was applied to all incomes.
Argument against treating the government like a household
Underlying all of these analyses is a misconception that the government is like a household that needs the publics money, rather than the public being a household that needs the government’s money. Government makes the money. It doesn’t need money. What the government is trying to do is 2 things: create a positive climate for production and redistribute income to counter the natural tendencies of capitalism to concentrate wealth.
For the first objective, the government should focus on things like production of infrastructure and other long term investments that the free market does not produce well. It should also focus on anti-trust and other regulations.
For the second objective, redistribution is best achieved by taxing all income, regardless of whether someone won the lottery, or a comet made of gold crashed into their backyard, or if they are a well paid CEO. It doesn’t matter how they got their income. The moment you tax only certain types of income, whether a special windfall tax, or a special dividend tax, then this creates a more complex tax code with more loopholes, when in reality the argument for redistribution is based on diminishing returns to consumption, which don’t care about the source of income.
Put simply, the government shouldn’t try to “hack” the private sector like it was a clever college kid. We don’t want a government that nickle and dimes us like a desperate small town setting speed traps in odd places. The government is not a small town, it’s the one that makes the money, sets the tax code, and tries to keep the whole system running. It is not an economic participant with a budget constraint, it is the parent trying to make sure the kids are playing fairly and everyone gets a piece of the pie.
End of rant.