MILAN – Proposals for a broad tax on wealth are not new, but they are receiving renewed attention in the United States. Steadily increasing income and wealth inequality has raised social and ethical concerns, even among a subset of the wealthy. This trend, along with declining social mobility, is contributing to political polarization, which in turn leads to poor and erratic policy choices. And we know from history that rising inequality and intensifying social and political polarization can lead to more dramatic and even violent outcomes.

Fortunately, there is a growing body of first-rate research on the magnitude, dimensions, history, and trajectories of income and wealth inequality. If there is growing demand for some type of tax-policy response to the problem, we have ways to determine which measures would be most effective, depending on the specific objective.

Listening to the contenders for the Democratic Party’s presidential nomination, it would seem that different wealth-tax proponents have quite different objectives indeed. Bernie Sanders, who has said, “Billionaires should not exist,” seems to regard extreme inequality as offensive in and of itself. But others focus more on what inequality means for those in the bottom half or two-thirds of the income and wealth distribution. Elizabeth Warren, for example, wants to tax wealth to pay for an ambitious expansion of social security and other services.

A wealth tax is essentially a levy that reduces investment returns. A 3% tax on wealth would bring a 10% pre-tax return on investment down to 7%, amounting to a 30% tax on investment returns, to be paid when those returns are converted into income. However, the same tax on a 5% pre-tax return would be equivalent to a 60% tax, whereas on a 20% pre-tax return, it would be equivalent to a 15% tax. That is a very big difference. As these examples show, when a wealth tax is held constant, the magnitude of the tax on investment returns declines proportionately as the pre-tax return increases.

Moreover, wealthy individuals generally have access to a broad range of asset classes, many of them illiquid. Owing to various regulatory restrictions and the illiquidity premium, the pre-tax returns on these asset classes tend to be higher. In this case, a wealth tax of 2% on assets of $500 million and of 3% on assets of $1 billion (as under Warren’s proposal) would not be all that high. A benchmark of $500 million would not limit most peoples’ capacity to spend, and would leave them free to invest in higher-return liquid assets for which the implied incremental tax on investment returns would be relatively low.

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