Bonus Episode: Taxes and Inequality in America

David Stewart: 0:01

Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: a bonus episode on taxes and inequality. I'm joined in the studio by Tax Notes international contributing editor Nana Ama Sarfo. Ama, welcome to the podcast.

Nana Ama Sarfo: 0:21

Thanks, Dave. Pleasure to be here.

David Stewart: 0:23

Who did you talk to?

Nana Ama Sarfo: 0:24

I spoke by phone with Gabriel Zucman. He's a professor of economics at the University of California, Berkeley and he's a well-known expert in wealth inequality and tax injustice. He recently wrote a book that's getting a lot of attention. It's called"The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay," and he coauthored this with his colleague at Berkeley, Emmanuel Saez.

David Stewart: 0:45

What did he have to say?

Nana Ama Sarfo: 0:46

He discussed some of the book's most important findings on tax inequality in America and explained how the country has deviated from its previously progressive tax tradition. And then he shared with me some solutions on how America can tax more progressively.

David Stewart: 0:59

All right, let's go to that interview.

Nana Ama Sarfo: 1:02

Gabriel Zucman, welcome to the podcast.

Gabriel Zucman: 1:04

Thank you. Thanks for having me.

Nana Ama Sarfo: 1:06

Absolutely. Tell us a little about the book. What are its most important findings on tax inequality in America?

Gabriel Zucman: 1:12

What we've tried to do in this book is to estimate how much taxes each group of the population pays today. So what's their effective tax rate? And taking into account all taxes at all levels of governments and not only federal taxes, but also state and local taxes. We find that the U.S. tax system looks like a dry and flat tax, where each group of the population, low-wage worker or the working class, the middle class, the upper middle class, the rich, pay around 28 percent of their income in taxes. Except the very wealthy, the top 400 richest Americans, who according to our estimates, pay less than everybody else. They paid 23 percent of their income in taxes last year in 2018, so that's the most important finding. The U.S. tax system, many people have this view that it's highly progressive, maybe because they have in mind the federal income tax which is progressive, but in fact, when you take a comprehensive perspective on the U.S. tax system, it does not look to be progressive. It looks like a giant flat tax that becomes regressive at the very top end.

Nana Ama Sarfo: 2:21

Now, your book mentions that America used to have a robust and progressive tax tradition. What are some of the factors or events that have eroded that progressivity over time?

Gabriel Zucman: 2:30

Yes. It's very striking to see that during the middle of the 20th century, the U.S. tax system was really very progressive. The effective tax rate of the top 0.1 percent highest income earners, for instance, was around 50 to 60 percent from the 1930s to the late 1970s. The working class at the time paid 15 percent of their income in taxes, so 15 percent for low-income Americans and 50 to 60 percent for the very rich. It was a highly progressive, maybe the most progressive, tax system in the world. The reason why this has changed, it's not a story we tell in the book, but it's a mixture of course of political and ideological changes, but more fundamentally, it's the choice that's been made by a number of governments to tolerate tax avoidance, tax evasion, and tax competition. So many people have a view that these things-- tax avoidance, tax competition-- are like laws of nature, and we can't do anything against these, but it's wrong. When you look at the history of the U.S., you see that a number of governments have been very serious about fighting tax avoidance. You look at Franklin Roosevelt for instance. He spent his time going on the radio shaming tax dodgers, explaining how important it was to pay taxes, and then you have other choices that were made since the 1980s. When Reagan takes office in 1981 he says the government is not the solution to our problems. The government is the problem and that legitimizes the tax avoidance industry. And you see a big increase in tax avoidance and tax evasion in the early 1980s. Policymakers-- both Democrats and Republicans-- feel that it has become impossible to tax the rich and they slash the top marginal income tax rate in 1986 to 28 percent and so you see a recurring pattern like that. First, an outburst of tax avoidance, then policymakers feeling that it has become impossible to tax the wealthy or to tax multinational companies, and then finally policymakers slashing their rates. That's the story of the Tax Reform Act of 1986 and in many ways, that's the story of the 2017 Trump tax reform, which reduced the corporate income tax rate quite dramatically from 35 percent to 21 percent.

Nana Ama Sarfo: 4:59

So let's talk about solutions for this wealth inequality problem. Your book has many suggestions, including a 60 percent marginal income tax rate and a 3.5 percent wealth tax rate, on large fortunes. Can you walk us through some of your ideas for addressing wealth inequality in America? And also how do you get around some of the valuation concerns that frequently appear in wealth tax discussions?

Gabriel Zucman: 5:23

Yeah, there are many ways to make the tax system more progressive with a more progressive income tax, for instance, or with a higher corporate income tax. The tax system of the 1950s and 1960s achieved this high progressivity mostly through these two instruments: a very progressive federal income tax and a high corporate tax of 50 percent. We think that for the 21st century, this would not be enough to restore progressivity. And we think that what's required is a new instrument, a new tax, which is a progressive wealth tax. So to understand that, think about Warren Buffett, for instance. He's worth about$80 billion, according to Forbes magazine. His true economic income is something like 6 percent of$80 billion, so close to$5 billion every year, but his taxable income is much, much less than that. The reason is he instructs his company Berkshire Hathaway not to pay dividends and so his only taxable income is when he sells a few shares every year and realizes a bit of capital gains. And so we know that his taxable income, we know that because he discloses this himself, that his taxable income is something of the order of$10 million to$20 million. So you can see that even if you increase the top marginal income tax rate to 90 percent, or even 100 percent, it would not make a lot of difference to the truly effective tax rate of Warren Buffett. His true tax rate today is something that he pays maybe$3 million in taxes out of a true economic income of$5 billion, that's close to 0 percent. And even with a more progressive income tax his true effective tax rate would still be close to 0 percent. The proper way to tax billionaires is through a wealth tax, a tax on the stock of wealth itself. So what would be in the base, in the case of Warren Buffett, would be the$80 billion. And it's true that in some cases, it can be challenging to to measure wealth, but in most cases it's actually not so complicated. Warren Buffett, again, is a good example. We know what the market value of his holdings and more broadly speaking about 70 percent or 80 percent of the wealth of the top 0.1 percent richest Americans is invested in equities, in bonds, in mutual fund shares, in listed securities that have a clear market value. And in the cases when there's no clear market value, you can have the IRS trying to come up with a good valuation for closely held businesses, for instance. And we even make more original proposal in the book. We're saying,"Look, let's say that a very rich person owns a private business. The IRS comes up with a valuation, says the business is worth$1 billion, for instance, but the taxpayer thinks this is overstated. The IRS valuation is too high. Then in that case what we're saying is that the taxpayer could have the option to pay in kind with shares." So for instance, if the wealth tax rate is 3 percent, that taxpayer would just transfer 3 percent of his or her shares to the IRS, which then sell these shares on a market creating the market value, which currently is missing. So this is just to illustrate that broadly speaking, it's not so hard to tax wealth. And in the few cases when it can be not straightforward, there are ways to innovate and there are solutions to the lack of market valuations.

Nana Ama Sarfo: 9:08

Now there has been discussion about raising payroll taxes in the United States in order to make Social Security solvent for future generations. Is there a better way to fix the problem or think about it based on your research?

Gabriel Zucman: 9:20

The problem with payroll taxes is that these taxes today are very regressive because they are capped at something like$120,000, which is roughly the threshold to be in the top 5 percent of the wage distribution. Which means that if you have a low wage, you pay payroll taxes from the very first dollar of wage earned. But if you have a very high wage of$120,000 a year, you don't pay payroll taxes for the most part. You do pay a bit of Medicare taxes, but most payroll taxes are capped. You know, if you just increase the payroll tax rates without lifting the cap, this would have the effect of making the tax system even more regressive than it is today. Payroll taxes exceed 15 percent for low-wage earners, again from the very first dollar of wage earned. Another way to generate more revenue to fund Social Security and Medicare would be to lift the cap on payroll taxes and to make sure that all the earnings contribute to Social Security contribution.

Nana Ama Sarfo: 10:31

You and your coauthor Emmanuel Saez are well known for advising Elizabeth Warren and Bernie Sanders on their wealth tax proposals, although you are not affiliated with either campaign. How were those relationships established and how do you view the proposals floated by both candidates?

Gabriel Zucman: 10:46

With my colleague Emmanuel Saez, we spent a lot of time trying to estimate the distribution of wealth in the U.S. and how much wealth there really is at the top of the wealth distribution. We have annual estimates that cover the entire population, that cover 100 percent of household wealth, and these data series that we created over time, that's the information that makes it possible to score a wealth tax, to estimate how much a wealth tax would generate in revenue. And so that's the reason why a number of presidential candidates have approached us to ask us to help them develop their wealth tax plan, so concretely help them score various versions of such proposals. For instance, how much revenue would be generated by a wealth tax that would start at$20 million in wealth or$30 million or$50 million. How revenue would change depending on the tax rate and so on and so on. So, initially we did that kind of privately in the sense of just developing this methodology for presidential candidates. But what we've done now is that we've published everything. We've created a website, taxjusticenow.org, where everybody can make such simulations. Anybody can go on taxjusticenow.org and simulate the revenue implications, for instance, creating a wealth tax, changing the wealth tax rate, or making any other tax reform-- changing the top marginal income tax rate, increasing the corporate tax rate. The website shows two things. One is how much revenue such reforms would generate, and second, how this would change the progressivity of the overall U.S. tax system. So now any candidate, any person who is interested about taxation has access to this technology that we developed. Everything is open source. Everything is transparent with all the programs, all the code, all the technical appendices on taxjusticenow.org

Nana Ama Sarfo: 13:03

There has been considerable pushback from critics who say that creating wealth taxes or increasing the top federal income tax rate will inhibit entrepreneurship or innovation or stymie job creation. What is your response to that?

Gabriel Zucman: 13:16

My response is look at the data. Look at history. When the U.S. tax system was very progressive with top marginal income tax rates in excess of 90 percent in the post-WWII decades. Top state tax rate of close to 80 perent, corporate income tax rates of about 50 percent-- that was the situation in the 1950s, in the 1960s, in the 1970s. Now look at innovation at the time and look first at economic growth. Average income per adults grew at 2.2 percent a year on average from 1950 to 1980 the U.S. when the U.S. tax system was very progressive and the effective tax rates at the top were very high. Then the tax system has become much less progressive. Top income tax rates have declined enormously, and now look at growth from 1990 to today. So another 30 years, or period of time and growth has been only half of what it's been from 1950 to 1980. From 1950 to 1980, 2.2 percent a year. From 1990 to today, 1.1 percent a year. So there is just no clear indication in the data that progressive taxation, high tax rates on the super wealthy, are detrimental for overall growth. And the reason for that is, look, it's not only the super rich who innovate. First of all, it's all of us. And second, you think about what motivates people, what drives people to create businesses, to create new products, to innovate; taxes matter a little bit, but many other things matter much more than taxation, like the quality of public infrastructure, how educated the workforce is, whether there's a big market, and so on and so on. And so there's no good data suggesting that wealth tax on wealth above$50 million would have any significant negative effect on growth. In fact, the more likely scenario is that such a wealth tax would have a slightly positive effect on growth. Because with the revenue that would be generated by such a tax, you could fund public childcare, for instance, family benefits, increasing women labor force participation, and so increasing overall economic activity and GDP. So if anything, it's more likely that a progressive wealth tax would have a slight positive effect on growth.

Nana Ama Sarfo: 15:59

Now your book and the idea of wealth taxation in general has elicited some particularly passionate responses from billionaires in recent weeks. Were you expecting such a strong reaction to your proposals?

Gabriel Zucman: 16:11

Yeah, I mean, I can understand them, but it's a bit hard to understand why they get so much attention. I think we should spend at least as much time trying to ask low-income people or food stamp transfer payment recipients how they feel about potential tax changes that would actually harm them. You know, the billionaires, of course, they're doing extremely well. Their wealth has been growing much faster than average wealth in the U.S. over the last decade and everybody understands that they are not paying a lot in taxes today, 23 percent effective tax rate, according to our estimates. Their wealth is booming and so it's legitimate to have a debate about how to tax them better. If you look at the Forbes 400 richest Americans, for instance, they owned about 1 percent of U.S. wealth in 1982. Today, they own about 3.5 percent of total U.S. wealth. Their share of wealth has been multiplied by almost four. If there had been a wealth tax of 6 percent on wealth above$ 1 billion dollars, which is what Elizabeth Warren is now proposing and which is very similar to what Bernie Sanders is proposing. If such a wealth tax had been in place since 1982, these 400 wealthiest Americans would still have seen their share of wealth increase, not as dramatically as it has increased. In actual fact, they're not multiplied by a factor of four, but their share of wealth would have increased from about 1 percent of total U.S. wealth to about 1.5 percent of total U.S. wealth. So even the proposals that are being discussed these days, although they are ambitious, even these proposals would not have reduced wealth inequality compared to what it was in the early 1980s.

Nana Ama Sarfo: 18:04

There are some organizations that have researched whether a VAT can replace payroll taxes as a way to raise taxes on the wealthy. What is your take on this? Is this sound policy?

Gabriel Zucman: 18:15

VAT is not a good way to raise taxes on the very wealthy because by definition, when you're extremely rich, you save almost all of your income. It's impossible to spend a$ 1 billion dollars a year. So if your income is$1 billion, essentially almost 100 percent of that income is saved and the VAT is only taxing consumption. It's exempting saving. So the VAT can have some justifications. For sure, VAT would be better than the consumption taxes, the sales taxes, that exists in the West today, which are very archaic, which only tax goods and not services. So it would be better to replace these archaic sales taxes by a VAT, but it's not the proper way to tax the very wealthy. The VAT is never going to do anything to reduce income and wealth concentration. If you want to tax the very rich, if you want to reduce inequality, you can do this with an income tax and even better with a progressive wealth tax.

Nana Ama Sarfo: 19:19

And lastly, your book stresses the need for international cooperation and a global minimum tax. Tell us a little bit about what that might look like. And relatedly, how would you assess the OECD on its current efforts overhaul the international corporate tax system?

Gabriel Zucman: 19:34

There's a lot that can be done unilaterally by the United States and by other countries to start with. So for instance, the U.S. could say,"Look, if U.S. corporations book profits in tax havens and don't pay taxes in these countries, we are going to collect the taxes that tax havens choose not to collect." So concretely, the U.S. could have a 35 percent, let's say worldwide tax rate for U.S. multinationals, meaning no matter where the profits are booked by U.S. multinational companies, they would be taxed in the West at a rate of 35 percent. That's something that the U.S. can do unilaterally. It doesn't require any form of international coordination and it would remove incentives for U.S. firms to move production or to move profits to low tax places. Now of course it's even better if you have international coordination because if the U.S. did this move of taxing the worldwide profits of U.S. multinationals, foreign profits reflected domestic profits, then there would be pressure for some U.S. firms to move their headquarters to low tax places and that's where international coordination is helpful. Setting a standard, a minimum tax, can alleviate this risk of competition for the location of headquarters and that's why the OECD work these days, pillar 2 of the current OECD discussion, is particularly important. For the first time we are finally having a conversation about setting minimum corporate income tax rate. The big question is going to be: What is the minimum tax rate going to be? If it's 10 percent or 12.5 percent, which is the Irish statutory corporate income tax, it's not binding. It's not making any difference. It's not be a meaningful progress. But if gradually countries agree on a high enough minimum corporate tax rate of maybe 20 or 25 percent, that could really change the face of globalization. That could put an end to tax competition, to the race to the bottom in corporate income tax rates. It would mean that companies would not pick the countries where they operate based on how low the tax rates are, which is the current situation, a very negative form of tax competition. But instead, if there was high enough minimum tax rate in each country, corporations would pick the location of their activity based on how good the infrastructure is, how productive the workforce is, how large the markets are. And so you would transform the current form of globalization characterized by tax competition and the race to the bottom into another form of tax competition characterized by your race to the top. Countries would have incentives to invest in public infrastructure, in education, in health, and so on. And it could really change the face of globalization and make globalization much more sustainable economically and politically.

Nana Ama Sarfo: 22:43

All right. Well, Gabriel Zucman, you've raised a lot of really fascinating and interesting points. Thank you so much for coming on the podcast.

Gabriel Zucman: 22:50

Thanks for having me.