Capitalisn’t: The End of China’s Miracle?
Chicago Booth’s Chang-Tai Hsieh discusses China’s economy with the Capitalisn’t podcast.Capitalisn’t: The End of China’s Miracle?
The United States Congress has already passed a $2 trillion coronavirus relief bill, the largest economic relief bill in the nation’s history. It’s half the size of the entire annual federal budget, and another stimulus bill may be on the way. On this episode of the Capitalisn’t podcast, hosts Kate Waldock and Luigi Zingales explore the economic labyrinth of how we pay for these relief bills. And, with Chicago Booth’s Eugene F. Fama, they discuss the possibility of a wealth tax.
Luigi: So, Kate, how are you? How many weeks of confinement for you overall?
Kate: I think I stopped keeping track. I think it’s five now, maybe. But this week everything changed, and I started liking it. I think it’s because I have a routine now, and I might never leave for the rest of my life.
Luigi: And what about dancing? You don’t want to go dancing?
Kate: Well, I do my own dancing here. I’ll just blast some music and then do a little dance party in my room. It’s fun.
Luigi: And the neighbors don’t complain?
Kate: My neighbors do it, too.
Luigi: Speaking of getting into the routine, I think that the fear is that this is going to be the new routine for a while. And I don’t know whether you noticed, but as we predicted, the government has gone back to Congress to ask for more money for CARES. So, the bill of $2 trillion and change may grow.
Finally, everybody, even the New York Times, is asking the question, how are we going to pay for it?
Kate: Yeah. And they’re right to be concerned. Our US debt now, our national debt, is over $24 trillion. If you break this down by taxpayer, it’s about $200,000 per person, and we haven’t run a budget surplus since fiscal year 2001. That’s almost 20 years ago.
Luigi: You were not even born when this happened.
Kate: That’s not true. I wish, I wish I were 19 years old.
Luigi: Anyway, so what we are going to do in today’s episode is we’re going to try to figure out how we are going to pay for it and whether this is going to be disruptive, or whether we can handle it fine, given that we are the great United States of America.
Kate: From Georgetown University, this is Kate Waldock.
Luigi: And from the University of Chicago, this is Luigi Zingales.
Kate: You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.
Luigi: And, most importantly, what isn’t.
Before we enter into how we pay for all of this long term, the sustainability of the debt, et cetera, let’s walk the listener through some basics. When the government approves the CARES Act of $2.2 trillion, how do they pay for it?
Kate: Well, I think there’s confusion about issuing debt and printing money. Those can be separate and distinct concepts. When it comes to the $2 trillion of the CARES Act, those are dollars that the government is sending out to businesses or individuals in the form of checks, and those dollars need to come from some tangible place. Now, normally, if we had enough tax revenue coming in, we would say, we’re going to be able to pay for these dollars of spending with dollars that we’re bringing in by taxing our citizens.
Obviously, in this current year and probably in the next few years, it’s not going to be enough. We’re not going to bring in enough tax money, which means that we need to finance the difference by issuing debt.
Luigi: And if you wonder who buys that debt, in part it is you indirectly. When you have a deposit at a bank, that deposit is backed by an investment in Treasury debt. When the government issues debt, somebody else has to be on the other side and buy it, and this somebody else can be either you indirectly, US financial institutions, or foreigners like the Chinese government, who wants to hold some of the dollars in reserve. Or there’s the third possibility, the Federal Reserve.
Kate: So, those $1,200 individual checks that are going out from the government that have Donald Trump’s name stamped right on top of them, where are those coming from at the end of the day?
Luigi: From your future taxes. In a sense, what you’re doing is, at least collectively what we are doing, we are borrowing from our future selves. Which makes a lot of sense in a moment of despair, right? And how do you borrow? Either you issue Treasurys, or if people want, you issue dollar bills. But dollar bills are nothing else than the right to use that to pay your taxes in the future. What is $10 written on a piece of paper? It is a claim that you can get something out of the government with those $10. At the very minimum, you can pay your taxes in the future for those $10. So, a dollar is nothing else than a little piece of debt of the US government.
Kate, let’s clarify one thing that often gets people confused, because you mentioned a scary number that basically each one of us owes $200,000 . . . to whom? In a sense, when you divide the debt by population, you are implicitly making a comparison between personal debt and government debt. That comparison is a little bit misleading.
Kate: Yeah. I mean, if you’re talking about personal debt, right? Let’s say you have a bank loan. You owe the bank $20,000 for some home repairs. That’s something that you’d have to eventually pay off. That’s not necessarily the case with the US federal debt. We do have to pay interest on it every year, but it’s not like it matures at some point, and at some point in the future we owe $24 trillion. The idea is that when it matures, we’re issuing more debt, we’re continually issuing debt, and what matters at the end of the day is that that new issuance is sustainable.
Luigi: And so, what is really important, the crucial question that we need to figure out, is not whether we can repay the existing debt, but whether we can sustain the payment of interest on a regular basis. And that’s the reason why people use and abuse this famous ratio of debt to GDP. Because the GDP for the US government is your tax base, and you know that you can only extract so much from your tax base. You cannot use it 100 percent, probably not even 50 percent, and you have to pay a lot of other things. So, how much of it can you take away every year to pay interest?
Kate: Well, in terms of the actual numbers, it changes every year. But what we’re spending of our federal budget on federal interest is about 10 percent, which is a nontrivial amount, right? That’s 10 percent that could have been spent on infrastructure, could have been spent on education and things like that. But we’re spending that amount every year just to pay interest on our debt.
Now, to this point about GDP, yeah. We do want to maintain a debt level that’s somewhere around our GDP, more or less. We don’t want our federal debt to be many times the size of our GDP. But this number also fluctuates quite a bit. Back around World War II, it was as high as 120 percent. Now it looks like, if our GDP shrinks by a lot this year, if GDP shrinks by 25 percent, we run the risk of having our debt-to-GDP ratio be 150 percent, which is a little bit scary.
But at the same time, other countries have sustained these debt-to-GDP ratios, or even worse, for a while without defaulting, like Japan, for example. And so, it’s not like there’s a number that’s written in the sand in terms of what debt-to-GDP ratio is dangerous, necessarily.
Luigi: No, you’re right. And I don’t want our listeners necessarily to be scared by the ratio that will come up at the end of this year. Because what we are concerned about is the sustainability in the long term, not in the short term. In that sense, what matters is the long-term GDP. If one year you have a much lower GDP, but your expectations are that you go back, that year’s ratio of debt to GDP is not that relevant.
It is a bit like the price-earnings ratio of a stock. Current earnings can be negative, but will the price be negative? Of course not, because people expect future earnings to be positive, and that’s why you have a positive price.
Kate: Yeah. And ultimately, if people were really so concerned about our default probability as the United States, then they wouldn’t be willing to lend to us, or if they were going to lend to us, they’d be lending to us at pretty high rates. But that’s just not the case right now. What we’re seeing is historically low rates. I mean, they’ve recovered a little bit since a few weeks ago, but rates are still quite low. We can borrow, on a long-term basis, on a 30-year basis, at about 1.25 percent. And so, if people are willing to lend to us at such low rates, then there’s the argument that this is the right time to be financing stimulus packages, so that we can get past this recession relatively quickly and go back to high GDP, so that we can then pay back that debt.
In addition to the CARES Act, there’s also been discussion of trillions of dollars being spent by the Federal Reserve to engage in the purchase of, in some cases, government bonds and in some cases, corporate debt. Where is that money coming from? Are we issuing bonds to finance the purchase of bonds? In this case, it’s a little bit different. Banks have a reserve account with the Federal Reserve, where they have to hold some money just to make sure that they have enough that’s, let’s say, liquid. Now, if the Federal Reserve wants to purchase, from the balance sheet of a bank, something like a US Treasury that the bank already owns, repurchase that Treasury from the bank, they’re not going to do that with dollars. They’re going to do it with credit. So, the Fed will just credit that account with the amount that they owe the bank for that bond, and then they will put the bond on their own balance sheet.
And in that sense, it is like they’re printing money, because that credit that they’re creating is just coming out of thin air. But at the same time, we don’t really need to worry as much about this printing-money-type operation leading to inflation that we would normally be worried about if the Fed were just printing literal dollars. Because they’re holding a security that is earning interest for the Fed, that’s earning interest for the government, and the expectation is that down the road, when markets recover, when banks recover, when everything’s stable and there’s plenty of liquidity, the Fed will just sell that security back to the bank, and then the bank will hold it on their balance sheet. This type of open-market operation, even though it sounds scary that we’re printing money, and in essence, that is what’s happening, we don’t need to be as concerned, because the expectation is that that transaction will be undone eventually.
Luigi: So, we’re saying there are three options for how to buy the debt. One option is that the Fed literally buys the debt from the Treasury and prints some money or issues some money. Most of the money is not printed because it’s digital money. But anyway, issues some money. And, to the extent that people or banks want to hold that money because they want to hold it as an investment, then we are paying by increasing the number of dollars that people hold in their pockets. If that number can increase dramatically without creating any inflation, then we have a free lunch, and we can have that increase without anybody really paying for it.
That’s to some extent what the Modern Monetary Theory is claiming. To the extent that at some point people say, “You know what? I don’t want to hold 90 percent of my wealth in dollars that yield nothing. I want to start investing in stocks, I want to start investing in houses, I want to start investing in other things,” they want to reduce the amount of dollars they hold, and then in that case, either the Fed has to sell back the Treasury to some investors, and so the investor will demand a return, and so we are back that the government eventually borrows from people, or we’re going to have inflation.
Kate: I think what this boils down to then is the United States, if we’re looking at this country in particular, what situation are we in, and how much are people willing to continue to hold US dollar-denominated debt? Now, this is also a pretty challenging question, because we’re not necessarily like other countries, and I’m not just saying that we’re special or whatever. But we actually do have a slightly different system when it comes to our currency that grew out of an agreement after World War II that countries weren’t going to keep holding gold, that was too complicated. Let’s just have the US government hold gold and other countries hold the US dollar. Now, this isn’t exactly the system that we have anymore, that’s slowly been dissipating, but the US dollar is special in the sense that it is viewed by many countries as a reserve currency.
In terms of currency that’s held by countries as a reserve, that amount used to be about 70 percent held in US dollars about a couple of decades ago. And now it’s slipping, it’s around 60 percent, but still countries mostly use the US dollar as a store, as a reserve. This has been called the exorbitant privilege, this idea that everyone wants dollars. And because people want dollars, that allows us to borrow cheaply and to continue borrowing. And so, the question is, not only how much do we want to keep holding our own debt, but how much are other countries also willing to continue lending to us? And this creates this fragile balance of trust that we don’t want to break.
We don’t want to spend so much money that all of a sudden we lose that privilege and start to have to pay much higher interest rates on our debt. Whether this all leads to inflation, whether this leads to people panicking and selling off US government securities, this question of how much debt is too much debt for a lot of countries boils down to how much confidence there is in our currency. And that’s a difficult question to answer. And whether we’ve reached that point or whether our spending on coronavirus is going to tip us over that limit, I don’t think it’s going to, but it’s hard to say.
Luigi: This is where economics meets politics or geopolitics, big time. The willingness of people to hold the dollar is very much a function of the role that the US government has in the life of everybody on the planet. The reason why the United States enjoyed this exorbitant privilege in part was because it was hegemonic power since World War II. As we move to a world in which there probably will be two powers, China and the United States, I think there is a question of whether maybe a number of countries will feel better protected by the Chinese government than by the US government.
Kate: Another sign is gold, right? There’s always gold as a store of wealth. And if, during panicky times, people are turning to gold rather than the dollar, that’s not a good sign. And there’s some evidence that that’s going on. And so, I think that we should be worried, we shouldn’t feel we can just spend profligately, but at the same time, some of this privilege is still around.
Luigi: Yeah. This is very difficult to manage politically, because it’s much easier to say you cannot do more than X. Because then this puts a political constraint. Saying that you certainly can do more, but down the line, this might cost you dearly, and down the line this might cause a crisis, our political system, and most political systems for that matter, tend to underappreciate the long-term costs and overappreciate the short-term benefits.
The temptation of saying, spend more today because there is no cost in the future is very high. Now, the opposite temptation is to say we are screwed, we can’t possibly borrow anymore. That’s clearly wrong. In the past, we might have exceeded in that direction. Now, in this corona situation, we tend to go to the other side, and I think the reality is in the middle. So, I think it makes perfect sense to borrow more in this moment of crisis. However, money does not grow on trees. We need to be very careful about the way we use that help, because eventually this is going to put some burden on us.
We need to be very strategic, especially if we think that this problem is going to last for the long term, because we are going to need more and more money.
Kate: OK. So, it’s pretty clear that we shouldn’t be trying to pay down this debt today. We don’t have any money today, GDP is dropping by how much, who knows? But it’s pretty clear that right now is a time when we need to be spending on ourselves and not worrying, at least in the moment, how to pay for it. But eventually we will have to pay for it. So, in a few years, assuming things recover, Luigi, should we be worried about raising taxes? Should we be worried about how to boost GDP? How are we going to end up paying for this additional $2 trillion at least?
Luigi: The best way to get out of debt is always to grow. And you can grow the GDP in two ways. You can grow the GDP by adding many more people—I don’t think the planet needs a huge demographic boom—or by increasing productivity a lot. If you can, that would be great. We have not done that well recently, and I’m not so sure that we can, by waving a magic wand, increase productivity and explode.
The other possibility is to increase taxes. And then the question is, how and in what form? This corona crisis is bringing back a discussion we had a couple of months ago on this podcast about a wealth tax. When we ran the episode last time, one of our listeners complained to me about what we said in the episode about the wealth tax. So, I decided to invite him on the show.
Kate: Luigi, you can’t just invite everybody on the show.
Luigi: Yeah, but you told me that we wanted to be friendlier with our listeners. So, I thought that was an opportunity.
Kate: OK, but we can’t have everyone on the show, all of our listeners.
Luigi: But what if he’s a good friend of mine?
Kate: That means you’re playing favorites, and I thought you were against cronyism.
Luigi: What if his name is Gene Fama, and he happens to have a Nobel Prize in Economics?
Kate: I guess in that case, we can make an exception.
Luigi: Gene, when we did the last episode on a wealth tax, you had some major objections. What were your major objections?
Eugene F. Fama: Well, I think everybody talks about it, and they don’t consider the fact that it could possibly affect asset prices, and everybody will end up paying the taxes through declines in asset prices. Nobody ever even talks about that. It’s like, you can take whatever you want of wealth, and that will have no effect on asset prices. That doesn’t make any sense to me.
Luigi: There was a very simple example you wrote in your response. Can you walk our listeners through that example?
Eugene F. Fama: The basic point is that if you have a wealth tax that you collect every year, that’s not really a wealth tax anymore. You can consider it either a tax on income or a tax on consumption, depending on what the asset is. And when you think of it in those terms, it turns out that the tax is a much bigger fraction of income or consumption than it is of wealth. And you should be thinking of it as a tax on income or consumption, because you’re collecting it every year.
Kate: Sorry, can I pause you there? What do you mean by thinking of it as a tax on income or consumption relative to wealth? What’s the difference?
Eugene F. Fama: I talked about a bond that was paying 4 percent a year, and its price was $100, so the equilibrium return on it was 4 percent. So, if people demand the same after-tax return, if you take 1 percent of the $100, that’s $1, you’ve taken a quarter of the return. So, it can potentially have a big price effect, because you’re taking such a large fraction of their return.
Luigi: And so, if—and this is a big if—if expected returns don’t change, the bond will fall in price. So, the point—
Eugene F. Fama: So, everybody that holds the bond is basically paying for the tax, even though no tax gets collected. And if the price falls, the wealth tax falls with it. It’s a self-defeating tax.
Luigi: But not only self-defeating. The point you’re raising, which I think is important and not often discussed, is that this will impact the people that don’t pay the tax directly.
Eugene F. Fama: Right.
Luigi: But all this is based on the assumption that the expected return doesn’t change. And the argument you make also applies to income tax. You’re saying that if you increase the income tax on interest income, then you should see the same effect?
Eugene F. Fama: Well, every tax should have a similar effect. If people are concerned with after-tax returns, every tax has that effect.
Luigi: So, it’s not specific to the wealth tax.
Eugene F. Fama: No, no. What happens with the wealth tax, is it looks like a small tax because the proportion of wealth that you’re taking is small. But in fact, the proportion of income that you’re taking is high, so it can potentially have a big effect. In the schemes that were proposed by Sanders and Elizabeth Warren, was only the “rich” who were going to pay the tax, but the rich hold lots of the assets. So, that doesn’t mean it won’t have a big price effect.
Kate: If such high taxes meant that prices of assets went down by a lot, then in the ’60s, when the marginal tax rate for the wealthiest people was 90 percent, why weren’t asset prices severely depressed back then?
Eugene F. Fama: That’s apples and oranges. That’s a tax on income, not a tax on investment. Who knows what effect that had on incentives? It’s hard to tell at this point, but it doesn’t in principle affect asset prices, except through the effect it has on the wages that people demand because the tax rate is so high.
Kate: But I thought you just said that we should think of the wealth tax as a tax on income.
Eugene F. Fama: A tax on income from the wealth.
Kate: Right. And so, just think of it as a really high tax on income.
Eugene F. Fama: From all the income from the wealth, that’s why it affects the value of the wealth.
Luigi: But, Eugene, in the . . . Actually, I don’t remember, in the ’60s and ’70s, how were interest income and dividend income treated? Were they taxed at 90 percent?
Eugene F. Fama: It was part of regular income. You paid the regular tax on it.
Luigi: So, even in the ’60s, when the marginal tax rate was 90 percent, you were paying 90 percent?
Eugene F. Fama: If you had the interest income, you paid on your combined income.
Luigi: And so, you had a marginal tax rate of 90 percent of your interest income?
Eugene F. Fama: Yeah, but nobody paid that.
Eugene F. Fama: I don’t know. Because, as Merton Miller always said . . . When he worked in the Treasury Department, he said, “You have to give rich people a way to stay rich.” So, you put into the tax law things that allow them to work around it, basically. So, collected taxes never approached 90 percent, I don’t think. And so, we don’t really know what the ultimate price impacts would be, but we know the prices aren’t going to go up.
Luigi: That’s for sure. That we agree.
Eugene F. Fama: Right. But the second part that can’t be forgotten is that everybody pays the price. Everybody pays the tax implied by the fall in the price, not just rich people.
Luigi: No, I understand it. And I think your argument is particularly true if this is a tax that will stay in place all the time. But now many European countries are floating the idea that if you want to pay for the costs of the pandemic, you will have a once-in-a-lifetime wealth tax.
Eugene F. Fama: Well, that’s not what they’re saying, actually. What they’re saying is it’s going to be a 10-year tax.
Luigi: OK, whatever, but it’s more in the form of what happened after World War II or after World War I, of some extraordinary tax due to an extraordinary reason.
Eugene F. Fama: Yeah, sure. Yeah. So, I can see that you may say you want to impose a wealth tax now, one-time tax. That’s fine, but my own view is you shouldn’t do it differentially. Everybody should pay it. So, the only fair tax, in my view, is a flat tax. If you’re going to impose a tax, you impose a flat tax, and then the rich do pay more because they have more. But everybody has skin in the game.
Luigi: But in a sense, what you are saying is regardless of who is taxed, everybody pays it as a proportion of their wealth.
Eugene F. Fama: Yeah. But the rich pay more because they also pay the tax.
Luigi: I see.
Eugene F. Fama: They don’t just get the capital loss. They also pay the tax. It’s very dangerous for democracy to impose taxes differentially, because it gives the incentives to the poor to steal from the rich.
Kate: I mean, is it a huge concern? Is it one of the most pressing concerns right now that the poor will steal from the rich?
Eugene F. Fama: It is indeed. Well, what policies were Sanders and Warren running on? It was basically steal from the rich.
Kate: Right. But if we just look historically at what the actual, realized problems are, that median household income hasn’t been rising for the past 30 years. Over my entire lifetime, just being a regular person hasn’t made you any better off and that the investments of today, I mean, what are we getting from them, how is my life being made better?
Eugene F. Fama: Everybody’s life is better than it was 30 years ago, pretty much.
Kate: Thirty years ago, sure, but in the past decade? And there’s just a ton of dry powder, there’s a ton of capital being deployed to every possible business that needs financing. Obviously not now or today, in coronavirus we’re in a different environment. But I don’t think that lack of financing has been the problem for the past 30 years. It’s been that the poor haven’t been—
Eugene F. Fama: What point are you addressing, though? I’m not getting your point here.
Kate: I mean, you’re saying that the problems we should be worried about are these hypothetical problems that certain politicians had been raising. Politicians who are no longer in the race, by the way, but I’m saying that we should be worried about the realized problems that have actually come to bear in the past 30 years.
Eugene F. Fama: That’s totally a different topic.
Luigi: No, but in a sense—
Kate: I’m just saying, what are your priorities?
Eugene F. Fama: My priorities? Which are we talking about? Are we talking about inequality or something like that? I mean, I don’t know.
Eugene F. Fama: Inequality, I don’t know what to do about it, because I don’t know what the optimal amount of inequality is. Nobody ever raises that question. It isn’t zero.
Luigi: Can I intervene a second? Because I think that you are talking past each other. I think both of you and the concern, there are opposite concerns, but they are both valid. One concern, is there a tendency, if you have a perfect democracy, for the poor to steal from the rich? And the answer is yes. Now, is that the biggest concern today? This is what Kate is talking about. No, because we’re far from a perfect democracy. And, I have to say, it seems that actually the political system is designed—take away for a second the taxation part of it—but the rest is designed more to take from the poor and give it to the rich, rather than the other way around. So, I think that if you have a combination of a more balanced tax rate and a system that works for everyone, then both of you are happy.
Eugene F. Fama: Well, wait, Luigi, now, what fraction of the taxes get paid by the rich?
Luigi: Today, 90 percent. Yeah, and I know that.
Eugene F. Fama: Right. So, how are they stealing from the poor?
Luigi: Through the fact that the rules are rigged. Take an example. There was an auction for 5G. This auction for 5G required buying back some spectrum from small, dinky [radio-wave license holders]. And what some private equity firms did, they bought it from these small, dinky [radio-wave license holders]. Then, they lobbied the government to structure their auction in a way that would make them super rich. So, they made on the order of $1 billion in this transaction where there basically was no risk involved, it was regulatory arbitrage, and the regulation was changed by those lobbying. And so, they took away $1 billion that ends up being paid by whom? It ends up being paid by all of us when we make phone calls. So, it is a form of distribution—
Eugene F. Fama: I’m definitely going against all of that stuff. So, there’s lots of stuff in the political process that’s lousy, that’s really bad. That’s a good example. So, that’s the downside of regulation.
Luigi: But that’s the reason why I say, I think the two of you agree more than you disagree.
Kate: But let’s say, hypothetically, I’m not saying this is necessarily true. But let’s say, hypothetically, rich people who are rich now are rich because they’d been stealing from the poor for the past 30 years. Shouldn’t some of that be undone in some way?
Eugene F. Fama: Well, how do you decide who did that? I mean, in cases like Luigi raised, that’s fine. If you think they stole it through the regulatory process, then fix the regulatory process so that that doesn’t happen. I don’t know how you do that except on a one-on-one basis.
Kate: So, you think because we can’t determine who stole what amount, that we just shouldn’t try to undo any of those discrepancies?
Eugene F. Fama: No. You want to get rid of the system that allows that to happen.
Luigi: No. That’s for sure, but to Kate’s point, Gene, after World War II, there was some tax on war profiteering. I think that some of that profiteering probably was legitimate, but some was excessive, especially at the time where people were dying to save the country. And so, there was a broad taxation to reshuffle things and make things more fair. So, I don’t think what Kate is saying is completely out of the reasonable set. Let’s say, maybe if we establish—and I don’t think we have established it strongly enough—that most of the people who made a ton, they made it in a kind of war profiteering. Then, we want to have, again, maybe a once-in-a-lifetime wealth tax to redistribute things. I think this leads to your point, Kate?
Kate: That’s my point.
Eugene F. Fama: A once-and-for-all wealth tax to pay for this epidemic would be fine. I’m all for that. I’m not all for it, but I think that’s legitimate. If you’re going to do it every year, then I’ve got a problem with it. We all talk in economics about one-off taxes not being distortive. That’s fine. But then the second question is, once the politicians get the one-off tax, what’s the probability that they’ll use it for everything and that we’ll get a one-off tax periodically?
Kate: So, it’s a slippery slope, which is why we shouldn’t do it.
Eugene F. Fama: Yeah. It’s a very slippery slope.
Luigi: In Italian. We use this Latin term, una tantum, which means “once forever.” But then we say, una semper, one every time. So, I think that the transformation from once in a lifetime to all the time, I think is dangerous.
I think we need to stop here, because we need to go to the rest of the episode. But, Gene, thank you very much for your participation. Thanks a lot. Bye bye.
Eugene F. Fama: OK.
Kate: Take care.
Luigi: Kate, did you realize that we got Gene Fama to say that in this situation a wealth tax is justified, especially if we can make it credible that we won’t do it again?
Kate: Yeah. I don’t know, is that a good thing? Is that that extreme?
Luigi: I think it’s interesting. I’m not saying it’s extreme, I’m not saying it’s good or bad, but I think that it’s an indication of the fact that probably we are going to get a wealth tax after the crisis. Because if even the more conservative economic thinkers agree with the fact that this might be a solution, I think that it is very hard to see it not happening.
So, Kate, if we don’t pay with a wealth tax, how are we going to pay for it long term?
Kate: Well, I mean, there’s any other type of tax, right? We could raise income taxes, we could go back to higher corporate tax levels. We could start taxing gifts, inheritance, things like that. I mean, there’s any manner of taxes that we could raise, it doesn’t have to be wealth.
Luigi: So, why do people bring the idea of a wealth tax into the picture? Why don’t they want an ordinary higher income tax of some form?
Kate: I think that higher income taxes are on the table, but part of the issue is that we’re already dealing with massive inequality right now. And raising taxes through income doesn’t deal with the fact that there’s a lot of wealthy people who don’t necessarily earn a whole lot of labor income but hold a great deal of wealth. And so, raising income taxes, I think the tax burden ends up falling on people who make a lot of money per year. They maybe make half a million dollars per year in compensation, but those still aren’t necessarily the richest people in the world. Not to mention, we shouldn’t be raising taxes by extreme amounts on people who are making $50,000 a year.
Luigi: I understand your concern, but imagine that I listened to your concern, and I want to do it by increasing the personal income tax on capital. And since your concern is inequality, your concern is about people not making enough to survive decently, that concern could be easily addressed by a massive increase in the marginal tax rate on capital gains and dividend income. So, why do you not prefer that and prefer a wealth tax?
Kate: Sure. Well, in some sense they would be similar. They’d be taxing the same people. But when it comes to dividends, if you raise the dividend tax rate, that’s just going to incentivize companies to buy back stock more. And most cash is returned through buybacks anyway. And when it comes to capital gains, you’re only taxed when a stock is sold. And a lot of rich people just hold onto stocks their entire life and then pass them on to their kids, who don’t have to pay taxes. So, then you’re raising a tax that is never actually realized. And so, if you just tax the actual stock itself, well, that’s a wealth tax.
Luigi: Actually, there is one thing I would like to say that we’ve not said at all in this discussion, which is the generational issue that I find very important. What nobody discusses is that both the covid itself and the measures that we’re taking to fight covid have massive distributional issues. If we let covid run by itself, it will kill mostly older people with relatively small consequences for younger people.
On the other hand, the moment we put in all these shelter-in-place rules, we save a lot of older people’s lives, but we kill a lot of young people’s livelihood. The livelihood of the old people is not affected because many of them are retirees and leave off their pensions. So, they pay no economic costs for the fighting measures, and they get all the benefits.
In a sense, the ideal way to pay for it would be a tax on the elderly. Now, I’m not so sure, I’m not a lawyer, I’m not so sure that a tax based on age is constitutional. However, a tax based on wealth, especially financial wealth, is pretty highly correlated with age. It is not perfect, but it’s pretty highly correlated with age, and so that makes the prospect of a wealth tax in the near future more likely.
So, is the idea of a wealth tax after the coronavirus crisis an idea that is capital-is or capitalisn’t?
Kate: I think that while our national debt isn’t something that we should constantly be losing sleep over, I mean, it might seem high as a percentage of GDP, particularly this year and maybe next when GDP is low, it’s still not so alarming that we’re going to default anytime soon. We still need to keep in mind that we have to pay for it at some point, and given inequality, given the various tax loopholes in place, I think a one-time wealth tax should be part of how we pay for it.
What do you think, Luigi?
Luigi: I think that we’ll see what the bill is at the end of all of it, but having that as an option seems to me a very good thing to add. Also, because just adding it as an option might reduce the risk of having a confidence crisis that would be devastating. I think it’s great that we have that option, and we’re lucky to be worth enough as a country to be able to afford several months of downturn without breaking the budget.
My heart goes out to developing countries like India that don’t have that luxury, and where millions of people may die as a result, one way or another, because you don’t fight the coronavirus and a million people die. You do fight it by shutting down the economy, and maybe a million people die of hunger.
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