by David J. Shakow*
Wealth taxes have taken a back seat to income and consumption taxes in the current tax reform debate. While income, consumption, and wealth can all be used to apportion total tax liability based on ability to pay,(1) few recent proposals explore using the wealth tax instead of our current tax system.(2) Indeed, it has been suggested quite reasonably by Professor McCaffrey that, if we are thinking of moving to a consumption tax in order to encourage investment rather than consumption, a wealth tax (which would seem to favor consumption over investment) seems quite perverse.(3)
Yet there may be more to wealth taxes than initially meets the eye. The term "wealth tax" is sufficiently broad and undefined that there may be some variations of it that would provide an interesting possible addition to our catalog of taxes.
Let me make clear, however, that I do not intend to propose a supplemental wealth tax that should be added to our income tax (or to a consumption tax).(4) Merely. I wish to consider below the possibility that we replace our current individual income tax with a wealth tax.
To make that somewhat audacious suggestion, I hope ultimately to demonstrate the following for a reasonable version of a wealth tax:
It is practical to value the assets subject to the tax.
The economic consequences of such a tax will be more favorable than those of the current income tax.
The burden of the tax will correlate more closely to economic income than the current income tax.
The tax will not raise undue problems of liquidity in respect of taxpayers.
Before I embark on that journey, I hope in this paper to explore some general issues regarding a wealth tax and, in particular, the level at which such a tax would have to be imposed to substitute for the individual income tax. This is an important place to begin, for if the rate of a wealth tax is too high, it is not practical to contemplate its introduction.
I. The Level of a Wealth Tax
A. The Aggregate Data
The Federal Reserve keeps regular track of assets that are held by different sectors of the economy. We are concerned with the household sector and the assets it holds.
There are a number of categories of assets that could be considered. These categories are ones used by the Federal Reserve.
1. Deposits--checking accounts, savings accounts (and certificates of deposit) and money market fund shares.
2. Credit market instruments--Government securities (including what are now tax-exempt municipal debt instruments), corporate and foreign debt, mortgages and open market paper.
3. Mutual fund shares (other than money market fund shares)
4. Corporate equities (both publicly traded and others)
5. Bank personal trusts
6. Life insurance reserves
7. Pension fund reserves
8. Equity in noncorporate business
9. Security credit
10. Miscellaneous financial assets.
11. Owner-occupied housing (including owner-occupied land)
12. Consumer durable goods
On the liability side, it is possible to identify home mortgage interest and consumer credit separate from other forms of indebtedness that are attributable to the household sector.
1993 is the most recent year for which all relevant data is available. As an initial exercise, I looked at the individual income tax collected for that year ($509.7 billion(5)) and divided it by a number of alternative tax bases to see at what level a flat wealth tax would have to be imposed in order to raise the same amount of tax revenue. The figures are as follows:
1. Limited base: Include only financial assets held directly by individuals (categories 1-4 and 8-10 above), as well as bank personal trusts. Thus, life insurance and pension reserves are excluded, as well as owner-occupied housing and consumer durables. Against this gross asset figure we net the debts of individuals, but not home mortgage debt (since the associated assets--owner-occupied homes--are excluded from the calculation). To raise through a flat wealth tax the amount now raised through the individual income tax, one would have to impose the wealth tax at a rate of 4.2%.(6)
2. Limited base plus life insurance reserves and pension reserves: The rate would be 3.0%.(7)
3. Limited base plus owner-occupied homes (including land), net of home mortgage liabilities (but not reserves on pensions and life insurance): The rate would be 3.2%.(8)
4. Expanded base: Limited base plus life insurance and pension reserves and owner-occupied homes (and land), net of home mortgage liabilities.(9) The rate would be 2.4%.
5. Universal base: Expanded base plus consumer durables.(10) The rate would be 2.2%.
In the above analysis, I have considered only the possible substitution of a wealth tax for the individual income tax. As the discussion below will suggest, it may be appropriate to eliminate the corporate income tax in favor of a wealth tax on individuals also. In that case, the $117.5 billion collected from the corporate income tax in 1993 should also be taken into account. The estate and gift tax would also be eliminated as redundant. The rates would then be as follows:(11)
Limited base: 5.3%
Limited base plus reserves in life insurance and pensions: 4.0%
Limited base plus owner-occupied homes: 3.8%
Expanded base: 3.1%
Universal base: 2.8%
The actual level at which a wealth tax would be imposed is important in order to determine the economic effect of such a tax when compared to the current law. It is also needed to determine if the rate of such a tax would be so high as to be politically inconceivable.
B. Wealth Reflected in Wages
Since the real rate of return on riskless investments is probably less than some of the rates calculated above,(12) these rates seem too high to be used in a practical proposal for a wealth tax. However, these figures omit a major category of wealth, albeit one that is not shown on the Federal Reserve's balance sheets: human capital.
The economic return on human capital is not a number as to which there is a clear consensus. Moreover, it is likely that different investments in human capital produce different returns.(13) However, a figure of 15% as a return on human capital does not seem unreasonable.(14) Thus, we can include human capital in our wealth tax in a principled way(15) by using earned income as evidence of a 15% return on human capital. If the return on human capital is 15%, we should include 6-2/3 times earned income in the wealth tax base, which is equivalent to taxing earned income at a rate that is 6-2/3 times the rate for other assets.
The effect of adding human capital into the wealth tax base is quite significant. In 1992, salaries and wages recorded on tax returns were $2,805 billion.(16) Multiplied by 6-2/3, this translates into $18,700 billion of wealth. Taking account of this figure in calculating the rates needed for a flat-rate wealth tax that substitutes for all Federal income taxes (individual and corporate), as well as estate and gift taxes, produces the following rates (rates without human capital are in brackets):
Limited base: 2.1% [5.3%]
Limited base plus reserves in life insurance and pensions: 1.8% [3.8%]
Limited base plus owner-occupied homes: 1.8% [4.0%]
Expanded base: 1.6% [3.1%]
Universal base: 1.5% [2.8%]
These figures seem within the range of a politically conceivable flat-rate wealth tax. If the real rate of return on riskless investments is around 4%,(17) it suggests that the wealth tax would be equivalent to an income tax on such investments ranging from 39% to almost 55%.(18) If the riskless rate of return is 3%, the wealth tax could be the equivalent of a tax of about 72% on a riskless return.(19)
These figures may suggest that the proposed tax rates for a wealth tax are still too high. Note, though, that using the figure of a 15% return on human capital gave us a tax on human capital which is equivalent to an income tax on earned income between 10% and 14%.(20) If we started from the assumption that returns on human capital were only 10% (or if, for other reasons, we decided to increase the tax on earned income), the wealth tax base would expand, and we could apply the following rates of tax (tax rates when return on human capital was assumed to be 15% are in brackets for comparison):
Limited base: 1.36% [2.1%]
Limited base plus reserves in life insurance and pensions: 1.23% [1.8%]
Limited base plus owner-occupied homes: 1.25% [1.8%]
Expanded base: 1.14% [1.6%]
Universal base: 1.1% [1.5%]
These rates would be the equivalent of a tax on earned income ranging from 13.75% to 17%, still not very high.(21) Meanwhile, the tax on investment income would have decreased. If the riskless rate of return is 4%, the range of equivalent income tax rates would be 28.6% to 35.36%; if the riskless rate is 3%, the range of equivalent income tax rates is 37.77% to 46.69%.(22) These rates are roughly in line with the rates paid(23) on much investment income at this time.
C. The Individual Data
A number of structural decisions about a wealth tax must be made before an actual tax rate can be set. For one thing, wealth taxes may not be assessed from the first dollar of wealth. The broader the base for the tax, the more likely that an exemption would be provided.
Once an exemption is provided for, it may become necessary(24) to determine what the taxable unit will be. If the taxable unit could consist of more than one person, we would also have to decide whether each member of the taxable unit gets an equal exemption amount.
Other considerations might lead to reducing the tax base from its maximum. The transition from an income tax to a wealth tax shifts the burden of taxes to older persons who are taxed relatively lightly under an income tax as they consume savings. In addition, the fact that those savings were accumulated under the income tax would be a basis at least for transitional relief to ease the burden on those at or near retirement when the change from an income tax to a wealth tax occurs.(25)
Also, it is reasonable to expect persons to save for their retirement, and thus one possible structure for a wealth tax would include an exemption amount that increases as the taxpayer gets older. This is particularly true if the wealth tax base includes retirement savings.
The considerations discussed above would lead to a shrinking of the tax base, which would mean a higher tax would be required to raise the funds currently raised by the taxes a wealth tax would replace. In the next part of this project, I hope to estimate how much the tax rate would have to be raised by simulating a number of different tax regimes using data from the Federal Reserve Board's Survey of Consumer Finances.
II. Economic Consequences of a Wealth Tax
Even if one accepts the sense of using wealth as the tax base, one can reasonably ask what the economic consequences of such a decision would be. Particularly if one feels that the current income tax discourages investment and encourages consumption, the move to a wealth tax does not seem like an improvement.
In thinking about the economic effects of a tax system, two aspects of it should be considered. First, the tax system can affect the decision to invest or to consume. Second, the tax system can affect the decision to work or not to. For the moment, I would like to make some observations about the first of those effects, as well as the interaction between inflation and the choice of a tax base.
A. Invest or Consume
Let us consider first the incentives created by a wealth tax when compared to an income tax. Think first about an asset whose value at the beginning of the year is V. The asset produces a fixed return, r. If the marginal tax rate under the income tax is T, and the tax rate under the wealth tax is t, then the tax under the income tax will be rVT, while the tax under the wealth tax will be tV(1+r). If the tax rates in our example are fixed, the taxes under the two systems will be the same when
rVT = tV(1+r)
Solving for r in this equation
rVT = tV + tVr
rT = t + tr
r(T-t) = t
r = t/(T-t)
The following table shows what r would be if we compare the possible rates developed in Part I of this paper to a current income tax rate of 39.6%.
Wealth tax ratet/(T-t) r
1.1% 110/38.50 2.86%
1.14% 114/38.46 2.96%
1.25% 125/38.35 3.26%
1.36% 136/36.24 3.75%
1.5% 150/38.1 3.9%
1.6% 160/38.0 4.2%
2.8% 280/36.8 7.6%
3.1% 310/36.5 8.5%
3.8% 380/35.8 10.6%
4.0% 400/35.6 11.2%
5.3% 530/34.3 15.5%
For the rates of return, r, given above, a wealth tax and an income tax would impose the same burden on an investment. Importantly, for rates greater than r, the wealth tax would be less burdensome than an income tax; for rates less than r, the wealth tax would be more burdensome.
What happens when there is a loss on an investment in the current year? Losses incurred in the context of the three types of taxes have very different results. A consumption tax, being even-handed in regard to investments, gives no tax benefit for a loss on an investment, just as it imposes no tax cost on a gain. The wealth tax may also be viewed as evenhanded. Just as a gain of $1,000 will attract the wealth tax in the current year (in the amount of the wealth tax rate times $1,000), so a loss of $1,000 will reduce the wealth tax liability by the wealth tax rate times $1,000. The income tax is less clear in its application. Some losses may be taken without limitation under an income tax, but others are limited. Moreover, any progressive tax runs the risk of giving less benefit on a loss than the burden it imposes on an equal gain. To the extent an income tax may have a greater need to be significantly progressive, certainly compared to a comprehensive wealth tax, the possibility of that asymmetry is greater for an income tax than for a wealth tax.
B. Inflation
It is interesting to see the effects of inflation on a wealth tax, as opposed to an income tax or a consumption tax, assuming the various tax systems do not make any compensation for inflation. Suppose the real rate of return is 4% and the wealth tax has a rate of 3%. The income tax rate will be assumed to be 40% and the consumption tax rate will be 23%. If there is no inflation, an asset that increases in value from 100 to 104 will be subject to a tax of 3.12(26) under the wealth tax (almost an 80% tax on the 4 of income), while the income tax (assuming a realization event) would be 1.60. On the other hand, if there is 6% inflation, and the asset increases in value to 110 to reflect both the 4% real rate of return and the 6% inflation rate,(27) the wealth tax would be 3.30, while the income tax would be 4.0. At that point, the income tax is extracting all the real income generated by the asset; at any greater inflation rate, the income tax actually reduces the real value of the asset from one year to the next.(28)
Note that inflation has differential effects on income from capital versus income from labor under the income tax. We can assume that, on the whole, income from wages will increase to match inflation. Thus, as long as we are dealing with a flat rate tax (thus avoiding the complications of "bracket creep" in the case of the income tax), inflation has no effect on the after-tax return on labor. Inflation increases the burden of taxes in the case of the income tax. Absent inflation, the income tax was 1.60 for an asset that was worth 104 at year-end. Thus, the tax was 1.54% of the year-end value of the asset. With 6% inflation, the tax was 4.00, or 3.64% of the year-end value, more than doubling the rate as a percentage of year-end value. In contrast, the rate for the wealth tax remains at 3% of year-end value. If we want to measure the burden of the tax as a percentage of real income rather than year-end value, the differences remain dramatic. Where there is 6% inflation, the income tax, as we saw, increases from 40% of income to 100%. The wealth tax increased from 78% to 82.50%
In order to compare the effects of the income tax and a wealth tax, I considered an investment which produced a taxable fixed return annually. The following table shows the excess of a 3% wealth tax over a 40% income tax as a percentage of nominal increase in value. Negative numbers indicate where the income tax was greater than a wealth tax. For the purpose of this table, I used a more precise calculation of the actual increase in value stemming from a combination of real interest rates and inflation.(29)
3% Wealth Tax v. 40% Income Tax
Difference as percentage of annual income
Inflation Real InterestRate ??
Rate 1% 2% 3% 4% 5%
0% 263.00% 113.00%63.00% 38.00% 23.00%
1% 112.25% 62.34%37.44% 22.52% 12.59%
2% 62.34% 37.26%22.29% 12.34% 5.25%
3% 37.44% 22.29%12.26% 5.13% -0.19%
4% 22.52% 12.34%5.13% -0.24% -4.39%
5% 12.59% 5.25%-0.19% -4.39% -7.73%
6% 5.49% -0.05%-4.32% -7.70% -10.45%
7% 0.17% -4.18%-7.62% -10.40%-12.71%
8% -3.96% -7.47%-10.31% -12.65%-14.61%
9% -7.27% -10.17%-12.55% -14.54%-16.24%
10% -9.97% -12.41%-14.44% -16.17%-17.65%
As can be seen, for a real interest rate of 2%, the two taxes are about the same at an inflation rate of a little below 6%; for a real interest rate of 3%, the figure is a little under 5%; for a 4% real interest rate, the figure is a little under 4%.
I made the same calculation using the lowest wealth tax rate that I had previously calculated, 1.1% (and adding in a 0% real interest rate).
1.1% Wealth Tax v. 40% Income Tax
Difference as percentage of annual income
Inflation Real InterestRate ??
Rate 0% 1%2% 3% 4% 5%
0% 71.10% 16.10% -2.23% -11.40% -16.90%
1% 71.10% 15.83% -2.48% -11.60% -17.07% -20.72%
2% 16.10% -2.48% -11.67% -17.16% -20.81% -23.41%
3% -2.23% -11.60% -17.16% -20.84% -23.45% -25.40%
4% -11.40% -17.07% -20.81% -23.45% -25.42% -26.94%
5% -16.90% -20.72% -23.41% -25.40% -26.94% -28.17%
6% -20.57% -23.32% -25.35% -26.92% -28.16% -29.17%
7% -23.19% -25.27% -26.86% -28.13% -29.15% -29.99%
8% -25.15% -26.79% -28.07% -29.11% -29.97% -30.69%
9% -26.68% -28.00% -29.06% -29.94% -30.67% -31.29%
10% -27.90% -28.99% -29.88% -30.63% -31.26% -31.80%
The following table shows annual percent changes in the Consumer Price Index (CPI-U) for 1980-1994.
Annual Percent Changes in Consumer Prices, 1956-1995
1956 1.5% 1976 5.8%
1957 3.3% 1977 6.5%
1958 2.8% 1978 7.6%
1959 0% 1979 11.3%
1960 1.7% 1980 13.5%
1961 1.0% 1981 10.3%
1962 1.0% 1982 6.2%
1963 1.3% 1983 3.2%
1964 1.3% 1984 4.3%
1965 1.6% 1985 3.6%
1966 2.9% 1986 1.9%
1967 3.1% 1987 3.6%
1968 4.2% 1988 4.1%
1969 5.5% 1989 4.8%
1970 5.7% 1990 5.4%
1971 4.4% 1991 4.2%
1972 3.2% 1992 3.0%
1973 6.2% 1993 3.0%
1974 11.0% 1994 2.6%
1975 9.1% 1995 2.8%
Source: Statistical Abstract of the United States, 1996, Table No. 746
Average, 1956-1995 = 4.46%
Average, 1956-1965 = 1.55%
Average, 1966-1975 = 5.53%
Average, 1976-1985 = 7.23%
Average, 1986-1995 = 3.54%
The median figure is 3.6%.
As the above table suggests, if we look at the average inflation rate for 1956-1995, it appears that a 40% income tax would have been about as burdensome on investors as a 3% wealth tax, assuming real interest rates are around 3% or 4%. If real interest rates are lower, then the wealth tax is more burdensome. If we compare the 40% income tax to a 1.1% wealth tax, the income tax is substantially less burdensome unless both inflation and the real interest rate are very low.(30)
CONCLUSION
The goal of this paper is modest. For the moment, I merely wish to assert that a broad-based flat wealth tax could be substituted for all Federal income and estate and gift taxes. In the future, I hope to show the distributional effects of such a tax, and its potential economic consequences. In the light of the findings on those issues, I also hope to discuss more fully the consequences of such a fundamental shift in our tax system on the system's equitable foundations.
Abstract
This paper is a preliminary exploration of a wealth tax. The initial question that is posed is whether it is conceivable that the United States could impose a broad-based, flat wealth tax as a substitute for all current Federal income taxes (individual and corporate) as well as the estate and gift taxes. If we look only at assets listed by the Federal Reserve in its national Balance Sheets, we find that tax rates would have to be too high to replace Federal taxes with a wealth tax--under many assumptions, the tax rate would be in excess of the riskless rate of return on assets, surely too high a rate for a politically viable tax structure. However, if human capital is included in the calculation under reasonable assumptions, the tax rate needed for the wealth tax drops below 2%, perhaps as low as 1.5%. This seems like a politically viable level for a wealth tax.
In the future, I hope to do further work to show the distributional effects of such a tax, and its potential economic consequences. In the light of the findings on those issues, I also hope to discuss the consequences of such a fundamental shift in our tax system on the system's equitable foundations.
In evaluating the economic consequences of a wealth tax, we need to compare the burden of the tax to the burden of the current tax system. To do this, we must look at the various categories of asset in the Fed's data and see at what rate it is taxed as a % of VALUE. Somehow, I have to figure in the corporate tax and the estate and gift tax also. . . .
I guess the corporate tax can be viewed as a tax on capital (which the economists would argue is a tax on future consumption and hence a tax on wages). The estate and gift tax is a wealth tax, after all, which would be a tax on all relevant assets. Ideally would want to know the mix of assets owned by persons who pay wealth tax, which may be partly doable based on SOI estate tax data.
Transitional issues here are rather severe and significant. At the moment, it seems to me that any existing assets have already been taxed, so that it would be wrong, at least in theory, to tax the income from assets owned at the time the new tax is introduced (at least to the extent of their tax bases). n other words, if I already set up a bank account with $10,000 with after-tax income, I shouldn't have to pay tax on the income from that $10,000 under a wealth tax. Such a transitional rule would sharply reduce the base of the tax and make it necessary to continue the existing taxes for a while--maybe a long while. BUT, can you combine my tax with the old taxes? Have to figure the numbers and make sure won't be overtaxing some aspect of the economy too much in the interim period of transition.
(1)*I would thank my colleague, Reed Shuldiner, for some very helpful observations regarding the effects of inflation on the tax system.
Kurtz, The Interest Deduction under Our Hybrid Tax System, 50 Tax L.Rev. 153, 158 (1995), citing Richard A. Musgrave & Peggy B. Musgrave, Public Finance in Theory and Practice 223 (5th ed. 1989).
(2)For one exception, see Edward N. Wolff, Top Heavy: A Study of the Increasing Inequality of Wealth in America (20th century Fund Press 1995). For an early consideration of wealth taxes, see G. Cooper, "Taking Wealth Taxes Seriously," 34 Rec. Ass'n B. City N.Y. 24 (1979) (Ninth Mortimer H. Hess Memorial Lecture).
(3)Edward McCaffrey, The Uneasy Case for Wealth Transfer Taxation, 104 Yale L.J. 283, 297 (1994).
(4)For a recent proposal of a wealth tax to supplement our income tax, see Edward N. Wolff, Top Heavy: A Study of the Increasing Inequality of Wealth in America, chapter 8 (New York 1995)
(5)Joint Committee on Taxation, Selected Materials Relating to the Federal Tax System Under Present Law and Various Alternative Tax Systems, (JCS-1-96), March 14, 1996, at 5.
(6)The figures (in billions), from the Federal Reserve Balance Sheets, are as follows. Financial assets--$16,464.5. Subtract life insurance reserves ($433.0) and pension fund reserves ($4,516.5). Take out debt (but not home mortgage debt): $4,142.9 (all debt) - $2,788.1 (home mortgage debt), leaving $1,354.8 net debt. Take out the totals for private foundations, that are included with individuals (financial assets of $803.1 - $496.6 of debt or $306.5; add $73.3 of real estate and $464.3 of pt and equities, for a total of $844.1). The total remaining is $12,025.7 billion. Using the figure of $509.7 billion for individual taxes, the rate for an equivalent wealth tax is 4.2%.
(7)Life insurance and pension reserves are $433.0 and $4,516.5 billion, giving total assets of $16,975.2 billion.
(8)Homes and land are $3,901.9 and $2,807.5 billion. Home mortgage debt is $2,788.1 billion. When added to the $12,025.7 billion of financial assets, the total is $15,947.0 billion.
(9)The figures are given in the previous two footnotes. The total of assets net of liabilities is $20,896.5 billion.
(10)Consumer durables were $2,222.2 billion, giving a total of all individual assets, net of liabilities, of $23,118.7 billion.
(11)If the estate and gift tax revenues of $12.6 billion in 1993 were not included in the calculation, the tax rates would need to be 0.1% less in each case.
(13)See generally G. Becker, Human Capital: A Theoretical and Empirical Analysis (3d ed. 1993).
(14)See, e.g. Adriaan Kalwij, Estimating the Economic Return to Schooling on the Basis of Panel Data (University of Tilburg, Working Paper) (estimating 15% return).
(15)To the extent a decision to use one tax system rather than another is driven by economic considerations rather than preexisting concepts of a "correct" tax base, it not necessary to base the rate of tax on wages on a calculated return on "human capital".
(16)IRS, Statistics of Income for Individuals, 1992, Table 1.3. Using figures for wages from tax returns means that we are excluding wages of those whose income is below the filing thresholds as well as those who improperly fail to file tax returns. In terms of thinking of a realistic wealth tax, this provides a minimal exemption for certain very low income persons, and takes account of one category of tax avoidance. The use of the figures from the Federal Reserve's Balance Sheets in the other calculations does not take account of either of these considerations.
(18)For example, if the real rate of return is 4%, and the wealth tax is 1.5%. the tax of 1.5% * 104% of the value of the asset at the beginning of the year would equal 1.56% of the value of the asset at the beginning of the year. As a percentage of the 4% income on the investment, that would be a tax of 1.56%/4% = 39% of the income. 2.1%*104% = 2.184% of the value of the asset. 2.184/.04 = 54.6%.
(19)Using the same analysis as in the previous footnote, 2.1% * 103% = 2.163%. 2.163/.03 = 72.1%.
(20)Multiplying the tax rates by 6-2/3 gives us a range of 14% if we start from a wealth tax of 2.1% and only 10% when we start from a wealth tax of 1.5%.
(21)In this paper, I do not take account of administrative concerns. Thus, I merely note here that, no matter how low the rate on wage income is, there will still be a preference for taxpayers under this wealth tax system to say that income comes from fixed capital rather than from the more highly-taxed human capital.
(22)The calculations follow. In each case, the end of year value is multiplied by the wealth tax rate to determine the amount of tax that would be owed. This is divided by the income (either .04 or .03) to calculate the equivalent income tax return.
(1.36*1.04)/.04 = 35.36%
(1.1*1.04)/.04 = 28.6%
(1.36*1.03)/.03 = 46.69%
(1.1*1.03)/.03 = 37.77%
(23)As noted before, the analysis disregards the additional benefit that comes from deferral in the case of many investment assets.
(24)If the exemption is small and the tax rate is low, the practical need for resolving the taxable unit issue is much reduced. For example, if only financial assets were in the base, an exemption of only $10,000 is imaginable. If the tax rate were 5%, the total saving from the zero bracket amount would be $500.
(25)Transition issues are not discussed in this paper. However, we need not assume that the transition from an income tax to a wealth tax would occur in one year.
(26)I apply the 3% rate to the end of year value, 104.
(27)For this purpose, I am doing nothing more complicated than adding the two rates together. More precisely, if the real interest rate is i and the inflation rate is I, the increase in value in one year will be (1 + i) * (1 + I) = 1 + i + I + iI. Thus, the precise figure is higher, by the amount iI, when compared to the figure used here in the text.
(28)Since the income tax depends on realization events, this will happen inconsistently to assets under the income tax. The effect will be most pronounced in the case of fixed income investments, such as bonds. It will be of least importance in the case of assets whose return is solely a function of increases in value, such as unimproved land. Discussions of inflation and the income tax have noted that fact.
(29)See note 27,above.
(30)For completeness, it should be noted that a consumption tax is generally viewed as not being affected by inflation.