Sunday, December 8, 2019

The endowment effect and the taxation of wealth

 - by New Deal democrat

As you may recall, I am reading the histories of a number of past Republics which have had various levels of success. Without getting too far ahead of myself, it appears that one constant is that, once plutocratic oligarchies are entrenched, they will refuse to yield power or money, even to the point of destroying democratic or republican institutions.  In other words, David Frum‘s observation that "If conservatives become convinced that they can not win democratically, they will not abandon conservatism. They will reject democracy" is true not just at the present, but across history.

I raise this in the context of Elizabeth Warren’s proposal for a “wealth tax.” Leaving aside its practicality or even Constitutionality, the above historical observation is probably at the root of the apoplexy with which plutocrats have reacted against it.

A further context to consider this issue is what psychologists and behavioral economists call “the endowment effect.” The endowment effect describes the consistent result that people would rather retain something that they have acquired - even if by charity, chance, or gift - than earn the  same thing when they do not own it. Put another way, people's maximum willingness to pay to acquire something is typically lower than the least amount they are willing to accept to give it up, even when there is no cause for attachment, or even if the item was only obtained minutes ago, and was not in any way “earned.”

This paradigm is applicable to taxation. Consider payroll tax withholding. Suppose a person’s income tax liability were $10,000. In strictly economic terms, they should be indifferent to paying that lump sum at the end of the tax year, or having it withheld at $385 per biweekly paycheck. But it is almost certain that the former situation would lead to a lot of anger at the end of the year, while the latter once started would be barely noticed. In the former case, the government is trying to take away the “endowed” $10,000, while in the latter case the taxpayer never even receives the money.

A “wealth tax” is like the former situation, and is likely to engender the strongest angry reaction. And it certainly appears to be the case from several thousand years of history that it oligarchs will be willing to trash everything else in order to keep their “endowment.”

Obviously this points to the importance of equitable interception of income before it vests in the recipient, I.e., withholding taxes. But in a case such as the US, where that horse has long ago left the barn, it argues for a recapture that at least minimizes the endowment effect. 

That, I think, is the estate or inheritance tax. I prefer the latter, because it emphasizes the fact that the heir has not “earned” the wealth, vs. the former which has been demogogued as a “death tax.” And it does make a difference. One of the Koch brothers, for example, could leave either $250 to every American household, or $40 Billion to their sole surviving heir. The estate tax would be identical, but the inheritance taxes would be very much different!

By no means am I suggesting that the wealthy would roll over for a robust inheritance tax. But I am suggesting that the reaction would be much less intense than for a “wealth tax.” That means a much better chance of the tax “sticking,” and a much better chance that the wealthy would not destroy our representative democracy to avoid it.