Even if you do not receive a bill from the tax collector, your living standards are still affected by taxes.
To understand who wins and loses from capital taxation, consider your personal experiences with theft.
Many people, including me, lock the doors of our homes and automobiles. We do not make a habit of keeping valuables in the car or large amounts of cash in the house. We lock our computer with a password (or, at least, know we should) and are careful about giving out our personal identification numbers. Many apartment buildings have a doorman to monitor who enters. And law-enforcement departments keep an eye out for theft, along with their other duties.
With all these precautions and defensive measures, perhaps your home, car and computer have never been burgled, nor your identity stolen. But that does mean that you are unharmed by theft.
First, theft has a kind of “excess burden,” because of the actions people take to avoid it. Theft’s total cost is not only the value of any items stolen from us, but also the costs and efforts of protecting ourselves from additional thefts. Simply put, the value of what thieves obtain is less that the costs to theft victims.
Second, theft victims are not the only ones whose living standards are reduced by theft, because third parties are affected as the theft victims react. For example, a store owner who has been robbed or burgled may shut his store or raise prices to pay for security and compensate himself for the risks of his business. Because of the store owner’s reaction to theft, his customers bear much of the cost of what is stolen from the store, even though they were never owners of the items stolen.
Taxation is not necessarily the moral equivalent of stealing, but the same principles apply because of the chilling effect that each causes.
Both taxpayers and theft victims have in common that they take actions to reduce what they pay. Prof. Richard H. Thaler, a colleague of mine at the University of Chicago, pointed out earlier this month that under President Obama’s proposal for the estate tax, 99.7 percent of people would not owe estate tax when they died, suggesting that the estate tax is something that affects only rich heirs and heiresses like Paris Hilton.
His conclusion ignores two basic results from the economics of taxation: Some of the people do not owe estate tax because they spent resources avoiding the tax, and these avoidance behaviors affect third parties — as these taxpayers take steps to reduce their wealth, they may invest less or generate less economic activity.
Because the estate tax is a tax on wealth, estate holders may accumulate less wealth than they would in the absence of the tax. In this regard, the estate tax has a lot in common with other capital taxes, like the corporate income tax and the personal income tax on “unearned” income.
In principle, capital accumulation, or a lack of it, has effects that are not limited to the owners of capital. If some among them accumulate less wealth because capital taxation reduces their incentive to do so, they will have less to invest in existing enterprises or new companies. And that will not only benefit competitors, but also adversely affect would-be workers, vendors or other beneficiaries.
The effect of capital accumulation on the rate of return enjoyed by capital owners is more than a textbook possibility — it is readily seen in the economic data.
The chart below, adapted from one of my papers on capital accumulation, displays the annual national income accruing to the owners of capital, subtracting capital income taxes paid, and expressed as percentage of dollars invested. For example, a value of 5 percent means that $100,000 invested gave the owners of that capital $5,000 of income in a year, after taxes, in the form of interest, dividends, property rent or retained earnings in a business.
What is striking about the data is how little they changed over the years. Capital income rates were almost always between 4.5 and 6.0 percent. Although the population more than doubled, our economy grew by a factor of five or six, and tax laws changed many times, the owners of capital at the end of the 20th century were earning at rates much like the owners 50 years earlier.
On average, the owners of capital saw little change in the rate they earned income as the economy dramatically changed its size, largely because of changes in the amount of capital and the competition among owners.
The same logic does not seem to apply to labor — the amount that workers earn per hour, week or year depends very much on the size of the economy — because the supply of people for work adjusts less than the supply of capital does. For this reason, we expected taxes on capital largely to affect the amount of capital, have little effect on the rate at which capital owners earn income and ultimately to have a significant effect on employment and wages.
You may think that the wealth accumulation of decisions of the mere 0.3 percent of taxpayers who pay estate taxes would have a minor effect on the rest of us, and you would be correct. But the estate tax also brings in little revenue — about $20 billion last year — so the minor effect on the rest of us is actually quite large in comparison to the revenue collected through the tax.
Taxpayer losses from taxes are not limited to the amount received by the public treasury, and the losers from taxes are not limited to those writing the checks.