Tax preferences aimed at wealth obstructing job creation

America’s stock indexes recently reached new all-time highs and real estate prices and consumer confidence are on the rise, but the percentage of our population actively participating in the workforce remains near all-time lows. Why is that? It’s because we’ve been re-inflating the bubble, not addressing the underlying dysfunction of our policies.

There are three potential sources of taxation: income, consumption and wealth. Modern economists and politicians aggressively argue the relative merits of income vs. consumption taxes but largely ignore wealth, which over the long term of recorded history has been a primary basis of taxation. There are enormous misincentives embedded in our personal and corporate income tax policies, and deeply regressive inequities in consumption taxes. But a nominal constant annual assessment against accumulated wealth (as a replacement for existing investment income taxes) could both distribute the burden more equitably and incent a search for more productive allocation of private capital — thereby stimulating job creation.

It’s time we take the blinders off and examine how current tax policies undermine our productive economy and fuel an ever-increasing concentration of income and wealth. Capitalist theory identifies the productive investment of capital as the driver of economic growth and prosperity, and it is axiomatic among economists that the more aggressively you tax something, the less of it you get. But we tax productive capital more heavily than we tax unproductive capital and we tax labor at the highest rates of all. Our tax and monetary policies have made tax avoidance and valuation manipulation far more profitable than productive enterprise. Why should we be surprised that we are creating recurring asset valuation bubbles instead of jobs?

The vast bulk of tax preferences accrue to the portion of our population who least need them. Mitt Romney and Warren Buffett and their billionaire peers do not need preferential tax rates or structural tax shelters to encourage them to save their wealth and income. They couldn’t possibly consume all their income and wealth if they tried. Thirty-five percent of our national wealth is held by 1 percent of our population; seventy-three percent is held by the top 10 percent. Preferential tax treatment of wealth and investment income is a gift to the already privileged — a gift they neither need nor deserve.

More importantly, exempting wealth from direct taxation distorts investment incentives. If stimulus to growth comes from productive domestic investment, we place our incentives precisely backward. We apply high income tax rates to productive capital, thus subsidizing returns on unproductive or low-profit capital. The intricate shell game of corporate profit and investment income taxes encourages aggressive income sheltering and tax avoidance strategies — diverting investors from the search for productive domestic enterprise that could drive economic growth. Investors and corporations suppress taxable income by manipulating earnings, shifting operations and profits offshore and deferring gains. Between 1988 and 2008, $37 trillion of increasing wealth was sheltered from taxation as unrealized gains, accruing tax free into the hands of investors who had no current need for the income it represented.

As an alternative: If we would impose a constant nominal assessment directly upon net wealth, essentially returning to the long-term historic norm and utilizing property as part of the tax base, we could equalize effective tax rates between labor and investment while simultaneously stimulating more productive allocations of private capital. Specifically, I propose we should:

1. Reduce the top marginal tax rate on earned income (i.e. wages and salaries) to 25 percent inclusive of employment taxes, thereby increasing disposable income for the bulk of our population; and
2. Replace all current investment related taxes, including those on corporate profits and personal interest, dividends, capital gains and estate taxes, with an annual tax on net accumulated wealth in excess of $250,000, taxing the earnings potential of such wealth at an effective rate equal to the same 25 percent.

If one assumes a target WACC (weighted average cost of capital, i.e., the average available return on investment) of 6 percent to 8 percent, a 25 percent income tax rate would be equal to a 1 and a half percent to 2 percent annual tax on net wealth.

Most people shy instinctively away from discussion of wealth or property taxes in the belief that they are redistributive mechanisms; but it is our current policies that are redistributive — from the working class upward. Modern economists and politicians claim that the structural tax preferences we offer to investors are necessary to encourage savings. But the evidence of our increasingly unstable economy stands as an indictment against their myopia. Today our leadership ignores structural misincentives embedded in our tax code that divert capital from productive deployment which would enhance growth and create jobs. If we want to stimulate economic growth and prosperity we need to remove the misguided structural shelters that currently subsidize unproductive capital.

Hopkins is the founder and president of Kestrel Consulting LLC, a crisis management and turnaround consulting firm. He is the author of
A Citizen’s 2 percent Solution: How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget.