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MSc Public Economics 2008/9 darp.lse.ac.uk/ec426

16 February 2009. MSc Public Economics 2008/9 http://darp.lse.ac.uk/ec426. Wealth Taxation. Some preliminary questions. Why wealth taxation? Revenue raising? Efficiency? Equity? What are wealth taxes? taxing personal wealth… …and the transmission of wealth What is wealth? composition

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MSc Public Economics 2008/9 darp.lse.ac.uk/ec426

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  1. 16 February 2009 MSc Public Economics 2008/9http://darp.lse.ac.uk/ec426 Wealth Taxation .

  2. Some preliminary questions Why wealth taxation? Revenue raising? Efficiency? Equity? What are wealth taxes? taxing personal wealth… …and the transmission of wealth What is wealth? composition distribution What is the appropriate way of modelling impact of wealth tax?

  3. Overview... Wealth Distribution and Taxation Wealth taxation Wealth distribution Why wealth taxation? Types of tax Wealth trends Long-run models

  4. Why wealth taxation? Consider the motives behind the introduction of any form of tax Revenue raising Funding public goods? Efficiency considerations Allocative efficiency Minimisation of distortion Administrative simplicity Equity considerations Short-run inequality Long-run inequality How do these considerations apply here?

  5. Estate, inheritance and gift taxes international comparison Taxes as percent of total tax revenue Source Cremer and Pestieau (2003) from OECD Revenue Statistics (2000)

  6. Efficiency and equity considerations Efficiency case for or against wealth taxes is unclear (Cremer and Pestieau 2003) Equity case for wealth taxes is more promising But needs careful empirical analysis Who owns what? Direct impact of wealth taxes on redistribution likely to be small small revenue raised… …less than 1% of receipts? not much taken from rich to give to poor But what of long run? taxes may influence savings behaviour and bequest behaviour these influence wealth accumulation and inequality

  7. Annual wealth tax: examples France. solidarity tax on wealth Sweden. 2003 out of a 1,314 billion kronor "general government" revenue, 3.818 billion kronor of "wealth tax" was collected. tax rate is 1.5% the net worth exceeding 1,500,000 kronor (single person, estate of deceased person Switzerland. Progressive wealth tax with a maximum of around 1% exact amount varies between cantons.

  8. Inheritance tax: examples Inheritance tax: The Republic of Ireland (where it is a tax on beneficiaries). The United Kingdom: see Inheritance tax (United Kingdom). Some states of the US: Nebraska, New Jersey, Pennsylvania ,Tennessee Estate tax: The United States: Some states of the US: Missouri, Virginia, Washington ,West Virginia, Wisconsin, Wyoming Estate duty (death duty) Hong Kong. Bermuda Without inheritance taxes Australia British Virgin Islands Vanuatu Some states of the US:: New Mexico, South Dakota , South Carolina, Utah

  9. Overview... Wealth Distribution and Taxation Wealth taxation Wealth distribution Definitions, composition and inequality Wealth trends Long-run models

  10. Wealth: the facts Wealth in UK concepts composition age profile inequality – comparison with income shape of distribution UK in context comparisons with other UK data …with other countries How change over time? next section

  11. Wealth concepts in the UK British Household Panel Survey fairly comprehensive suffers from standard participation / attrition problems Wealth and assets survey still at experimental stage HMRC Identified personal wealth emerges directly from the estate multiplier method it is clearly biased (missing wealth, missing persons) differs from balance-sheet concept of wealth HMRC Series C: marketable wealth only valuation issues addressed excluded population corrected HMRC Series D: includes a valuation of pension rights unfortunately no longer regularly published HMRC Series E: includes a valuation of state pension rights unfortunately no longer regularly published

  12. HMRC “Identified wealth” 1999 • Residential buildings about 40% of net worth, except for £500,000+ • Debts concentrated amongst those with less than £100,000 • Securities concentrated amongst the rich Source: HMRC statistics table 13.2

  13. net capital value of Loans, mortgages Other Buildings Net as % gross Other assets Other debts Residential Policies of Mortgages Securities insurance and Land buildings estate Cash etc 0 - £50,000 4.6% 22.7% 5.6% 8.9% 47.6% 0.1% 10.5% 61.0% 5.7% 33.4% £50000 - £100,000 4.5% 16.2% 3.0% 14.6% 55.0% 0.0% 6.8% 83.3% 4.1% 12.6% £100000 - £150,000 3.9% 14.0% 2.4% 18.6% 55.2% 0.1% 5.8% 84.4% 4.3% 11.3% £150000 - £200,000 4.5% 14.4% 0.7% 12.1% 59.4% 1.6% 7.5% 89.0% 4.9% 6.1% £200000 - £500,000 8.5% 12.8% 0.9% 12.6% 54.7% 1.5% 9.0% 89.7% 6.5% 3.8% £500000 - £1000,000 17.6% 11.2% 1.6% 7.6% 42.5% 5.3% 14.1% 93.8% 3.9% 2.3% £1,000,000 and over 23.8% 10.8% 1.9% 5.0% 28.1% 8.1% 22.4% 94.2% 2.9% 3.0% HMRC “Identified wealth” 2003 • Residential buildings about 50% of net worth, except for £500,000+ • Debts concentrated amongst those with less than £100,000 • Securities concentrated amongst the rich

  14. Proportion of wealth in residential buildings. UK 1999

  15. Proportion of wealth in residential buildings. UK 2003

  16. Proportion of wealth in securities. UK 1999

  17. Proportion of wealth in securities. UK 2003

  18. Wealth distribution by age. UK 1999 • Quantiles fan out and stay fanned out

  19. Wealth distribution by age. UK 2003 • Quantiles fan out, but not so much

  20. Identified Wealth UK 1999

  21. Identified Wealth UK 2003

  22. Income and Wealth: Lorenz

  23. UK wealth, 1994: Lorenz

  24. UK: BHPS (LWS) and HMRC

  25. Household portfolio composition – LWS United US US Wealth components Canada Finland Germany Italy Sweden Kingdom PSID SCF 1999 1998 2002 2002 2002 2000 2001 2001 Non-financial assets 78 84 87 85 72 83 67 62 Principal residence 64 64 64 68 61 74 52 45 Real estates 13 20 23 17 11 9 14 17 Financial assets 22 16 13 15 28 17 33 38 Deposit accounts 9 10 n.a. 8 11 9 10 10 Bonds 1 0 n.a. 3 2 n.a. n.a. 4 Stocks 7 6 n.a. 1 6 n.a. 23 15 Mutual funds 5 1 n.a. 3 9 n.a. n.a. 9 Total assets 100 100 100 100 100 100 100 100 Total debt 26 16 18 4 35 21 22 21 Home secured 22 11 15 2 n.a. 18 n.a. 18 Total net worth 74 84 82 96 65 79 78 79 Source: Sierminska et al (2006); see also Davies et al (2006)

  26. LWS series ordered by Gini c of v Gini ITALY 2004 NW1 1.387 0.565 ITALY 2002 NW1 1.477 0.573 FINLAND 1998 NW1 1.453 0.588 CYPRUS 2002 NW1 3.993 0.635 FINLAND 1994 NW1 1.419 0.648 UK BHPS 2000 NW1 1.705 0.689 CANADA 1999 NW1 2.396 0.755 GERMANY 2002 NW1 2.550 0.758 SWEDEN 2002 NW1 5.969 0.849 US SCF 2001 NW1 5.062 0.911

  27. Measurement tool for wealth distributions Choose an arbitrary base level wealth b Calculate a conditional mean and normalise: “average” E(x | x³b)  =  “base” b • Advantages: • easy interpretation • focuses on upper tail • Disadvantage: • depends not only on distribution but also on the arbitrary b

  28. Functional form for wealth distribution 0 1 2 3 4 5 • The Pareto Distribution • Higher a (less inequality) f(x) a = 2.0 a = 1.5 • F(x) = 1 − [ x/ x ]a • f(x) = axaxa1 • a captures “weight” of the tail • x “locates” the distribution average a  =  base a− 1

  29. Pareto diagram: application 0 log Wealth 8 9 10 11 12 13 14 15 -1 -2 -3 log(1−F) -4 -5 -6 -7 • Plot log wealth against log( 1 – F) • Data points • Top 7 points • Fit straight line • UK: Identified Personal Wealth 2003 • Inland Revenue Statistics 2006 Table 13.1 • log (1−F) = −1.7618 log W + 19.761

  30. Wealth distribution: Summary Patchy information: internally and internationally Observable part conforms to a standard pattern Pareto distribution A good fit A convenient model Wealth much more unequal than income A rational explanation for this? Important policy consequences? Distinctive patterns of wealth holding By age By position in the distribution

  31. Overview... Wealth Distribution and Taxation Wealth taxation Wealth distribution Rising inequality or stability? Wealth trends Long-run models

  32. Trends in wealth inequality Useful to look at trends in distribution what effect of wealth taxation in the past? equalisation? is there a trend toward stability…? ….or divergence? For historical and recent wealth trends in US Kopczuk and Saez, (2004) Substantial time coverage: From early 20th century For historical wealth trends in UK Atkinson et al. (1989) Similar time coverage… But incomplete series Recent picture from Inland Revenue data

  33. Distribution of wealth US 1916-2000

  34. Distribution of marketable wealth UK 1976-2002 (Series C)

  35. Pareto’sa: USA and UK • Sources: see Cowell (2009) Chapter 4

  36. Wealth trends US and UK: Substantial wealth inequality UK Inequality falls in early 20th century roughly from first world war substantive rises in income tax and estate duty Reductions in inequality continue through mid-century US inequality falls from time of great depression Largely attributable to stock prices Large concentration of corporate stock in wealth of very rich But US inequality also carried on falling through to 70s This despite recovery in stock prices Antitrust legislation? Development of estate tax Distribution remarkably stable over time in recent years appropriate to use an equilibrium-distribution approach?

  37. Overview... Wealth Distribution and Taxation Wealth taxation Wealth distribution Fairy tales? Wealth trends Long-run models

  38. A way forward Direct impact of wealth taxes on redistribution will be small But wealth taxes may work by influencing long-run distribution of resources. requires careful modelling small taxes can have powerful effects on the equilibrium (Kaplow 2000) Develop a story of what happens to wealth distribution in the long run (Piketty 2000): Characterise each generation as a fixed time unit Set up intergenerational budget constraint Model dynastic tastes or habits Model exogenous resource flow Specify family formation mechanism Examine three illustrative models can be used to illustrate role of tax in long-run distribution

  39. Outline of model (1) • Common practice to combine in a neoclassical model • (Becker and Tomes 1979) • Preferences and behaviour • Cobb-Douglas preferences (simplified savings behaviour) • utility maximisation by parental generation • look one generation ahead • Simplified family characteristics • exogenous attributes • no “marriage story” • no “fertility story” • Resources and markets • “perfect” markets • exogenous (labour) earnings and initial endowments

  40. Illustrative model (1) Total wealth of generation n • Generational budget constraint Planned bequest Generation n’s consumption • Wealth accumulation equation Cn + Bn+1 /[1+rn] £Wn • Prospective resources Ratio of kids to parents • Proportionate savings rate s • Equation for wealth accumulation ½k Wn+1 = Bn+1 Earnings of generation n+1 Wn+ En+1 /[1+rn] ½k Wn+1 = s[1+rn] Wn+ s En+1 Wn+1 = g[1+rn] Wn+g En+1 • Stochastic “earnings” will give a simple Markov chain. • given sensible parameter values will get convergence (regression to mean) • Initial wealth inequalities will be damped away • In the long run wealth inequality is going to be determined just by E.

  41. Simulation approach • It is common to put some variant of is this into a simulation model. • But is it based on optimisation – and of what sort? • Type of utility function s crucial • What motive for bequests…? • …see e.g. Gokhale et al. (2001) who come to strong conclusions based solely on “accidental bequests”. • What characteristics of the simulation model? • representative agent • size and length of the run • criteria for evaluation • Type of solution? • convergence to equilibrium? • an equilibrium distribution?

  42. Illustrative model (2) An intergenerational perspective based on Champernowne-Cowell (1998) common elements with recent literature Use a simplified model focuses on the role of consumption naïve savings behaviour but family features are absent A model of single person-dynasties. each individual ( “Mutt”) leaves all his terminal wealth to just one descendant. Mutt inherits T years after attaining adulthood and dies T years after that. Wealth left in excess of W*attracts inheritance tax at rate t. During the earnings span Mutts get the same earnings, E*. Mutts consume: C* if they have positive wealth otherwise E* .

  43. A Mutt's Life earnings E* t -T T 0 age

  44. Generations of Mutts n =0 -T T 0 n =1 -T T 0 n =2 -T T 0 n =3 -T T 0

  45. Consumption in the model c(t) C* consumption E* c(t)=C* if W(t)>0 =E* if W(t)=0 y(t) E* income

  46. Bequest and inheritance 1-t W(0) inheritance W* W(0) =min {Bn , [1-t]Bn + tW* } Bn W* bequest

  47. Wealth over the Lifetime Given savings rule and inherited wealth W(0) we get ^ ^ W(t) = max { W(0) ertB [ert1], 0}, B := [C* E*]/r ^ So wealth rises/declines according as W(0) B Evaluating at end of life (t = T) and substituting for W(0): ^ Bn+1= max { min {Bn ,[1-t]Bn + tW* } erTB [erT1], 0} Change in bequest DBn+1= Bn+1− Bn as a function of Bn Get three possible regimes where Bn > W* where W(t) = 0 intermediate between 1 and 2

  48. Bequest Dynamics 40 30 20 10 50 100 150 200 250 300 0 -10 -20 -30 -40 • Plot DB against B DBn • The phase diagram Bn falling Bn rising Bn falling • Paths to riches • Paths to ruin • Find equilibria (DB = 0) • Now cut tax… Stable Stable Bn ^ • W* B Unstable

  49. Wealth distribution amongst the wealthy f(W) 0.0225 0.02 0.0175 0.015 0.0125 0.01 0.0075 0.005 0.0025 W 0 150 160 170 180 190 200 210 220

  50. Wealth distribution. All Mutts f(W) 0.0225 0.02 0.0175 0.015 0.0125 0.01 0.0075 0.005 0.0025 0 0 50 100 150 200 250 W

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