Reading over the debate over whether inequality is rising or falling an interesting question came to mind? How does or should one measure wealth? And are the numbers that we have at hand skewing the debate? That current debate is focused on measuring incomes and whether the gap between the highest and lowest incomes in the U.S. is rising or falling. What never comes up is how good a measure income is of wealth itself, and it is wealth disparities that really matter in things like political power.
Take two extreme examples. Bill Gates, one of the world's richest men, is stepping down as CEO of Microsoft to focus on charity. Say, for this example, that he declines to receive dividends from his Microsoft shares and instead lives for this year off whatever cash is under his mattress. If he does this he would have an income of $0 according to the IRS and fall into the bottom one percent. However, it would be silly to contend that he no longer ranks among the world's richest.
A second example. Suppose I earn an above average income -- say $100,000 annually. Yet, I borrowed heavily to attend medical school and still owe most of my student loans. In addition, I own no real property (I rent and lease a car). How much wealth do I possess.
Third. I have no assets and education and am unemployed. One day I play the lottery and win $250,000. Am I now wealthy?
In the three examples, the third person would likely pay the most in income taxes, the doctor a middle amount and Bill Gates the least. I argue that the order of wealth the reverse of that and that the person in the third example could be argued to be poor.
Obviously, wealth consists of much more than income. Indeed, income may be only a small component of wealth. The doctor has accumulated wealth through knowledge -- human capital. Bill Gates has ownership in a business through his stock. The unemployed person has merely the after-tax value of the lottery ticket (perhaps $150,000) as a one-time windfall with no prospect of repeating it.
These examples underscore a problem with the income tax that is little discussed by those who want to level disparities of wealth in society -- income is only a proxy for wealth and sometimes it is a poor one at that.
So why do we tax income? The short answer is that with the exception of land taxes and sales taxes, an income tax is the easiest to implement because whatever is taxed must first be counted. Imagine a wealth tax. Each year you would have to value each of your assets, that book collection on the shelf, the five-year-old Dell, the Ford in the garage and a thousand other items. The tax collectors would then either trust you ... right ... or perform an audit. Not a prospect that an IRS man would relish.
This does not mean that governments have not tried to tax wealth instead of income. The English government levied a "
window tax" in the 18th century on the theory that windows, and the glass that they were made of, were a good proxy for wealth. Remember this the next time you are wondering about all of the bricked up windows while touring a historic section of London.
A similar tax -- the room tax -- was levied here in North America. Taxing rooms meant taxing wealth because only wealthier colonists would be able to build and heat more rooms. Closets, by definition of the tax, were considered rooms. Remember that the next time you wonder why colonial houses lack closets.
See the effect of this tax here (scroll about halfway down the page).
I was first made aware of these types of taxes during a tour of the Garden District in New Orleans. The guide stopped at Anne Rice's house, said "hi" to the friendly dog, and pointed out all of the exterior stairways in the houses. If I recall correctly, he explained that interior stairs were taxed by the French, so people built them on the outside of the house where they failed to meet the definition under the tax.
Today, the only property taxes that remain are on items that are hard to hide, easy to assess, too essential to forego and impossible to transform into something else. Think land, houses and cars.
Income taxes also eliminate the equity puzzle presented by those who are asset rich and income poor -- a group that is mostly the extreme elderly who have retired and own their house but are unable to work and do not own income producing assets.
So, income taxes may be a good thing, but they are clouding our debate over equality. You see, in a nation of 300 million souls good data is hard to collect and any debate needs good data. Academics and pundits therefore look for short cuts in data collecting (and who could blame them?).
The biggest short cut of all is the Internal Revenue Service. The IRS has the best picture of income out there and is the only reliable source of historic income. It even provides its data to researchers so they can study these issues. And, it is the IRS data that is showing the increasing gap between the rich and poor.
Unfortunately, the IRS data was not collected with the question of equality in mind. It was collected to collect income taxes.
The computer industry has a saying: Garbage in. Garbage out. That may be what is happening to our debate.
