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The Inequality Illusion

Why a Wealth Tax Won't Work

Wringing one’s hands about inequality seems like the new national pastime. According to emerging conventional wisdom, those born-rich will hoard all the wealth and leave everyone else behind. It's a new gilded age, the economist Paul Krugman recently declared, “But we've known it for a while.” 

In response to the public outcry, several prominent economists are proposing an annual wealth tax, which would apply only to those with assets worth more than a set amount. But there’s limited evidence that wealth inequality has actually worsened in the United States in the last 30 years. And, even if it does eventually get worse, imposing a tax on wealth is a terrible way to promote equality. It actually benefits the super wealthy the most. 

Economic inequality might refer to disparities in income or wealth. Although the two are related, they are distinct concepts shaped by different underlying forces. Income inequality represents the inequality in what people are paid each year. This includes earnings and capital income (sometimes called “unearned income”). By all measures, income inequality has become more severe in the United States over the last 30 years, especially at the very top. What is not widely understood is that the growth in income inequality has been driven almost entirely by earned income, that is, what people are paid for their work rather than what they earn on their investments. 

Wealth inequality refers to the stock of people’s assets. It represents the accumulation of saved income and returns on investments over the years. Some wealth inequality is inevitable, even desirable, because wealth represents a lifetime of saving and not just luck or opportunity. Extreme income inequality can beget extreme wealth inequality because people with a lot of income, if they save, can amass large fortunes and pass them on to their children. But over time, such wealth can also dissipate as people leave it to multiple children, get married and divorced, develop expensive lifestyles, contribute to charities, or make poor investment decisions.

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