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Despite its advantages, the U.S. has seen little progress in passing a carbon tax. Some conservatives dislike the imposition of a tax that would likely produce a massive (e.g., trillions of dollars) source of new government revenues that might be used poorly. Conservatives also worry about the harm it would cause to workers in fossil fuel industries and the increased prices faced by consumers. Liberals also object to the higher prices, which could disproportionately harm those with the lowest incomes.

In 2018, a tax designed to fight climate change in France led to weeks of violent “yellow vest” protests against rising fuel prices, among other concerns, causing the French government to back down. A plan for an E.U.-wide carbon tax has never been successful. Recent referenda in Washington State have failed again and again. In fact, no U.S. state has successfully passed a carbon tax (although many U.S. states and the E.U. have passed cap and trade policies).

Firms in major polluting industries have different carbon intensities. The degree of emission asymmetry varies in different industries. In some industries, the carbon intensity of some firms may be several times higher than that of others. Yet surprisingly, emission asymmetry has been largely ignored in the literature. In this paper, we adopt a game-theoretical framework that incorporates emission asymmetry with a carbon tax and imperfect competition. We show that emission asymmetry plays a key role in shaping firms’ production and investment decisions toward green technologies. Due to emission asymmetry, among other factors, a carbon tax does not necessarily induce the adoption of green technology. Nevertheless, upon the introduction of a carbon tax, the carbon-inefficient firm is more likely to benefit from the green technology than the carbon-efficient firm because the green technology can mitigate or even eliminate the initial emission asymmetry. This might be an important driver for firms to further invest in new technology to have an edge over their rivals. One particularly compelling insight is that besides social welfare, industry profit may also improve upon the introduction of a carbon tax if it is properly enacted. Our findings therefore provide renewed support for alleviation of the economic concerns of governments as well as businesses and the general public about the impact of tightening environmental regulations. Policymakers may also foster green technology through well-designed carbon regulations.

Explore another side of the debate with Ian Parry, principal environmental fiscal policy expert in the International Monetary Fund’s Fiscal Affairs Department, who argues that carbon taxes are critical for reducing greenhouse-gas emissions at pace. Read his take here. Would carbon taxes help hold polluting companies accountable? Read the explainer article here. It is time to give up on the carbon tax. Putting a price on carbon has not been popular with the public (although a 2021 global poll indicated increasing support), and few politicians are eager to attach their name to a policy with the word “tax” in it. I, like many economists, have been a long-time supporter of carbon taxes. But there are two important reasons for a rethink. Focusing on market failures First, major advances in solar, wind and electric-vehicle technologies have radically reshaped the policy environment over the past ten years in ways that many have been slow to recognise. Second, while carbon taxes are part of the optimal portfolio of policies to fight climate change, they are not the most important part. We can better target policies to fight climate change by identifying underlying market failures that make climate change a problem. These are: Firms and consumers generally don’t pay for the damage caused by the greenhouse gases they emit. Those who innovate are generally undercompensated for the value of what they create. Existing infrastructure is designed around a fossil-fuel energy system. Each of these three failures constitutes a different externality. The problem with carbon taxes is that they address only the first. Economists like the idea of a carbon tax because it forces firms and consumers to pay for the damage they cause, creating incentives for them to seek out more eco-friendly alternatives. While shifting consumption is good, innovation, when it works, is better. The benefits of innovation can spread to others across the globe and create lasting change that does not need perpetual government regulation to maintain. While carbon taxes can encourage innovation, policies like prizes, research grants and subsidies do more to prioritise it. format_quote New technologies will require new grid and charging infrastructure, which only become viable when enough people make the switch. Subsidies can move the economy over that hump. Markets will then take care of the rest. Subsidising the solutions One common critique of subsidies is that they involve bureaucrats or legislators making guesses about which innovations will matter when they decide how to spend taxpayer money. Advocates of a carbon tax believe that it is better to tax what you know to be bad, rather than subsidise what you think might one day be good. You never know where innovation might come from. Case in point: the world has spent billions of dollars each year subsidising technologies like nuclear and ethanol fuel, with the hope that they could one day replace fossil fuels, to no avail. Spurred on by a mix of pre-existing carbon-pricing policies, renewable-electricity mandates, government grants and tax subsidies in the US and around the world, renewables are now cheaper than fossil fuels. At the same time, innovation in electric-powered engines and battery technologies makes electric cars increasingly cost-competitive with conventional ones. It is easy to pick winners when you already know who won. Markets chase lower costs. Forcing them to adopt higher-cost renewable technology is like pushing a boulder up a hill. It requires taxes and heavy-handed regulation. But now that renewables are getting cheaper, we just need to get that boulder over the transition-cost hump. New technologies will require new grid and charging infrastructure, which only become viable when enough people make the switch. Subsidies can move the economy over that hump. Markets will then take care of the rest. Many believe carbon taxes are more efficient than subsidies because subsidies must still be paid for via taxes. But that efficiency presumes that governments use carbon-tax revenues effectively. It is not only unclear what counts as “effective”—economists’ preferred idea of returning money to people via a dividend has not proved popular with US voters. Many also fear that revenues would be spent on things they care little about or actively resist. Furthermore, a case can be made that increasing income taxes (which primarily fall on the relatively well-off) to pay for subsidies is better than a carbon tax, which is paid by everybody, even if a carbon tax is ostensibly more efficient. Finally, the efficiency case for the carbon tax rests on the assumption that energy markets are otherwise operating efficiently. But joint research from UC Berkeley and the University of Chicago has found that because energy markets are often mispriced (because of technological limitations and a mess of regulations) carbon taxes can indeed be less efficient than other policies. An international perspective Perhaps the most important benefit of a climate policy focused on innovation is its ability to spread to the developing world. Most emissions going forward are expected to come from places like China, India and Africa. It took just 12 years for most of the world to get a smartphone, because people saw the inherent value in personal mobile-communications technology. Innovative, lower-cost renewable-power technologies can follow the same path. It is likely far easier to convince voters in developing countries to adopt money-saving technologies than it is to convince them to support a costly carbon tax. If I could turn back time to the Industrial Revolution—when historical greenhouse gases began to surge—a carbon tax would undoubtedly be the centrepiece of my climate agenda. But we do not live that world. Existing regulations, carbon prices and subsidies have already done a lot of the work towards achieving the innovation we need to meet global environmental goals. In that world—our world—a focus on innovation and infrastructure are the policies with the highest chance of success.

One of the most popular strategies for fighting climate change could come at the cost of even greater inequality in the world economy.

The policy, known as carbon pricing, would impose a charge on businesses and consumers with the hope of curbing greenhouse gas emissions. Whether and how to adopt such a levy is a topic of  at the COP26 summit in Glasgow. A concern is that such an approach would risk disproportionately hurting the world’s poorest households that are already suffering the most from global warming. That’s because they tend to spend a larger share of their income on gas, heat and other emissions-generating activities.

Marie Sapirie and David Kreutzer, 8-13-2021, "The Case Against A Carbon Tax," Forbes, (David Kreutzer is an economist at the Institute for Energy Research.) https://www.forbes.com/sites/taxnotes/2021/08/13/the-case-against-a-carbon-tax/?sh=16f399eb18ba, accessed 6-30-2023/hcc

In the first of a two-episode series, Tax Notes contributing editor Marie Sapirie interviews David Kreutzer, an economist at the Institute for Energy Research, about his views on a carbon tax. David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: the carbon cycle, part one. As reports of the devastating effects of climate change rise, so do the voices discussing how to tackle the anthropogenic causes of this phenomenon. One of the much discussed solutions today is a carbon tax, which would put a price on greenhouse gas emissions. To further this discussion, we'll be dedicating the next two episodes of Tax Notes Talk to the issue, highlighting both the positives and negatives of a carbon tax. This week's episode, part one, features an interview with David Kreutzer, an economist at the Institute for Energy Research. David was on the Trump presidential transition team at the Environmental Protection Agency in 2017, and previously was a senior research fellow in energy economics and climate change at the Heritage Foundation. He opposes taxing carbon emissions, which we'll get to in a minute. Next week's episode, part two, will feature an interview with Shuting Pomerleau, a climate policy analyst at the Niskanen Center, who supports a carbon tax. But before we get to our first interview, I'm joined by Tax Notes contributing editor Marie Sapirie for some background on the issue. Marie, welcome back to the podcast. Marie Sapirie: Thank you. It's always good to be here. David D. Stewart: Let's begin with the basics. What is a carbon tax? Marie Sapirie: The term carbon tax is essentially shorthand for a tax regime that makes it more expensive for producers of goods and services to emit greenhouse gases that contribute to global warming. Most proposals would likely also cover emissions of methane, nitrous oxide, and possibly other types of gas. Carbon dioxide is the gas that we admit the most of, according to a 2016 EPA report, and carbon dioxide emissions account for roughly 82 percent of greenhouse gases from human activities. Fluorinated gases make up a much smaller percent of emissions, but they're considered particularly potent. It might make sense to include them too. The basic idea is fairly simple. By making it more expensive to pollute, polluters will be more active in searching for ways to cut emissions, which will incentivize more innovation. They will also switch to less polluting options that are already available. In a 2016 report titled "Effective Carbon Rates: Pricing CO2 Through Taxes and Emissions Trading Systems," the OECD said that the principle appeal of using prices to induce carbon abatement is that it encourages emission reductions where they are cheapest. Both in the sense of using the cheapest available options today and steering innovation and investment towards lower carbon technologies. The thought is that a carbon tax could get us to a place where there are lower global emissions without making dramatic changes to the way many people live. This type of tax will be recognized by students of economics as a Pigouvian tax. That's a tax on the negative externalities like pollution that aren't included in the market price, but end up being absorbed by society at large. The economist Arthur Pigou recommended taxing the producers whose processes produce such negative externalities by setting a tax to equalize the marginal private cost and the marginal social cost. The idea is to correct the market failure. But note that to apply Pigou's principle requires measuring the externalities so that the tax is set appropriately. That's the general concept. But there are potential wrinkles in putting that idea into action to protect the environment. David D. Stewart: How would implementation of such a tax work? Is there an approach that's become prevalent? Marie Sapirie: Implementation is one of the major open questions. How Congress might choose to design a carbon tax would necessarily drive what the implementation looks like. We don't know yet where Congress might settle on the fundamental question of whether we should have a carbon tax in the first place. As far as the design options go, the main pieces that Congress would have to decide include the rate of tax on emissions, which is an area where there's a lot of debate because where the tax rate is set changes the impact on emissions, as well as the total revenues that would be raised. Next, Congress would have to decide whether the rate should increase over time, perhaps by starting low and gradually ratcheting up to give companies some time to adjust and seek out alternatives with lower emissions. Also, where the ratcheting should stop, which depends on whether the goal is to mitigate emissions to some acceptable level or to eliminate them entirely. Another question is when to collect the tax. There are options all along the supply chain, from the point of extraction, to the point of sale of the final product to consumers, or some combination. How to provide a rebate for sequestering carbon emissions is another question. How to do a border adjustment, which is a way to prevent a carbon tax regime from resulting in American consumers shifting to purchasing more imported goods and services from places without a carbon tax and American companies from moving abroad or becoming less competitive relative to their overseas competitors. Finally, how to solve the problem of regressivity. Because the incidence of a carbon tax would end up falling more heavily on taxpayers who consume more of their income, unless a carbon tax were enacted with some sort of rebate mechanism. David D. Stewart: Now, you alluded to some debate on this issue in the U.S. Could you give us an idea of where the various sides stand on this issue? Marie Sapirie: Perhaps the chief point of dispute is around the fact that a U.S. carbon tax regime has the potential to raise a large amount of revenue. That is either a point in favor of enacting a carbon tax or a point against it, depending on whether you agree with how the revenues might be spent. As we know, members of Congress are frequently looking for ways to pay for items of spending that are important to them and their constituents. This is an area of a lot of discussion. There are carbon tax proposals that rebate all of the revenue to American families, like the bipartisan climate roadmap from the Climate Leadership Council. But that's a feature of the climate tax regime that is up for discussion should Congress take it up in the future. The broader economic impact of the adding a carbon tax is another big question. A new tax would certainly have costs, but the extent of those depends on how the tax is designed. Another issue that opponents point out is that there is uncertainty in the magnitude of the problems that climate change could cause for humans on the planet. The argument is that the focus should be on building a strong economy that's better able to respond to adverse impacts of any sort, whether from climate change or some other disaster. That uncertainty could also be a potential argument for starting with a lower rate of tax. Even if Congress were to enact a carbon tax, there are of course, all of the other details in the potential design of a U.S. carbon tax that I mentioned earlier that are still debated. David D. Stewart: Now, enacting a carbon tax is not just a U.S. issue. How are other places around the globe fairing when it comes to enacting such a tax? Marie Sapirie: In order to achieve the beneficial effects of reducing greenhouse gas emissions, there would need to be some sort of coordination around the world so that the sources of emissions aren't simply shifted to jurisdictions where it's less expensive to emit. According to the World Bank's carbon pricing dashboard, 45 national jurisdictions have carbon pricing initiatives today, which is far from 100 percent of countries in the world. Some countries have adopted emissions trading systems instead of carbon taxes. That's another type of market-based approach that is sometimes called cap and trade. Of the countries that have implemented carbon tax programs, some have been around longer than others. Finland, Poland, Norway, Sweden, Denmark, the Netherlands, and Germany all introduced taxes on carbon in the 1990s. The results of these taxes in lowering emissions are kind of mixed. According to data from the World Bank, on a per capita basis, carbon dioxide emissions actually increased a bit Norway between 1990 and 2015. They stayed about the same in the Netherlands, during the same time. They dipped in Germany, went down in Finland, Poland, and Sweden, and dropped dramatically in Denmark. It should be noted that Sweden started out much lower than the others. But even with its success, Denmark remained above the world average, and also above other European countries like France and Spain. By comparison, Belgium dropped its emissions during the same period in a pattern that was similar to Finland's, but they didn't have a carbon tax. One of the interesting points about Denmark's achievement was that part of the revenue was used to provide subsidies for technologies with lower environmental impacts. Since the first carbon taxes were introduced in the 1990s, there's been slow but steady growth in the number of taxes introduced around the world. Most recently in July, the European Union released a plan to impose a fee on imports of certain products as part of its climate package. That could be an opening for more global coordination on the cost of carbon. David D. Stewart: Now, you interviewed both David and Shuting on this issue. Could you give us some highlights of your interview with David? Marie Sapirie: David discussed why he doesn't support carbon taxes as a climate policy tool. He doesn't dispute that human greenhouse gas emissions have caused and continue to cause global warming. The problem is the implementation of the carbon tax and the ways that could go wrong. David D. Stewart: All right, we'll go to that interview. Marie Sapirie: Thank you, David, for joining me today to talk about climate policy and how the tax laws might or might not be used to put limits on carbon dioxide and other greenhouse gas emissions. David Kreutzer: Thanks for having me on. Marie Sapirie: Proposals for imposing federal taxes on greenhouse gas emissions have been around for quite a while, but none of them have been put into effect in the U.S. There are a number of reasons for that. Today we'll go over the history of carbon tax proposals. Then we'll cover the role of economic analysis in designing policies to regulate greenhouse gas emissions and what that can tell us about the frameworks legislators might select to accomplish emissions reduction goals. Finally, we'll take a look at some of the challenges in implementing a carbon tax and consider alternatives. To get started, would you give us a brief history of carbon tax proposals, including where they came from and how interest in them has evolved over time? David Kreutzer: The basic theory of the carbon tax comes from Pigou, an economist who was around 100 years ago. His argument was that you have these market imperfections called an externality. With carbon, we call it the social cost, which is somewhat misleading. What he said is we can have an offsetting tax that would bring the market back to, in essence, perfection. Where marginal benefits when you include all the benefits equals marginal costs when you include all the costs. Economists have loved this. There has been a century of dissertations and theses written on finding market imperfections and correcting them with the exact right tax. That's the economic theory. There really haven't been many successful uses of these offsetting taxes. There are few, but in the carbon area, none of them have been implemented. You could say that the [British thermal unit] tax that Al Gore tried to get through in the 1990s was a sort of carbon tax. It turned out to be very, very unpopular. Right after the Obama administration came in office, there was something called cap and trade, which would have features similar to a carbon tax. Then in 2010, the Kerry-Lieberman bill was more explicitly a carbon tax. People have been talking about it because you can draw such nice economic diagrams to show how wonderful it would be if you knew exactly what the tax level should be and if the implementation was costless. Marie Sapirie: Setting the level of tax for a potential carbon tax is one of the major questions that policymakers would have to confront in designing any new tax. You've written about the difficulties in performing economic analysis on climate policies. Would you tell us about why that is and how economic analysis should be used to help shape the appropriate policy response? David Kreutzer: What the policymakers would use as the guide for the level of the carbon tax is something called the social cost of carbon. There are some economists, one who won a Nobel prize, who have put together models where they try to estimate what the damage is for each ton of CO2 that's emitted now if you look at the damages over the next several centuries, and sometimes even thousands of years, which in my opinion, is laughable to try to do that. The way they do that is they use the climate models and say, "Well, this much additional CO2 will lead to this much warming, which will lead to this much more sea level rise. And, perhaps, some higher level of winds and hurricanes." Though, we haven't really seen that yet. Then they translate that into economic damages. Then they discount it to bring it back to the future, saying, "OK, if there's going to be $10,000 worth of damage in 150 years from a ton of CO2 emitted today, how much would we be willing to spend to cut that CO2 today?" You want to compare it to, well, what if we made another investment that could generate $10,000 worth of benefits in 150 years? How much would we have to invest to get that benefit? You wouldn't want to spend more than that on the climate benefit. In any event, that discount rate is a huge area of controversy. But that's just one of them. Trying to actually figure out where the economy is going and how much damage global warming is going to do is a nearly impossible task. Marie Sapirie: Turning to the existing carbon tax proposals. A critique of them generally is that they will introduce complexity and administrative burdens. They're also potentially regressive and less rebated to lower income taxpayers in some way, and are economically disruptive. Could you tell us about the challenges to implementing a carbon tax that need to be considered? David Kreutzer: Pretty much anything that raises energy costs is going to be regressive because people with lower income spend a higher percentage of their income on energy, on gasoline, on heating, and so on. A carbon tax would be no different than just simply any regulation that would do the same thing. The other complexities are where do you charge the tax? You could imagine the carbon tax proposal being similar to the cap and trade proposal, where they looked at oil and petroleum refiners, taxing the refiners, taxing natural gas producers, and taxing coal at the mine mouth. But there is also going to be problems with what you do with people who are doing offsets. Certainly that's going to be part of it because Wall Street wants to have something to trade. Then you get up, well, how much carbon is saved by a farmer that uses no till in Iowa that otherwise was going to use a plow? All of that introduces scientific complexity, as well as just administrative complexity. They're also simply administrative costs. Any tax has administrative costs. You'd want to look at whether those would be significant compared to whatever benefit you're trying to provide and the problem of people viewing the carbon tax not as a market efficiency generator, but as a revenue generator. Marie Sapirie: Are there ways to avoid or to minimize some of the potential problems with the implementation of a carbon tax? David Kreutzer: I think it's difficult to avoid the ones that I just laid out. Economists have a bad habit of coming up with wonderful ideas that work in the abstract and ignore the politics of actually getting them implemented. One of my professors won a Nobel Prize doing something called public choice and saying, "You need to look at what are the political incentives that come around with these various tools that you want to implement." I did some modeling of the revenue part of a carbon tax with some colleagues when I was at the Heritage Foundation. Even a carbon tax of $25, $30, growing by the rate of interest, generates hundreds of billions of dollars a year in revenue. It also does hundreds of billions of dollars of economic damage to the economy each year. If the solution to a problem is going to fund your pet project, you're much more likely to believe there is that problem. I think we see that. People on Capitol Hill talk about we need to fix the climate problem, but they're really excited about the revenue. Marie Sapirie: Recent carbon tax proposals include a border adjustment. An export rebate coupled with an import tax equal to the domestic tax. What are the merits and the potential problems in that approach? David Kreutzer: Yeah, that maybe is the most compelling sounding part of this thing. But it is, I think, the most dangerous. It is a constant battle to keep people that want tariffs and other trade restrictions at bay. There are always special interests that want to protect whatever their industry is or whatever their product is. It's an almost impossible task for economists to keep that as low as possible. This carbon border adjustment would be very, very difficult to set up. I mean, you'd have to know, for instance, if you're bringing in a car from Japan, how much of a carbon tax did they have in Japan? Did they import something from Korea where they had a different carbon tax? Did they use steel from some other country? What's the carbon content that hasn't been taxed and all of these products that are coming in? There are going to be lobbyists who are going to go out and say, "Our competitors' imports actually have more carbon than they claim." There are going to be lawsuits. There's going to be all sorts of rent-seeking and lobbying going on. Once you get that in place, I think that would be the most difficult thing to unwind. It's very, very difficult to get rid of tariffs because of what we call the special interests effect. The benefits are narrowly focused and the costs are spread out so there's not much organized opposition to them. I think that the carbon border adjustment tax — that tariff — is the scariest of the proposals that they've put out. Marie Sapirie: To conclude, what are the alternatives to a carbon tax that policymakers should consider? David Kreutzer: I believe that manmade emissions of greenhouse gases have caused warming of the earth and will continue to do so. I'm also convinced that we're not heading to an existential threat. For instance, even the Intergovernmental Panel on Climate Change knows that we don't have any upward trend in hurricanes, floods, droughts. The National Oceanic and Atmospheric Administration says, looking at the tornadoes, there's no upward trend in tornadoes, after you adjust for the fact that we've been using radar to find them lately. I don't think the climate problem is as scary as the solutions they're offering. Even if it were, you can look and see, well, what would happen if we got rid of all CO2 emissions in the U.S. altogether? It has a pretty minor effect on whatever global warming there might be, less than two tenths of a degree. You can do that for the whole developed world and you might get something of four tenths of a degree reduction. That's talking about getting rid of all CO2 emissions, which isn't going to happen. What you have to do is impose what I would consider some fairly draconian restrictions on the growth of CO2 from the developing world. People that hardly produce any CO2 at the moment who are desperately poor, who need affordable energy. What I'm getting around to saying is I think what we need to do is promote economic growth, not just in the U.S., but worldwide. The impact of the climate will be something that rich people can adapt to. The projections for world income per capita world income by the end of this century would be four, five, six times what it is now and the more so for the developing world. If we do nothing, we'll still do a lot. People will still build stronger houses. People will continue to build the sand up on the beaches as they already do. We will make adaptations that will happen without any policies. But I think it's a mistake to impose significant economic costs for almost trivial impact on global warming. I also think it's totally disingenuous to call climate change the greatest threat of the 21st century. I think poverty is a bigger threat. I think the potential of crazy world leaders with nuclear weapons on intercontinental ballistic missiles is a huge problem. But whatever problems we're going to come up with, the richer we are, the better we handle them. That's absolutely crystal clear. You can look at the people that do this research. They say that the problems of climate are not that much for rich countries. If we allow economic growth to continue and to increase, in an absolute sense, all the countries are going to be rich in 150 years.

Despite its positives, CBAM has several challenges on an international scale. First, tariffs could further exacerbate US-China relations and antagonize high-emissions economies such as India, decreasing US diplomatic leverage.

Second, insufficient regulation could incentivize countries to abuse the system and reorganize their production to export from the most efficient production lines while diverting pollution towards non-CBAM-impacted exports and domestic products such as consumer products.

Although reasonable at face value, unilateral carbon border adjustments merely represent the latest form of economic imperialism and are antithetical to the principles of equity enshrined in the Paris Agreement (pdf). Article 2 clearly states that the agreement “will be implemented to reflect equity and the principle of common but differentiated responsibilities.” Without buy-in from countries like India and China, carbon border adjustments risk becoming a climate-based sanctions regime.

A short history lesson can be helpful. That China, India, and other developing countries rely on fossil fuels to power their economies is not an accident. These growth models are a consequence of post–World War global dominance by the West in economic, political, and financial spheres.

V Conclusion The findings from our quasi-experimental econometric analysis of household electricity consumption based on metered data from a large provider of green electricity in Germany suggest that switching to a green tariff leads to a non-monetary renewable rebound effect of around 7.7%. Further, our results imply that this renewable rebound effect is persistent over at least four years, possibly reflecting moral licencing effects that induce households to permanently change their habitual behaviours and/or to acquire additional electricity-consuming technologies. For our data, these findings appear to be driven by households in the first switching period (2004/2005). For later periods, we mostly fail to find statistically significant results. Because we have no information on household characteristics or individual attitudes, our data unfortunately did not allow us to account for potential heterogeneity in findings by socio-economic groups. Such analyses must be left for future research. Further, because of missing data on electricity tariffs of the previous provider, we had to use proxies for a large share of customers in our data set. Thus, we cannot robustly estimate the potential (negative) monetary rebound for switching from a grey tariff to a possibly more costly green tariff. Yet, our findings have several implications for policymakers and electricity providers. In particular, to limit potential negative effects of the non-monetary renewable rebound, policy makers could provide additional information. More specifically, such information may vividly describe the mechanisms which have been found to result in non-monetary renewable rebound effects in response to tariff switching. In addition, such information could explain the negative environmental effects such as higher greenhouse gas emissions pertaining to the renewable rebound effect. Such information could be targeted at individuals likely to subscribe to green tariffs, i.e. females, households/individuals with large incomes, high education levels, low electricity consumption, and ecological orientation (e.g. Sommer ; Ziegler ). Regarding policy analysis and design, ex-ante policy assessments carried out to define energy and climate policy targets should take renewable rebound effects into account. Failure to do so may lead policy makers to systematically underestimate the costs of achieving these targets. Our findings further suggest that these assessments should be based on difference-in-difference estimations rather than before-after analyses. Because the latter do not take into account developments which would have happened without the treatment – in our case moving into a larger dwelling, for example – they may lead to an overestimation of renewable rebound effects. Last but not least, utilities’ procurement of green electricity needs to account for a non-transitory increase in electricity consumption for new and old customers switching to a green tariff.

CAPITAL GAINS TAXES (CGT) AND OFFSHORE INDIRECT TRANSFERS (OIT) Capital Gains and Capital Gains Taxation A capital gain is the rise in value of an asset – for example shares of companies, real estate property or valuable art items. When there is a change in ownership of an asset (normally through a sale), the capital gain is realized. Some of the most valuable transactions often involve licenses for extractive industries or telecommunications. Domestic legislation varies on the fine print and specific details, but it is widely accepted that capital gains occur when an asset changes hands. For example, at the moment shares in a company are sold. The amount considered to be a capital gain will be the value received by the final transfer of the asset minus the value initially paid. A simple example can illustrate this: As countries need revenue for financing public services, governments are normally interested in levying taxes over meaningful economic activities. This includes capital gains. In most domestic tax regimes, the right of a jurisdiction to tax capital gains is either included in the main tax legislation (such as an Income Tax Act) or established in a specific legislation (a Capital Gains Act). While some countries design a specific rate for the taxation of capital gains, other countries will simply use the rate already in place for Corporate Income Taxation. Following on the previous example: The structure of multinational corporations also affects the ability of countries to tax its operations. Most people think of a multinational corporation as one entity that has direct control over its assets spread around the globe. However, it is not that simple. The ownership structure of multinational corporations is often complex – motivated by management structures, international operations, corporate legislations and of course, tax minimization. For instance, multinational corporations often establish a complex network of holding companies and subsidiaries to control assets that generate revenue (like oil extraction licenses). This can be illustrated by examining two opposing scenarios: Simple scenario of direct control: · OilCorp is a multinational corporation with its headquarters in the United States; · OilCorp has direct ownership of OilCorp Resourceland, a subsidiary registered in the oil-rich country of Resourceland; · OilCorp Resourceland has direct ownership of extraction licenses of oil fields located in Resourceland. Complex scenario of indirect control: · OilCorp is a multinational corporation with its headquarters in the United States; · For tax purposes, OilCorp has created a holding company in the Netherlands. The corporate structure of OilCorp involves subsidiaries located in many jurisdictions, including locations that have no oil reserves or relevant staff and that are described by some as competitive and business friendly, or as tax havens by others. These jurisdictions tend to have a broad network of Double Tax Agreements, generous corporate tax incentives, secrecy around transactions and ownership structure, reduced tax rates and non-intrusive tax administrations; · OilCorp’s Resourceland subsidiary is not directly owned by the main entity of OilCorp but is routed through a number of related entities located in various jurisdictions. As a result of these relatively complex structures and networks of entities spread across many countries, multinational corporations have at their disposal a number of techniques and strategies they can use to reduce their tax payments. Among these is the shifting of profits out of resource-rich countries to low tax jurisdictions. This often results in the avoidance of taxes in developing countries. This paper looks into a specific technique for the avoidance of Capital Gains Tax, which is the focus of the following pages. Abuse of CGT through Offshore Indirect Transfer (OIT) Due to the wide variety of laws and regulations across different jurisdictions, corporations are able to structure their organization and cross-border transactions for their own benefit. This will be again examined through our previous example: As observed in the example above, the objective of OITs is the transfer of the effective control and ownership of an asset without actually changing its legal direct owner. While there is an actual transfer in the control of legal entities, the relevant asset (which holds value) is only being indirectly transferred. OilCorp Resourceland continues to control the oil license, but now EnergyCorp controls OilCorp Resourceland. As the license remains directly controlled by OilCorp Resourceland, no CGT is levied in the jurisdiction where the asset is located. OIT is a clear example of a technique used to avoid taxes which would normally have been charged after the direct transfer of an asset. As direct and indirect transfers both result in the actual control of the asset changing hands, tax systems should guarantee that both forms of transfers are treated identically for tax purposes. With the system as it is, there is a clear incentive for multinational companies to distort transactions and deny developing countries of much needed public revenue8 .

Put simply, those who are most likely to benefit from the wealth effect of asset price inflation are also those who earn the highest wages or salaries (Grudnoff, 2015). For the tax year running from mid-2014 to mid-2015, Grudnoff reports a highly unequal distribution for the benefits associated with negative gearing: 34.1% of total negative gearing benefits went to the 10% of household incomes; 62.2% went to the top 30% (Grudnoff, 2015: 5). The benefits associated with the capital gains tax discount are distributed even more unequally: 73.2% of total capital gains tax benefits went to the top 10% of household incomes (Grudnoff, 2015: 5). Even these figures, however, underestimate the true wealth-generating effects of asset appreciation in as much as they only register capital gains at the moment of sale and thereby exclude the impact of unrealized capital gains (as pointed out by Robbins (2018), the tax datasets used by Piketty and Saez suffer precisely from this limitation). A hidden leveraging effect is provided by the simple appreciation of asset prices, which may greatly inflate the imputed value of an investor’s collateral and hence allow easier access to credit and a tremendous accumulation of new wealth without ever appearing in the tax data. Although entirely ‘virtual’ and prone to volatility, the market valuation of capital gains generates powerful leverage effects that can generate real and long-lasting increases in wealth. The cumulative effect of government incentives over the past few decades has been to facilitate the debt-plus-equity pathway to asset purchase at the expense of the work-savings route that prevailed in the immediate postwar era, where mortgage repayments were set at 30% of a ‘breadwinner’s’ wages (Yates, 2014: 365). The situation openly favours the ownerinvestor at the expense of the wage-earner and prospective first-time purchaser. It is simply much easier to accumulate housing assets when you already own a house that is subject to rapid price appreciation: wealth begets wealth. With investors setting the bar, first-home buyers have had to take on rising levels of debt simply to remain in the game. But the effect of this competitive spiral has been to push house prices even further out of reach. These trends have a pronounced generational dimension, leading many to assume that the problem is essentially one of intergenerational injustice (Daley and Wood, 2014). But this ignores the fact that capital gains are spread unevenly among the baby-boomer 558 EPA: Economy and Space 53(3) generation and that the adult children of the wealthiest baby boomers are likely to benefit from these capital gains in the form of intergenerational transfers (Christophers, 2018). What distinguishes successive generations, then, is less a difference in absolute wealth holdings than a difference in modes of access to wealth: while older ‘baby-boomer’ generations were in a better position to buy property through wages alone, this option has become less accessible to younger generations who are increasingly dependent on the ability and willingness of their parents to lend or give them money for a deposit in order to enter the housing market (Simon and Stone, 2017: 23). This is confirmed by analysis of Australian Census and HILDA (Household Income and Labour Dynamics in Australia) data, which reveal that young adults who are competing against each other and investors to make a firsthome purchase are significantly more likely to purchase a dwelling (and a dwelling of higher relative value) if they receive financial help from their parents (Barrett et al., 2015). Kohler reports a dramatic increase in the reliance on parental support for the purpose of purchasing a home, and the sum total of these commitments would make the ‘Bank of Mum and Dad’ a mid-size home lender, smaller than ING but larger than HSBC (Kohler, 2018). There is growing evidence that parents are not only engaging in direct forms of support to adult children, but also taking on debt or guaranteeing loans to support them (Yeates, 2016). In short, social mobility is increasingly associated with the asset position of parents not only for the super-rich (cf. Gilding, 2005) but also for ordinary households. The decades of sustained property inflation have thus had a major impact on the distribution of wealth in Australian society. Figure 2 shows that during the period 2003–2011 the highest quintiles have experienced far greater increases in wealth than lower ones. These consequences were perhaps not so visible in the 1980s or 1990s, when for substantial parts of the population capital gains compensated for stagnating wages and house price inflation catapulted many working class (that is, lower-income but home-owning) households into a higher wealth bracket. Some of these households may well have permanently changed their class profile, especially if they went on to purchase an investment property.

Another argument in favor of continued preferential treatment of capital gains and other capital income taxes relates to the state of the economy since the Great Recession. Ramey (2020) discusses the state of the United States economy since the Great Recession and specifically examines the slow recovery and historically low interest rates. Ramey concludes that by late 2019 (prior to the pandemic3 ) unemployment was relatively low and investment was relatively high – which is inconsistent with the theory of secular stagnation. Thus, increasing aggregate demand to increase long run economic growth is unlikely to be a successful policy response (although this was not the case at the beginning of the pandemic). Instead, Ramey argued that the economy was in a period of “technological lull” and that the policy response should focus on increasing innovation and faster diffusion of new technologies. Increasing taxes on the return to investment (and specifically capital gains) is unlikely to achieve either goal suggested by Ramey, even if tax increases target the very wealthy. While the pandemic justified the use of demand side stimulus in the short run, as the economy continues to recover, we will need to alter our fiscal policy response to focus on increasing innovation and faster diffusion of new technologies. 3 The pandemic led to increased unemployment and a decline in investment and justified increases in aggregate demand to support the economy. However, the economic effects of the pandemic are dissipating as shown by a reduction in the unemployment rate closer to pre-pandemic levels and a significant rebound in investment. Thus, the appropriate policy response is shifting back towards increasing innovation and the diffusion of new technology and away from supporting aggregate demand. 8 Increasing capital gain taxes will do exactly the opposite by reducing investment and shifting investment into owner-occupied housing rather non-housing assets, which would reduce innovation and the diffusion of new technologies. IV. SIMULATION RESULTS We use a computable general equilibrium model of the U.S. economy to simulate the economic effects of these policy changes assuming that additional revenues increase non-social security transfers. This section provides a brief description of the model used in this analysis. 4 The model is a dynamic, overlapping generations, computable general equilibrium model of the U.S. economy that focuses on the macroeconomic and transitional effects of tax reforms. The model is a general equilibrium model in which households act to maximize utility over their lifetimes, and firms act to maximize firm value, with behavioral responses dictated by parameter values taken from the literature; these responses include changes in consumption, labor supply, and changes in the time path of investment by firms that take into account the costs of adjusting their capital stocks. Households and firms are characterized by perfect foresight.

EXECUTIVE SUMMARY In this paper, we examine the economic effects of enacting a proposal by the Biden Administration to tax long term capital gains at ordinary income tax rates for those with taxable income above $1 million and tax unrealized gains at the time of death (i.e., repealing step up of basis) for single (joint) filers with more than $1 million ($2 million) in unrealized gains. Current economic conditions may exacerbate the problems associated with increasing the taxation of capital gains. In particular, rising inflation would exacerbate the negative economic effects associated with taxing capital gains income at a higher rate as well as repealing step up in basis. It also exacerbates the differential treatment of current and future consumption, that is it discourages saving, that occurs under an income tax. Simulations show that in the long run GDP falls by roughly 0.3 percent, as a result of a decline in the capital stock of roughly 1.0 percent and a decline in total hours worked of 0.1 percent, and aggregate consumption falls by 0.1 percent. Initially hours worked declines by 0.1 percent in a full employment economy; if instead labor hours worked per individual were held constant, this would be roughly equivalent to a loss of approximately 209,000 jobs in that year. Real wages decrease initially by 0.2 percent, by 0.2 percent five years after enactment, and by 0.6 percent in the long run. Higher levels of inflation would exacerbate the negative economic effects of raising capital gains tax rates and repealing step up in basis. Finally, two decades of relatively slow economic growth call for increased innovation and faster diffusion of new technology, but higher capital gains tax rates will reduce innovation and technology diffusion. 2 I. INTRODUCTION In this paper, we examine the economic effects of enacting the Biden Administration’s proposal to increase the taxation of long-term capital gains. The Biden proposal would tax longterm capital gains at ordinary income tax rates for those with taxable income above $1 million and tax unrealized gains at the time of death (i.e., repealing step up of basis) for single (joint) filers with more than $1 million ($2 million) in unrealized gains. As under current law, capital gains from the sale of a primary residence would receive an exclusion of up to $250,000 ($500,000) for single (joint) filers. We begin by discussing the structure of capital gains taxes. We then describe how inflation will likely exacerbate the negative economic effects of these policy changes. We present simulation results of the proposal analyzed in this study, and examine how inflation may affect the negative economic effects of the policy changes. In the final section, we offer some general conclusions. II. CAPITAL GAINS TAXATION A capital gain is the difference between an estimate of the fair market value and the adjusted basis of an asset. The adjusted basis is the original cost of the asset (cost-basis) adjusted for changes in the asset’s value due to depreciation (which would decrease the value of an asset) or improvements to the asset (which would increase the value of the asset). If an asset is transferred to another person or entity as a gift, then the value of the asset for calculating the capital gain is the carryover basis, which is equal to the adjusted basis at the time of the transfer of the asset. If a person or entity inherits an asset at the time of the donor’s death, then the value of the asset is equal to an estimate of the fair market value of the asset at the time of donor’s death (referred to as a step up in basis or stepped-up basis). 3 A tax on capital gains is due at the time an asset is sold. Thus, under current law, capital gains taxes are deferred until realization instead of being taxed on an annual basis similar to many other types of income. Taxation at the time of realization and the treatment of inherited assets implies that when an asset is inherited, and the value of the asset is stepped-up, there is no tax on the existing capital gain (i.e., the difference in the fair market value and the adjusted basis at time of death). Repealing step up in basis would subject the existing capital gain to taxation at the time of death if the capital gains tax is imposed immediately regardless of whether the inheritor sold the asset. An alternative is to tax the asset at the time of sale with the value of the asset equal to the adjusted basis. The proposal examined in this paper assumes the tax occurs at the time of death regardless of whether the asset is sold. Note that in this case determining the value of many assets is difficult and liquidity issues can arise if the inheritor cannot afford to pay the tax from liquid assets. However, one of the most important issues is that capital gains are not adjusted for inflation and thus much of the taxable gains are not reflective of a real increase in wealth. Taxing nominal gains will reduce the after-tax rate of return and lead to less investment, especially in periods of higher inflation. III. INFLATION AND INVESTMENT Inflation increases nominal capital gains but these gains do not represent a real gain in wealth. The fact that the United States does not index capital gains for inflation implies that taxing the nominal value will reduce the real rate of return on investment, and may do so by enough to result in negative rates of return in periods of moderate to high inflation. Lower real rates of return reduce investment, the size of the capital stock, productivity, growth in wage rates, and labor supply. 4 As an example, consider an investment of $1000 in year 2000, the $1000 investment would have to grow to $1577.79 in 2021 to maintain the same buying power as in 2000 given the actual price level increases over the 21-year period.1 The nominal gain of $577.79 offsets the loss in purchasing power that occurs as prices increase. This implies a zero real before-tax rate of return on the investment from 2000 to 2021. Imposing a 43.4 percent tax on nominal capital gains in year 2021 would reduce the nominal gain from $577.79 to $327.03, and thus the real after-tax rate of return on the investment is -5.2 percent. In this specific case, indexing nominal capital gains for inflation and allowing for stepped-up basis in year 2021 yields an after-tax real return equal to zero. The same general conclusion holds using actual investment data. For example, a $100 investment in the S&P 500 in 2000 would have yielded a nominal return of $294.90 ($394.90 - $100) by 2021. This implies an average before-tax nominal return of 6.8 percent from 2000 to 2021. Given that inflation averaged 2.2 percent from 2000 to 2021, the inflation-adjusted beforetax real return would be $150.29, or a 2 percent average before-tax real return. Imposing a capital gains tax of 43.4 percent in 2021 yields an after-capital-gains-tax real return of only 0.7 percent. Note the S&P returns also include dividend payments that are subject to tax each year if held in taxable accounts, thus it is likely that the after-tax real return in this example would be negative or close to zero given that dividends account for a significant fraction of total returns on the S&P 500.2 This provides a solid case for allowing step up in basis and for preferential tax 1 All data on inflation and returns on the S&P 500 in this section is from “$1,000 in 2000 → 2021 | Inflation Calculator.” Official Inflation Data, Alioth Finance, 19 Jul. 2021, https://www.officialdata.org/us/inflation/2000?amount=1000. 2 From 1990 to 2015 total returns on the S&P 500 were 988.8 percent while returns from stock price increases were 517 percent according to Bespoke (https://www.bespokepremium.com/think-big-blog/sp-500-total-return-vs-price/). This implies that dividends provided almost half of the total returns from 1990 to 2015. 5 rates for capital gains since the tax code does not index capital gains for inflation. The potential for rising inflationary pressures makes the case stronger. Figure 1 shows inflation data from 1915 to 2021. In the first six months of this year, inflation has increased in each month. The latest data in June of 2021 shows that prices are increasing at the highest rate since August 2008. While a return to the runaway inflation of the 1970s is unlikely, but possible, risks of significant inflationary pressures in the short and medium term seem imminent. The risks are increased given the sizable new fiscal stimulus in the form of an infrastructure bill and more social spending in an omnibus budget bill, continued bottlenecks in production, massive budget deficits, the inability to adopt sustainable budget reforms, reduced labor force participation rates, and increases in inflation expectations. In addition, the Federal Reserve’s new policy of average inflation targeting may lead to higher price inflation in the short and medium term. It is likely that the United States will experience higher levels of inflation than in the past two decades on average (which averaged 2.2 percent). The negative macroeconomic effects of repealing step up of basis and raising capital gains tax rates are likely to be larger than expected because of this issue. 6 The model used to simulate of the economic effects of increasing capital gains tax rates does not account for inflation so that the decrease in the after-tax rate of return and investment are too small. Accounting for inflation in such models would also exacerbate other existing distortions. For example, higher inflation would increase existing distortions in the allocation of capital across sectors. An increase in the capital gains tax rate or repealing step up of basis will make investments in owner-occupied housing more attractive relative to other corporate and noncorporate investments. This occurs because the first $250,000 ($500,000) of capital gains in owner-occupied housing are exempt from taxation, and current proposals extend this preferential treatment. Poterba (1980) shows that higher levels of inflation lowered the cost of housing services given the tax treatment of mortgage interest and capital gains in the 1970s. Feldstein (1980) argues that higher inflation increases the real price of land relative to corporate capital. In Figure 1: Inflation in United States At 5.4% the 12-month increase in the Consumer Price Index in June was the largest since August 2008 25% 20% 15% 10% To date this year each month has seen a higherrate of increase: Date 12-month change Jan-21 1.4% Feb-21 1.7% Mar-21 2.6% Apr-21 4.2% May-21 5.0% Jun-21 5.4% 5% 0% -5% -10% -15% -20% Recession period 12-month change in Consumer Price Index Notes: Chart shows 12-month change in Consumer Price Index for All Urban Consumers All Items US City Average. Data are monthly and not seasonally adjusted. Source: Bureau of Labor Statistics. See: https://www.bls.gov/data/. 7 addition, the use of debt to buy housing assets acts as a potentially important hedge to expected inflation, since house prices increase with inflation but the value of nominal debt is constant (while the dollars used to pay off that debt can purchase less goods and services). Thus, models that only look at relative price effects (e.g., real models that do not explicitly include inflation) are likely to understate the negative economic effects related to the level of investment as well as the misallocation of investment across assets during periods of increasing inflation.

1 Introduction Over the past two decades inequality has attracted increasing attention, with development of inter- national data (Alvaredo et al., 2018a,b), even longer run series (Piketty and Saez, 2003; Moriguchi and Saez, 2008; Bartels, 2017; Garbinti et al., 2018), and the development of Distributional National Accounts (Alvaredo et al., 2016; Piketty et al., 2018). A recent strand of literature has studied measurement of income sources for those at the top (Piketty et al., 2018; Smith et al., 2019). Smith et al. (2019) highlight the role that income-shifting plays in changing the characteristics we associate with those at the top: in particular, top earners largely receive income from human, not financial, capital. This income-shifting is in large part driven by tax incentives to adjust the timing of in- come receipts (le Maire and Schjerning, 2013; Miller et al., 2019). However, such incentives not only encourage shifting between income forms, but from income into capital gains. The difference in tax rates makes these incentives much larger, and the fungibility between income and gains is precisely why the optimal tax literature regularly calls for common marginal rates between income and gains (Slemrod, 1995; Slemrod and Kopczuk, 2002; Mirrlees et al., 2010; Blundell, 2012, 2016). Since capital gains are not part of fiscal income, they are excluded from standard income inequality measures. Including them can therefore not only change the pattern of receipts among those at the top, but also which individuals are at the top, and what share of total remuneration they receive. This paper studies the implications of including capital gains for measured inequality in the UK. We combine confidential administrative data on the universe of UK taxpayers over more than two decades to understand where gains come from, who receives them, and the implications for inequality. We show three main results. First, capital gains are largely shifted income: they largely reflect returns to human capital, rather than simply exogenous changes in the value of assets held. This highlights the limitations of focusing on a narrow fiscal income definition when studying inequality, since the line between income and gains is often blurred. Second, particularly at the narrowest top shares, including gains substantially changes who is at the top. One in ten individuals in the top 1% when gains are included are not in the top 1% based on fiscal income alone. ‘Joiners’ to the top 1% are more likely to be business owners, to be older, and to be female than ‘stayers’ who are at the top on either definition. Third, including gains substantially increases the share of total resources going to those at the top, as well as the observed trend in top shares. Including gains increases the pre-tax share of resources to the top 0.01% by 60% in 2017; their post-tax share almost doubles. Strikingly, including gains also changes the narrative for UK inequality over the past two decades: 2 while top fiscal income shares have remained largely constant since the late 1990s, once gains are included there has been a large and sustained rise. Capital gains are taxed at a lower rate than ordinary income. The top tax rate on labour income in the UK is 47%, for dividends it is 38.1%, while on capital gains it is between 10% and 28% depending on the type of underlying asset. In the US the top federal tax rate is 40.8% for income from labour or ordinary dividends, while on capital gains it peaks at 23.8%, and similar patterns hold elsewhere. The patterns we highlight are therefore likely to be of much broader relevance than to the UK alone. They matter for the time series of top income shares, as incentives to shift remuneration into gains vary with policy; for cross-country comparisons as these incentives vary across locations; and for the type of individuals we see in top shares. To establish where gains come from, we make use of capital gains tax filings. These document not only the amount of gains received by individuals, but the asset classes from which they derive. Around 71% of gains come from unlisted shares and ‘other assets’—a category comprising mainly business assets eligible for ‘entrepreneurs’ relief’, which lowers the tax rate to 10%, compared with a 20% standard rate. Such gains are substitutes for returns that could have been taken as capital income, and may in many cases actually be repackaged labour income (Miller et al., 2019). A further 5% of gains are from ‘carried interest’: payments for fund managers which depend on their investment performance (human capital) rather than equity stake. As in the US, the UK treats these as a return on investment. Three-quarters of all gains therefore come from returns that could just as well have been received as income. Most of this will being missing from national income, as well as from fiscal income, so will not show up in any measure of top share inequality based on income only (Alvaredo et al., 2016; Piketty et al., 2018).1 To understand who receives these gains, we link capital gains and income tax records. We first construct a measure of fiscal income using the deidentified administrative income tax data, to match the commonly used ‘Survey of Personal Incomes’ (Atkinson, 2002, 2007; Jenkins, 2017; Joyce et al., 2019). Combining it with capital gains tax records, we see that gains are extremely concentrated at the top of the existing income distribution.2 Around 50% of all gains by value go to the top 1% of individuals ranked by income, compared to just 13% of all fiscal income. At the indivdual level, nine out of ten people who are in the top 1% when ranking by income are also at the top when gains are included. However, the one in ten ‘joiners’ to the top 1% by total remuneration (income plus gains) 1While national accounts will pick up the part of gains that come from disposal of businesses that previously had retained earnings, they will not pick up intangibles like goodwill. 2It is also important to note that, conditional on having gains, the average amount of gains is similar across most of the income distribution. Although this has little aggregate effect, exclusion of gains is therefore important for understanding inequality further down the income distribution as well. Tables A1 and A2 provide the full distribution. [image omitted] 3 look very different in terms of their characteristics. In line with our first result, and with Smith et al. (2019), owners of businesses are much more likely to be at the top. Those at the top are also substantially older, and more likely to be female. This change in ranking matters because, while recent developments in inequality measurement are able to distribute all parts of national accounts, they do this in proportion to components of fiscal income (Piketty et al., 2018). By construction they miss any components of inequality that change when gains are added to that series. If gains were proportional to some income component, most likely dividends, then that might serve as a proxy and receive higher weight when scaling up to the national accounts (even assuming all real gains are captured in national accounts components). However, we see a prevalence among joiners of individuals with majority pension income, as well as of investors, who would not receive such scaling. While the share of gains going to the top 1% has remained relatively constant over the past twenty years, aggregate gains have risen sharply, tripling in the last decade. The share of total remuneration going to the top has risen in parallel, from 14.1% in 2009 to 16.8% in 2018. By contrast the share of income going to the top has been rising much more slowly: from 12.7% to 13.8% over the same period. Using data on asset holding lengths, we show this pattern holds when gains are considered on an accruals – rather than realisation – basis, while stripping out some of the excess volatility caused by policy changes. Including gains not only changes the nature of inequality trends, but also the apparent effectiveness of policy. Since gains are taxed at lower rates than income, the impact of including gains on post-tax inequality is even larger; the lack of redistribution of gains highlights again why they are a preferred form of remuneration for those that can repackage their income. Top share series including gains have been considered before (Piketty and Saez, 2003; Moriguchi and Saez, 2008; Alvaredo and Saez, 2009; Roine and Waldenstr ̈om, 2012; Alvaredo et al., 2013; Bartels, 2017). Authors have largely rejected these series in favour of an income only series, either because adding gains makes little difference (Bartels, 2017) or because adding gains makes a big difference to the volatility of the series (Piketty and Saez, 2003; Moriguchi and Saez, 2008; Alvaredo et al., 2013). We show that excluding gains is problematic even when interest is primarily in income inequality, because gains can contain a substantial share of shifted income. International differences in the taxation of gains relative to income – as well as differences over time – will influence how large an issue this is in a particular context, but exclusion of gains may bias down top income shares where shifting into gains is occuring.3 While the volatility of realised gains series is understandably seen 3These differences also help explain why in some contexts authors found inclusion of gains to add little, while in others they are substantial. [image omitted] 4 as unappealing, recent work studying estimating these on an accruals basis is likely to be preferred to complete exclusion. Our top share series including accrued gains is no more volatile than the top income series, but does pick out a different trend and level for top share inequality.

At least one thing is clear: the European wealth taxes of the past are not examples to follow. They kicked in at far too low a threshold – less than €1 million ($1.1 million) in the case of France’s impôt de solidarité sur la fortune – and were riddled with loopholes as a consequence. In the French case, a business owner was exempt as long as he or she did not sell the company. That led to successful serial start-up founders being taxed while sleepy entrepreneurs were not. And whereas a moderately wealthy French household’s financial portfolio could easily generate a negative after-tax return, the effective tax rate on the wealth of the country’s 100 richest individuals was a ridiculously low 0.02%.

As Saez and Zucman argue, a wealth tax should treat all assets equally and have a high enough threshold. Warren is proposing a 2% tax on wealth above $50 million. The equivalent threshold in Europe would probably be lower, but certainly not low enough to satisfy Thomas Piketty, who proposes in his  a 5% annual tax on wealth of $2 million. Whereas Warren wants to reform capitalism, Piketty would like to end it and eradicate private property as we know it.

In a recent post for the Slow Boring blog, Simon Bazelon and Milan Singh argue that raising taxes can be an effective way to reduce inflation. Unlike their criticisms of using interest rate policy to lower inflation (which are broadly correct), their proposal to raise taxes is unlikely to work in the manner they describe. In fact, it may even have the opposite of its intended effect. To begin with, economists generally consider monetary policy to be more effective at fighting inflation than fiscal policy, which includes tax policy. Fiscal policy tends to be slow and inefficient, and too often it just redistributes money from one sector of the economy to another without greatly affecting aggregate demand. This explains why economists such as Valerie Ramie have found that government spending multipliers tend to be less than one in normal times (which means that one dollar of government spending increases GDP by less than one dollar). Monetary policy works much better for fighting inflation, but the mechanism by which it works is often misunderstood. Bazelon and Singh are correct when they argue that interest rate policy, which is one aspect of monetary policy, is an inefficient way to reduce inflation. They point to a chart that claims to explain how interest rate hikes lead to tighter credit conditions, to lower spending for borrowers, and—ultimately—to lower prices. The authors claim that the mechanisms outlined in the chart are too complicated to work cleanly. The problems with using interest rates to curb inflation are more serious than this, however. While it is true that higher interest rates are bad for borrowers and that they often curb borrowers’ spending, higher rates also increase income and spending for savers. As with taxes, changes in interest rates in and of themselves do little to affect aggregate demand. Instead, they redistribute wealth and income from one group of people to another—in this case, between borrowers and savers. As the economist Scott Sumner has pointed out, interest rates are not a good reflection of the stance of monetary policy. In fact, the Federal Reserve is largely a follower—rather than a setter—of interest rates. It responds to market signals by helping guide interest rates closer to where the market determines they should be based on the supply and demand for credit. This does not mean that monetary policy is ineffective at fighting inflation. Instead, monetary policy affects aggregate demand by influencing the quantity of money in the economy. Total spending falls temporarily in response to a drop in the money supply. Output decreases as well, since prices adjust only after a lag. (Ideally, this process is carefully managed so that output growth merely slows and there is no full-blown recession.) Investing Digest: Know what's moving the financial markets and what smart money is buying with Forbes Investing Digest. Bazelon and Singh propose tax policy as an alternative to interest rate policy, but tax policy is unlikely to be very effective in this role. Tax policy primarily affects the supply side of the economy. A substantial tax increase reduces firms’ incentive to produce, thereby reducing the supply of goods and services in the economy relative to the quantity of money. In such a situation, prices would naturally go up—exactly the opposite of Bazelon and Singh’s desired outcome. Strangely, the authors recognize the productivity-enhancing benefits of other supply-side measures, such as zoning and permitting reforms. But they don’t recognize the productivity benefits of tax cuts. If policymakers want prices to fall, cutting taxes is the natural policy response, not raising them. However, even if the government implemented large tax cuts, we shouldn’t expect a very long-lasting effect on inflation. Inflation is the rate of change in prices. Changes in taxes, meanwhile, affect the level of taxation. It follows that tax changes are more likely to have level effects on prices than rate of change effects. By contrast, changes in the money growth rate in the economy are much more likely to affect the growth rate of prices (i.e., the inflation rate). The variable to target to bring down inflation is the rate of change in money growth. Interestingly, money growth has been falling in recent months and has even turned negative. Don’t be surprised if inflation starts to fall with it. Bazelon and Singh seem to be attracted to the Modern Monetary Theory idea that revenue from higher taxes can be “sucked” out of the economy, thereby reducing the money supply and lowering inflation. While such a situation is conceivable, it is most likely to occur if new revenue is used to reduce the federal debt. Since Treasurys are close substitutes for money, reducing the supply of Treasury bills is similar to (though not exactly the same as) reducing the money supply. It is unclear whether earmarking new revenues toward paying down the debt is what the authors have in mind. They do mention a possible grand bargain that involves reducing the deficit, which could be a good idea. If this is not the goal, however, and if the new revenue is instead intended to be spent by Congress with no change to borrowing, there is no reason to believe that raising taxes would reduce inflation. All told, hiking tax rates to fight inflation doesn’t make much sense from an economic point of view. It would be far better for policymakers to rein in excess aggregate demand through sensible monetary policy. That’s a much more direct and simple approach. Such macroeconomic management is not without its challenges, to be sure, but at least it’s based on sound economic thinking.

Era Dabla-Norris, Frederico Lima, Macroeconomic effects of tax rate and base changes: Evidence from fiscal consolidations, European Economic Review, Volume 153, 2023, 104399, (Era Dabla-Norris is a Division Chief in the IMF's Fiscal Affairs Department. She is currently working on issues pertaining to structural reforms and productivity, income inequality, fiscal risks and spillovers, and demographics and fiscal dynamics.) (Frederico Lima is an economist in the African Department of the International Monetary Fund. ) ISSN 0014-2921, . /hcc *Dynamic effects of tax changes section and conclusion section is included

We first present our estimates for the dynamic effects of tax changes for all tax types combined. After, we differentiate between the effects of tax rate and base changes. All impulse responses show the impact of a tax increase worth one percent of GDP, and we show results for a forecast horizon of 16 quarters, together with one and two standard deviation confidence intervals. In the results that follow, we focus on exogenous shocks with a consolidation motivation, but the results are similar if we include measures with a long-run motivation as well. All tax types. The response of tax revenue and output to a narrative tax shock covering all tax types is shown in Fig. 3. The left panel shows the response of the tax-to-GDP ratio to the narrative tax shock, the first-stage of our IV estimation. The point estimates are positive throughout, with the response building up during the first year, consistent with the revenue effects projected by country authorities shown in Fig. 2. The improvement in the tax ratio remains around one for the first 12 quarters, and gradually declines after, although it does not reach zero. There are several reasons why the improvement in the tax ratio could be temporary. First, it could be due to statistical noise, noting that one remains well within the confidence interval. It could also be driven by economic agents adapting to the tax changes, including through mobility or noncompliance, although it is not clear why these behavioral changes would take years to have an impact. Lastly, it may reflect a partial unwinding of tax reforms after a few years, especially since many tax changes are enacted after elections, and governments have an incentive to relax taxes before the next election. The timing of the decline, three years after announcement, is consistent with this interpretation. The right panel of Fig. 3 shows the response of GDP to an improvement of one percent of GDP in the tax-to-GDP ratio, which is instrumented by the narrative tax shock in the second-stage of our IV estimation. Consistent with the findings elsewhere in the literature (e.g., Romer and Romer, 2010, Guajardo et al., 2014, Alesina et al., 2015), an increase in tax liabilities during fiscal consolidations results in a decline in output, with an announced increase in taxes of one percent of GDP leading to a decrease in output of 0.3 percent in the first quarter, and a peak decline of 1.1 percent two years after announcement. The impact of GDP is somewhat lower after a few years, consistent with the smaller impact on tax revenue. Tax rate and tax base changes. We next turn to the dynamic impact of tax rate versus base changes on output, the focus of our paper. To estimate the impact of tax rate changes, we continue to use Eq. (3), but now instrument the change in the tax-to-GDP ratio using the narrative shock for rate changes only. To account for discretionary changes in tax bases that may happen around the same time, we also control for lagged narrative tax base shocks. We estimate the impact of discretionary tax base shocks similarly, this time adding lagged narrative tax rate shocks as controls. As before, the estimates show responses to a 1 percent of GDP tax increase enacted either through rate or base measures. The panels on the left in Fig. 4 show the responses of GDP and tax revenue to tax rate shocks, while the panels on the right show the responses to tax base shocks. The response of GDP is shown in the top row. A tax rate shock leads to a large decline in GDP, with a decline of about 0.4 percent in the first quarter, and a peak decline of 1.7 percent after two years. The impact is persistent, and remains significant throughout the estimation horizon. In contrast, tax base shocks have a much smaller impact on GDP that is not statistically significant. Importantly, this difference is not driven by base shocks having a smaller impact on tax revenue than rate shocks, since both tax rate and base shocks lead to a significant increase in tax revenue. The following panels in Fig. 5 examine the response of different GDP components, including consumption, investment and government purchases. To ensure that these magnitudes can be directly compared, we scale the impulse responses to have the same units in percent of GDP. The first row shows the response of private-sector consumption. After a tax rate shock, consumption shows a steep decline, decreasing by 0.9 percent of GDP after eight quarters, and then recovering slightly over time. In contrast, the response of consumption after a tax base shock is more muted, with point estimates indicating a decline of 0.3 percent of GDP two years after announcement. However, this decline is not statistically significant. A similar picture emerges for private-sector investment (here defined as gross fixed capital formation), which is shown in the second row of Fig. 5. Investment decreases after a tax rate shock, declining by 0.8 percent of GDP after eight quarters, and then partially recovering. However, investment responds less to a similar size tax increased enacted only through base measures. The point estimates indicate no decline in the first two quarters, and a decline of 0.6 percent of GDP after eight quarters, although it remains not statistically significant. Finally, we examine the responses of labor market indicators to tax rate and tax base increases in Fig. 6. The top row documents the response of the unemployment rate to a 1 percent of GDP increase in taxes. For increases adopted through rate hikes, we observe a significant increase in the unemployment rate, starting at 0.4 percent in the first year, and building up to 0.9 percent after three years. However, the impact on unemployment is considerably smaller when tax increases are adopted through base broadening. In this case, there is an increase in the unemployment rate of 0.2 in the first year after tax increases are announced, and the point estimate increases gradually to 0.5 percent over the medium-term. Moreover, these estimates remain statistically insignificant in all quarters. The bottom row shows the response of average wages per employed worker, and here again the difference between rate and base responses is noticeable. Wages decline after a rate hike is announced, and the point estimates indicate a statistically significant decline of just under 2 percentage points after two years, which appears to be persistent. However, a tax increase implemented through tax base changes is associated with a much smaller decline in wages of about 0.5 percent over the same two-year horizon. There is evidence of a continued decline in average wages over the medium-term after a base shock, but these estimates continue to be not statistically significant. 4.2. Tax multipliers The previous section describes the dynamic impact of tax shocks. Alternatively, these impacts can be translated into multipliers. Following Uhlig (2010) and Ramey and Zubairy (2018), we estimate multipliers by considering the impact of the cumulative change in tax revenue on the cumulative change in output: (4) ɛ This approach has the advantage of taking into account the total change in output and tax revenue following the announcement of a tax shock, independently of their specific paths over time. For example, this could be important if tax shocks have an immediate impact on tax revenue while having a delayed impact on growth, or vice-versa.<DATA OMITTED> Conclusion Our analysis shows that tax changes can have significant macroeconomic effects, but these effects vary with their composition. Using a new narrative dataset of tax changes during fiscal consolidations, we find that base broadening leads to smaller output and employment declines than rate increases. The estimated cumulative tax rate multiplier two years after announcement is close to 1.8, while the cumulative tax base multiplier is only 0.5 over the same horizon and not statistically significant. On average, a one percent of GDP rate hike is associated with a sustained increase in the unemployment rate of nearly 1 percentage point, while similar-size base broadening measures lead to an increase in unemployment that is only half as large. We find similar results when we separate rate and base changes within specific taxes, including personal and corporate income taxes. Our findings support the common policy advice that base broadening is less detrimental to growth, and suggest interesting possibilities for future research. First, our dataset could be extended to non-consolidation years and additional countries. This would make it possible to examine how rate and base multipliers vary by income level, the state of the business cycle, or tax system characteristics such as the initial size of the tax base and the initial tax rate (Ramey and Zubairy, 2018, Gunter et al., 2021). Future work could also examine differences in tax changes, like contrasting measures with long-run and consolidation motivations or separating by type of base broadening, and look at the long-term impact of rate hikes and base broadening on economic growth. Finally, it may be useful to explore the interaction between rate and base measures and improvements in tax administration, since the latter can have a large and immediate impact on tax compliance (Slemrod, 2019). he change in tax is instrumented with the relevant narrative tax shock, and all baseline controls are included. We focus on the multiplier at a two-year ( ) horizon, but the results are similar at shorter (4 quarter) or longer (16 quarter) horizons. In all cases, we also display the first-stage robust F-statistic, which suggests there is no weak instruments problem. Nevertheless, to ensure that our results are not affected by possible issues with instrument relevance, we conduct key hypothesis tests using Anderson and Rubin (1949) statistics, which are robust to weak instruments. The estimated tax multipliers are shown in Table 3, which contains two key findings. First, we find that the multiplier across all types of tax changes is 1.28 after two years, which is somewhat smaller than estimated in the literature. For example, Romer and Romer (2010) and Guajardo et al. (2014) also adopt a narrative approach and find two-year tax multipliers closer to 3, while Ramey (2019) surveys the recent literature and concludes that most estimates fall between 2 and 3. Instead, our lower estimate is consistent with those of Barro and Redlick (2011), who find a tax multiplier of 1.1 for the U.S. in the postwar period, and Alesina et al. (2017). The latter find a multiplier of 1.3, although they focus on tax-based consolidations (i.e., fiscal consolidations where more than half of the consolidation effort was adopted through tax changes) rather than tax changes directly. The second key finding is that tax base multipliers are significantly lower than tax rate multipliers. The impact of tax rate changes on output is large and statistically significant, reaching 1.84 after two years, while tax base changes have a much smaller impact, with a point estimate of 0.46, which is not statistically different from zero. The last column of Table 3 conducts a formal statistical test for the difference between the two multipliers, and finds it is statistically significant at 1 percent level. The Anderson-Rubin statistic, which is robust to weak instruments but may have lower power, also rejects the hypothesis that the two multipliers are equal at the 10 percent level.

Every time I hear that we as a nation cannot afford something — whether that might be assuring non-toxic water in Jackson and Flint or universal pre-K or an industrial policy with teeth — I have wondered how many dollars a national wealth tax might yield. So I looked the numbers up.

Wealth turns out to run way bigger than income. Our total U.S. wealth in 2021 sat at . Total income, combining  and , amounted to about $25 trillion. A small wealth tax would clearly produce much more government revenue than a much larger income tax.

The coronavirus has been nothing less than a calamity. But more than a year into the pandemic, it is distressingly clear that although the virus affects everyone, we are not all in this together. Instead, the disease highlights and worsens existing fault lines in American society, especially economic inequality. The Biden Administration recognizes the problem. The , signed into law in March, is the most economically progressive legislation in a generation. But for all that it does to fight poverty, the ARP will do distressingly little to reduce inequality. The statute works almost entirely through public spending. But the economic inequality that separates the rich from the rest has become so great that spending alone can’t repair it or even reverse inequality’s increase over the course of the pandemic. The rich have too much money. We simply can’t spend our way back to equality. Curing , and redistribution means taxes. National solidarity in the face of a universal threat like the pandemic requires the rich to contribute to the relief effort. Income taxes can help, but the best way to reduce inequality and honor shared citizenship is to tax wealth. The first wave of the pandemic hit the rich, who were exposed to the virus through travel and public appearances. But privilege quickly reasserted itself. COVID-19 infections soon became concentrated among low-paid workers, who cannot afford to leave their jobs and whose working conditions make social distancing difficult. In one study, the of counties experienced COVID-19 death rates 67% higher than the most privileged fifth. Another study reports that from COVID-19 at more than twice the rates of their white counterparts. Unemployment, and the lost income and dignity that follow, have also hit the worst off hardest. Perhaps no facet of inequality has grown more dramatically than wealth. The have become over $400 billion richer since the markets bottomed out in March 2020. Meanwhile, a yearlong bull market—triggered by the CARES Act’s passage at the market trough and supported since then by a series of government rescues—has added roughly to the richest 1% of American households. More comprehensive measures, which include real estate and privately held companies, report that the richest 1% of Americans over $7 trillion of wealth from the end of March to the end of December 2020. By comparison, the money in the ARP—$1.9 trillion over 10 years—sounds relatively modest, and truly is. The ARP’s spending is front-loaded, so that $1.2 trillion will be spent in 2021. On average, each percentile in the bottom 80% of the income distribution will get a little over 1% of this sum, or about $12 billion. That’s less than 1/500th of the increased wealth that the richest 1% have accumulated over the pandemic year—a drop in the ocean. The only truly effective way to tackle wealth inequality this extreme is to meet it head-on, by taxing wealth itself. A levy on the super-rich figured prominently in the presidential campaigns of Senators Bernie Sanders and Elizabeth Warren, who have now teamed up on a to impose an annual 2% tax on household wealth above $50 million, rising to 3% above $1 billion. I propose with lower exemptions and higher rates, tied directly to a national response to pandemic emergency: a onetime tax starting at 5% on the richest 5% of households, that is, on wealth in excess of $2.5 million. Americans agree that the extraordinary catastrophe caused by COVID-19 calls for an extraordinary response—one that draws not on the income used to fund everyday government expenditures, but rather on the stock of advantage that the most privileged have accumulated across decades of good times. When asked in , Democrats favored the plan by a ratio of 6:1, independents by nearly 3:1, and even Republicans favored the tax by 2:1. All the proposed wealth taxes have strengths and weaknesses. Ongoing taxes can have higher exemptions and lower rates and might raise more revenue over the long run. On the other hand, the complexity of the extreme fortunes (offshore trusts, private investments, art, etc.) on which ongoing taxes focus make them difficult to administer; the super-rich have many opportunities for tax avoidance; and the prospect of regular wealth-tax bills might discourage capital accumulation and reduce economic growth. A onetime tax can reach a broader tax base with a simpler structure and fewer unwanted side effects. The richest 5% of American households own two-thirds of the country’s total wealth, much of it in forms (publicly traded securities, real estate property) for which already exist. Using a past date—for example, the date on which the wealth-tax bill was introduced in Congress—to fix valuations makes tax avoidance much less of a problem. And a onetime tax will create no economic distortions on savings and investment going forward. A onetime tax can also raise more immediate revenue and reduce inequality more quickly than an ongoing tax, even as it leaves unresolved future battles over economic justice. Oliver Wendell Holmes once said, “I like to pay taxes. With them, I buy civilization.” He should be taken literally. World history teaches that are almost impossible to unwind except by war or violent revolution. Extreme wealth inequality confronts the U.S. with a civilizational threat. Wealth taxes answer the threat.

Capital Flight and Expatriation A further argument against an annual wealth tax is that it could result in capital flight and relocation by those subject to the tax. While some researchers found significant capital flight from France following its introduction of a highly publicized wealth tax in 1989, others have found limited mobility and expatriation.44 Saez and Zucman, and Senator Warren, have proposed that a wealth tax could be combined with measures to limit capital flight, such as an exit tax of 40 percent of net wealth for those who renounce their citizenship.45

Tax Evasion A common objection to an annual wealth tax is that it can be easily taxed through tax evasion. This certainly could have been the case in the past, but the rules of the game are changing as a result of the OECD's base erosion and profit shifting (BEPS) reforms and the implementation of more extensive anti-avoidance measures by national governments. By far the largest share of assets held by the wealthiest individuals is controlled by their equity ownership of either listed or partially held corporations.46

For the first time in a quarter of a century, extreme wealth and extreme poverty have increased simultaneously. This has been driven by a seismic wave of inequality, exacerbated by recurrent crises and an economic system that concentrates resources at the top rather than allocating them where they are most needed.

The numbers are astonishing. In the past two years the richest 1% of people have acquired nearly twice as much new wealth as the rest of the world’s population put together. Oxfam found that, for every $1 of new global wealth earned by a person in the bottom 90%, each billionaire gained roughly $1.7m (£1.4m; €1.6m). Meanwhile, the combined fortune of billionaires has increased by a staggering $2.7bn a day.1