Increasing capital gains tax solves inequality – current tax gap allows the rich’s income to go untaxed

The Rise of Wealth Inequality A first step toward the creation of US distributional national accounts was taken in Saez and Zucman (2016), who produced estimates of US wealth inequality allocating 100 percent of the household wealth recorded in the Financial Accounts, the official US macroeconomic balance sheet. Household wealth includes all the nonfinancial assets (such as real estate) and financial assets (such as equities, bonds, and pension wealth, whether held in individual retirement accounts or through pension funds) of US households, net of debts. In 2019, the Federal Reserve released its own official Distributional Financial Accounts painting a similar picture of a large rise in wealth concentration. Measuring Wealth When There Is No Administrative Data on Wealth Because there is no administrative data on wealth in the United States, Saez and Zucman (2016) use an indirect method, known as the income capitalization technique, to estimate wealth inequality. The idea is to link the Financial Accounts aggregates to the income flows that these assets generate: thus, interest-bearing assets are linked to interest payments, corporate equities are linked to dividends and capital gains, business assets are linked to business profits, and so on. Concretely, if the ratio between the stock of interest-bearing assets in the Financial Accounts and the total flow of interest income reported in tax returns is 50, then someone with $1,000 in interest is assigned $50,000 in bonds, saving accounts, and other interestgenerating assets. Wealth, in other words, is estimated by capitalizing income; in the preceding example, interest is capitalized using a capitalization factor of 50, or equivalently, an interest rate of 2 percent. Because not all assets generate taxable income (pensions, most importantly, do not), tax data need to be supplemented with other data sources to capture all forms of wealth. The basic capitalization method is simple and transparent, and it delivers results consistent with other evidence about US wealth. In 2016, according to the basic capitalization method, US billionaires owned $3.1 trillion in wealth, a number close to the $3.0 trillion implied by the Forbes annual list of the 400 wealthiest Americans. Tax units with less than $1 billion and more than $50 million in net wealth owned $9.2 trillion, a number not dissimilar to the $10.2 trillion found in the Survey of Consumer Finances. In its simplest form, the capitalization method relies on the assumption that within an asset class, the link between income reported in tax returns and wealth is the same across individuals; in other words, that people have the same realized rate 6 Journal of Economic Perspectives of return to wealth. Of course, not everybody actually has the same realized rate of return. The rates of return may even be positively correlated with wealth. In Saez and Zucman (2016), we showed that the assumption of constant realized returns within an asset class appeared reasonable, based on data from estate tax returns matched to the income tax return of the decedent the year before death, the Survey of Consumer Finances, and tax returns from foundations. In particular, we showed that the capitalization technique works well for US foundations despite the fact that the wealthiest foundations—with sophisticated investments in private equity and hedge funds—have higher total rates of returns than less wealthy foundations. The reason for this apparent paradox is that the high total returns of top foundations stem from high unrealized capital gains, not from high realized income (interest, dividends, realized capital gains) relative to wealth. What matters for the capitalization method is that within an asset class, the flow of realized income be proportional to wealth, which generally seems to be the case. However, we also found in matched estate-income tax data, an interest rate premium that seemed to appear among the rich starting around the time of the Great Recession of 2008–2009 and noted (Saez and Zucman 2016, p. 550) that this pattern should be watched. Subsequent research suggests that the interest rate premium of the rich has become a fixture of the post-Great Recession era. In the Survey of Consumer Finances, the top 1 percent richest households have a higherthan-average interest rate in the 2010, 2013, and 2016 waves of the survey by a factor of 1.3 (Bricker, Volz, and Hansen 2018; Saez and Zucman 2019a). In matched estates-income tax data, estates above $10 million have continued to exhibit a slightly higher interest rate than average Americans after 2012, the last year in Saez and Zucman (2016) (Smith, Zidar, and Zwick 2020). Thus, assuming that all Americans have the same interest rate exaggerates the interest-bearing assets of the wealthy in the post Great Recession period. For equity wealth, the capitalization method infers assets based on dividends and realized capital gains, and thus it cannot capture the wealth of someone who receives no dividend and barely realizes any capital gains. A striking example is given by Warren Buffett, the main shareholder of Berkshire Hathaway, a company that does not pay dividends. In 2016, Buffett disclosed he had an adjusted gross income of $11.5 million in 2015, a negligible realized return relative to the value of his stake in Berkshire Hathaway, which amounted to about $60 billion (as reported in Cohen 2016). Six of the top 10 wealthiest Americans—Jeff Bezos (Amazon), Mark Zuckerberg (Facebook), Warren Buffett (Berkshire Hathaway), Sergey Brin (Alphabet), Larry Page (Alphabet), and Elon Musk (Tesla), collectively worth more than $600 billion in September 2020, which is 0.6 percent of all US wealth—are the main shareholders of corporations that do not pay dividends. Indeed, by triangulating the available sources on the reported incomes of the ultra-wealthy, Saez and Zucman (2019a) estimate that the top 400 wealthiest Americans as a whole earn less taxable equity income (dividends and realized capital gains) relative to their equity wealth than the rest of the population by a factor of about 2. Assuming that all Americans have the same realized return on The Rise of Income and Wealth Inequality in America 7 equities thus underestimates the equity assets of billionaires—a problem that has become more acute in the 2010s with the growth of giant tech companies that typically do not distribute dividends. Capturing these trends calls for implementing a more sophisticated version of the capitalization method. The September 2020 update of the Saez and Zucman (2016) estimates of wealth inequality, published on the World Inequality Database and also presented in this paper, incorporate the interest rate premium of the rich seen in matched estates-income tax data. They also upgrade the equity wealth of billionaires so that the total net worth of billionaire keeps matching Forbes. These changes do not significantly affect the level of top wealth shares nor their trend but bring asset composition in line with the existing evidence. For example, in these updated series, interest-bearing assets account for 23 percent of the wealth of the top 1 percent in 2018, consistent with the asset composition seen in the official Federal Reserve data on wealth inequality.