Tax reform could reduce wealth inequality gap, Stanford scholar says

Stanford Law Professor Joseph Bankman discusses eight tax policies aimed at reducing inequality among the wealthiest Americans and the rest of society. 

Symbols of wealth

Wealth inequality is a topic that deserves attention but is very difficult to influence, writes Stanford Law Professor Joseph Bankman in a new paper.

Tax reform could ease the escalating high-end wealth inequality trend in the United States, according to a Stanford tax scholar.

Law Professor Joseph Bankman writes in a new paper that the optimal tax response to wealth inequality is significantly more complicated than portrayed in books like Thomas Piketty’s best-selling and widely noted book, Capital in the 21st Century. Bankman’s co-author is law professor Daniel Shaviro of New York University.

Today in America the top 1 percent controls 40 percent of the nation’s wealth. Twenty-five years ago, the corresponding figures were 12 percent and 33 percent. On Jan. 20, President Obama in his State of the Union address touted the goal of alleviating economic inequality in the United States.

In his work, Piketty, a French economist, proposed a global tax on capital – on assets such as land, natural resources, houses, office buildings, stocks and bonds, and more. This tax would start small but rise to as high as 5 percent to 10 percent annually for fortunes in the billions.

Bankman and his co-author praise Piketty for jumpstarting the conversation about unequal wealth. However, they argue that inequality in the United States differs from the type of inequality that Piketty focuses on.

“In the U.S., inequality is associated with human capital, rather than inherited wealth,” said Bankman, the Ralph M. Parsons Professor of Law and Business at Stanford University.

“Human capital” is the stock of knowledge, habits, social and personality attributes, including creativity, embodied in the ability to perform labor so as to produce economic value, he said.

As Bankman noted, the winner-take-all global economy appears to have increased the inequality issue behind human capital. “Our tax laws are not really designed to reach those who have used human capital to amass great fortunes,” he said.

Bankman offers the example of Larry Ellison, founder of Oracle.  Ellison can fund consumption by borrowing against the value of his stock. “He is unaffected by taxes on capital gains, dividends or high salaries, because his borrowing does not create any income,” he said. 

The wealth tax proposed by Piketty would affect Ellison, but that tax may be unconstitutional here.  Inheritance taxes could limit the amount Ellison leaves to heirs, but wouldn’t affect his lifetime consumption.

In the paper forthcoming in the Tax Law Review, Bankman offers eight types of taxes that could address wealth inequality in the U.S:

• Surtax on capital income: A surtax on capital income might seem the most obvious way to reduce wealth concentration, they noted. “Current (tax) rates could be raised across the board, or the preferential rate for dividends and capital gains might be eliminated,” wrote Bankman.

• Surtax on corporate income: A tax on large multinational corporations could be thought of as a subset of the capital tax surtax. “As such, it would face all of the difficulties described in connection with that tax,” he wrote.

• Surtax on high labor income (or high income from any source): Extending the surtax to all income would combine these effects with those of the capital tax surtax.

• Reforming income taxes in specific industries:  Eliminating loopholes and reforming the treatment of certain forms of income would at least initially reduce after-tax returns to those already in those sectors, Bankman said. For instance, amending the law to treat certain returns to venture capitalists as ordinary income, rather than capital gains, might reduce wealth in the financial sector.

• Larger scale income tax reform: A significant income tax reform could increase and rationalize the system’s impact on the wealthy, he said. “For example, borrowing off untaxed proceeds, as Ellison and others have done, could be eliminated by taxing the receipt of debt principal to the extent it is not reinvested,” Bankman said. Also, corporate earnings might be taxed through the business enterprise.

• Progressive consumption tax: Under this tax, families would report their taxable income and annual savings to the IRS. The difference between those two numbers – income minus savings – is the family’s annual consumption expenditure. Generally speaking, it would increase overall taxes for the extremely wealthy.  However, transitioning to a consumption tax would be very difficult, Bankman noted.

• Wealth tax: Although there is a strong possibility that a wealth tax like the one Piketty proposed would be held unconstitutional, Bankman wrote, it could reach the super-rich whose wealth is largely held in the form of publicly traded securities.

• Estate or inheritance tax: Significantly tightening the enforceability of existing estate and gift taxes could ease the “dynastic transmission of wealth,” as Bankman described it.

Another idea is to convert the estate tax into an inheritance tax, in which the tax depends on the amount one inherited, rather than on the size of the overall estate, the researchers suggested.

According to Bankman and Shaviro, designing a workable, attractive tax mix that reduces capital concentration is extremely difficult.  “It requires that we reach some political consensus on the right amount of inequality, and then weigh the efficiency costs of each tax,” Bankman said.

In some cases, regulatory alternatives might be more attractive. 

“For example, rather than, or in addition to, levying a surtax on human capital to reduce inequality, we might try to use programs like early childhood education to spread human capital to other segments of our society,” he added.

The fact that people are talking about tax reform is encouraging, Bankman said.

“From a tax policy perspective,” he wrote, “Capital in the 21st Century’s chief contribution lies less in the solution it proposes than in its extraordinary contributions to awareness of high-end inequality issues, and to the advancement of informed debate.”

Media Contacts

Joseph Bankman, Stanford Law School: (650) 725-3825,
Clifton B. Parker, Stanford News Service: (650) 725-0224,