The very wealthy often own businesses or are self-employed professionals. Many grow their money in the stock market - either through direct investments or via mutual funds, annuities, trusts and pension funds. They tend to have a more diverse set of investments than the middle class and so are better protected against declines in particular asset categories. Thanks to robust growth in financial markets, the super-rich have done rather well lately, with the top 1% now owning half of the household wealth in the whole world. In the meantime, there are still a lot of poor people on this sorry planet. Shouldn’t we tax the wealth of the most fortunate among us to help those who haven’t been so lucky?
To address that question, we have to consider what wealth is. Wealth is an accumulation of assets that can be sold or exchanged for other assets. Wealth may be measured by its current resale value or its estimated resale value at a later time. Some assets, like cash and bank accounts, are relatively reliable and safe. Absent mugging, high inflation, bank runs, or the collapse of civilization, the value of these assets are reasonably predictable over a fairly long time horizon. The problem with safe assets is they don't grow much by themselves. Their probable future value isn't worth that much more than their current value. This is a problem because a lot of people want to grow their wealth, especially for retirement.
That's where risky assets come in. Risky assets are where the big bucks are made and lost. Risky assets include volatile investments, real estate other than one's own home, or a business. Households heavily invested in risky assets tend to experience big swings in wealth. Some of these households, called "jumpers", move up or down three or more wealth quintiles within a decade. Take a look:
The above chart shows more risky-asset households jumped down than up between 2003 and 2013. In other words, more went down three wealth quintiles than up. Now consider the following:
So the top 1 percent derive most of their wealth from risky assets: almost half in real estate or business equity and another quarter in stocks, financial securities, mutual funds, and personal trusts. But as we saw in the chart about jumpers, what goes up often goes down. A good number of households that reach the top don't stay there for long.
The willingness to invest in risky assets is a good thing. Without such willingness, economic growth would come to a grinding halt. A wealth tax targeting the very rich would pull assets out of the market economy, because that's where the assets are doing their wealth-building work: starting or growing businesses directly or through the financial markets. Perhaps a smallish wealth tax wouldn't do much damage to the economy, but a smallish wealth tax isn't going to have much impact on poverty or stalled social mobility. Problem is, a wealth tax that packed a real bunch could end up hurting the very people it's meant to help, by triggering recession and unemployment. There must be a better way.
Next: A better way. Maybe.