Isaac Swift and Kerk Phillips, Economics Department

Introduction

In 2013 French economist Thomas Piketty, one of the leading experts on inequality, published a book titled Capital in the Twenty-First Century. This book quickly became a bestseller and received worldwide attention. In his book Piketty described data that he had carefully collected on income and wealth inequality over a few hundred years. From the data he noted that inequality has been on the rise in the U.S. for the last forty years, and he predicted it would continue to rise. He gave several policy proposals to combat this inequality. Among these proposals was a progressive wealth tax. My research aimed to build a rigorous mathematical model of the U.S. economy that could actually estimate the effect a wealth tax would have and compare it to other redistributional taxes. For this project we specifically compared the effects of a progressive wealth tax, and a progressive increase to the income tax that raises the same revenue.

Methodology

To estimate the effects of these taxes, we built a large-scale macroeconomic model. In the model, there are 700 types of heterogeneous agents that make decisions on the amount the want to work and the amount to save. Agents have different ages, and different levels of effectiveness at their work. The effectiveness levels of the workers in the model are taken from U.S. Treasury data. Mortality rates, fertility rates, and immigration rates in the model also match those in the United States. We calibrate the utility functions such that wealth holding of agents in the model will match wealth holdings in U.S. data. We then put one of the taxes into effect to see how the agents’ behavior change and what the effects on the macroeconomy are.

Results

We found that in this model, the wealth tax was able to reduce inequality far more effectively than an income tax of the same size. The wealth tax hindered the 1 percent’s ability to accumulate huge amounts of wealth. It also greatly reduced the amount that the wealthiest bequeath to their heirs. Through this channel it was able to reduce inequality. Furthermore we found that the wealth tax had a smaller negative impact on macroeconomic variables such as GDP. This is because the wealth tax made saving a less attractive option for the agents. They instead had to keep working more and for longer. This increase in labor offset the other negative effects on production. The income tax on the other hand makes working less valuable. This caused people to work less and greatly reduced national output.

Discussion

These results we very supportive the of wealth tax as advocated in Thomas Piketty’s book. They show one model in which a wealth tax would be an effective way to reduce inequality. Being a model, it is of course a greatly simplified version of the actual U.S. economy. There are many things that could be added to the model and may change the results. These include adding a stochastic income process and changing how bequests are handled. We also don’t discuss the question of whether or not we want to reduce inequality. This project focuses on answering the question, if you want to reduce inequality, what is the most effective way to do it.

Conclusion

I’m so grateful to the Office of Research and Creative Activities for making this possible. We have submitted our paper on this project to be published and it is currently under review at the American Economic Journal: Macroeconomics. I will be starting the Economics PhD program at Minnesota this fall. This research was the main reason I was able to get accepted as such a great university. The things I learned while doing this research will be helpful to me during my graduate program and throughout my career.