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Hutchins Roundup: Warren’s wealth tax, low profits, and more

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Studies in this week’s Hutchins Roundup find that Elizabeth Warren’s wealth tax raises more revenue than a Swiss-style wealth tax, lower profit margins for banks after a financial crisis slows recapitalization and recovery and more.

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Warren’s wealth tax raises more revenue than a Swiss-style wealth tax

Using data on U.S. wealth from the 2016 Survey of Consumer Finances, Edward Wolff of New York University compares how much revenue would be collected under Elizabeth Warren’s wealth tax versus under a Swiss-style tax which would hit many more people but impose a much lower tax rate. Using equivalent thresholds as the Swiss system—$121,000 for married couples—and the Swiss marginal tax rates—ranging from 0.05 to 0.3 percent, Wolff finds that a Swiss-type wealth tax would yield $189 billion in revenue, only 3 percent of total federal tax revenues. More than half of Americans would fall below the wealth tax threshold, and therefore be exempt; only 15 percent would pay $500 or more in additional taxes. In comparison, the original Warren wealth tax proposal — which imposes a 2 percent tax on wealth above $50 million and a 3 percent tax on wealth above $1 billion—would raise 60% more in tax revenue than the Swiss model, would affect many fewer Americans (just 0.07 percent), and could trigger “considerable capital flight,” he says. Wolff notes that neither tax would affect the Gini coefficient. “If the objective of a wealth tax is to substantially reduce wealth inequality, neither tax system would achieve that objective,” he argues.

Lower profit margins for banks after a financial crisis slows recapitalization and recovery

The economy takes longer to recover from a recession caused by a financial crisis. Saki Bigio of the University of California, Los Angeles, and Adrien d’Avernas of Stockholm School of Economics show that low profit margins at banks associated with a financial crisis lead to the slow recovery of bank capital and economic activity. The authors reason that when banks incur large losses, they lose their appetite to take financial risks and lend less. As a result, banks become more selective in their lending, so profit margins and retained earnings fall, which slows the recapitalization process. A coordinated equity injection into the financial sector to boost lending can improve profits for the industry, the authors say. This would mitigate the depth and length of financial crises.

Household product choices are becomingly increasingly diverse

Using data from Neilsen, Bernt Neiman and Jospeh Vavra of the Becker Friedman Institute find that households are increasingly concentrating their spending on a few preferred products. Aggregate spending concentration is falling, however, because households are buying increasingly different goods from one another. Neiman and Vavra find that household consumption bundles are becoming more differentiated even when measured within cities, store chains, and demographic groups. They argue that, rather than reflecting increasingly different households, the rise in spending variation is due to increasing product availability, which allows households to select products better matched to their tastes. This improved matching yields significant gains in living standards which, they note, are not captured in standard measures of output and consumption.

Chart of the week:

policy rate reductions in 2019 for countries and areas around the globe

Source: International Monetary Fund

Quote of the week:

“Whilst the infrastructure that underpins our markets is now in much better shape, nascent risks remain that, if left unchecked, could bring new problems. Consider market liquidity. During the crisis, liquidity dried up, particularly in the interbank market, as cash-rich banks hoarded excess funds. In parallel, a “run on repo”, triggered by increased haircuts on collateral to guard against counterparty risk, pushed the shadow banking sectors in advanced economies to collapse. […] Global reforms address the fault lines that caused this fiasco. New global standards for liquidity regulation are now in place including the Liquidity Coverage Ratio and Net Stable Funding Ratio. Bank capital standards now take into account exposures to shadow banks, including step-in risk, and through-the-cycle margining prevents Minsky cycles in secured lending. These reforms are transforming banks’ approach to liquidity management and building the resilience of the system as a whole,” says Mark Carney, Governor of the Bank of England

“[H]owever, the recent volatility in US dollar repo markets suggest there are still frictions that need to be addressed. Contrary to expectations, banks did not step into the market to lend cash, viewing the profit opportunity to be insufficient to offset the impact on perceived regulatory liquidity requirements. The Federal Reserve’s open market operations have since calmed the market, but term repo rates remain elevated, as dealers are pricing in a higher likelihood of similar spikes in future. While it may be tempting to conclude this is an isolated incident, there have been others, including the taper and bund tantrums. These could signal a broader problem of discontinuous market liquidity in stress.”

Jeffrey Cheng

Research Analyst - Hutchins Center on Fiscal & Monetary Policy, The Brookings Institution

Kadija Yilla

Senior Research Assistant - Hutchins Center on Fiscal & Monetary Policy, The Brookings Institution

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