Forget a Tax on Capital, Bill Gates Wants a Consumption Tax

Source: Stefan Postles/Getty Images

Source: Stefan Postles/Getty Images

Bill Gates doesn’t rock the boat too much, considering how immensely wealthy and influential he is. The world’s richest man and founder of Microsoft instead spends his time running The Bill & Melinda Gates Foundation in their hometown of Seattle, which takes aim at helping cure disease and solve poverty issues around the world. But a book that has been making a lot of waves in the business and economic world — Thomas Piketty’s Capital in the Twenty-First Century — has apparently moved him enough to speak out on some of the current happenings in the U.S. economy.

In a lengthy write-up, Gates explains how he read the book after hearing many others clamoring about its virtues and fallacies. While he says that he agrees with Piketty’s take that high levels of inequality aren’t good — capitalism lacks self-correcting features to address it and that governments are able to step in and help — Gates does point out some flaws.

“He does not give a full picture of how wealth is created and how it decays,” writes Gates. “At the core of his book is a simple equation: r > g, where r stands for the average rate of return on capital and g stands for the rate of growth of the economy. The idea is that when the returns on capital outpace the returns on labor, over time the wealth gap will widen between people who have a lot of capital and those who rely on their labor.”

For many people, that idea alone may present a rather foreign concept. The Economist does a good job of cleaning up the language a bit, translating Piketty’s idea as such:

Other things being equal, faster economic growth will diminish the importance of wealth in a society, whereas slower growth will increase it (and demographic change that slows global growth will make capital more dominant). But there are no natural forces pushing against the steady concentration of wealth. Only a burst of rapid growth (from technological progress or rising population) or government intervention can be counted on to keep economies from returning to the “patrimonial capitalism” that worried Karl Marx.

Now, by “patrimonial capitalism,” they mean how wealth was distributed prior to the first World War. Before that war broke out, inequality was at very high levels, with a handful of wealthy families owning more capital and wealth than most governments. 

Gates writes that while Piketty may be on to something, his hypothesis doesn’t necessarily take into account the different ways that wealth is used within the economy. Some rich people put their money to use by investing in their businesses through raises to their employees, while others donate large amounts to charity. Yet, others simply buy yachts and expensive toys. Gates argues that there is some social value being delivered in these circumstances (with the exception of the third), even though the main characters are still a part of the inequality problem.

He also says that Piketty doesn’t account for generational forces that may counteract vast transfers of wealth between family members, although that certainly still happens. “There are also forces that contribute to the decay of wealth, and capital doesn’t give enough weight to them,” Gates says.

So, what’s Gates’ idea to deal with increasing inequality? Put a tax on consumption, rather than capital.

“Piketty’s favorite solution is a progressive annual tax on capital, rather than income,” Gates says. “Rather than move to a progressive tax on capital, as Piketty would like, I think we’d be best off with a progressive tax on consumption.”

What does that mean, and why would it be a better approach to addressing the issue?

“Think about the three wealthy people I described earlier: One investing in companies, one in philanthropy, and one in a lavish lifestyle. There’s nothing wrong with the last guy, but I think he should pay more taxes than the others,” Gates says. “As Piketty pointed out when we spoke, it’s hard to measure consumption (for example, should political donations count?). But then, almost every tax system — including a wealth tax — has similar challenges.”

Basically, by taxing the things we consume, rather than our labor or money itself, Gates feels that we would be better suited at solving the inequality problem. But he doesn’t stop there, saying that he would also support the implementation or enlarging of the estate tax, which would take a percentage of an individual’s estate upon death. He also advocates for more philanthropy, which Piketty doesn’t address.

With those things in mind, does Gates’ approach hold any water?

Setting the philanthropic and estate tax parts of his argument aside, there is some definite upside to switching our taxation approach to consumption. Right away, many people will say that taxing consumption can be regressive, but it doesn’t necessarily have to be with proper progressive tax scheduling. There are also a few different ways it could be implemented, as a report from the Kansas City branch of the Federal Reserve points out. Those options include a national retail sales tax, a value-added tax, or a simple flat tax. Of course, these changes would have consequences, but in the end, the Fed comes to the conclusion that the change would likely address inequality in the way policymakers would have hoped.

“With respect to economic efficiency, most research suggests switching to a consumption tax could raise the capital stock and real output per person over the long run,” the report says.

By also causing a higher savings rate in the long-term, capital stock and long-term income should increase as well. The system could work without much investment on the administrative side as well, by simply tracking the savings and spending of taxpayers, rather than their income. In fact, there are a multitude of ways to make this system work, but there are also a multitude of issues to work out, such as how to tax investments, etc.

In the end, Gates is onto something with his consumption taxation idea. Is it perfect, or is it the magic bullet to help solve inequality? Not at all, but it is another strategy to combat an issue that is largely being ignored by most policymakers. It’s important to remember, however, that the current system obviously has plenty of downfalls as well.

Will we see a state or two try to experiment with a radical new tax policy, or will Gates’ suggestions continue to live on in debates on Internet message boards and in economic theory? It would be great to see someone give it a shot, because sooner or later we’re going to be throwing the entire playbook at the inequality problem if we can’t find a solution.

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