Paul L. Caron

Wednesday, July 6, 2005

Taxing Endowment

Larry Zelenak

There's been a recent flurry of academic interest in the idea of endowment taxation--taxing people on what they could earn, rather than on the (frequently lesser) amounts they actually earn.  Although the concept has been around for at least a century, much of the recent interest dates from a very thoughtful article by Dan Shaviro in Tax Law Review (53 Tax L. Rev. 397).  Kirk Stark has made an important recent contribution (18 Can. J. of Law and Juris. 47 (2005)), and David Hasen has an interesting paper in draft.  I've been trying to pull together my own thoughts on the subject, and I've come to dread having to answer the question of what I'm working on, because everyone I've described the concept to has had the same reaction (regardless of location on the political spectrum)--that that's the craziest thing they've ever heard.  So let my try to suggest why the idea is worth thinking about, even though I'm not ready to lobby for enactment of an endowment tax.

Liberal egalitarians generally believe that redistribution on the basis of differences in "brute luck" is appropriate, but that redistribution on the basis of differences in individuals' choices is not.  If innate differences in earnings capacity are a matter of brute luck (faring well or poorly in the "natural lottery"), but differences in how fully people exploit their earnings capacities are a matter of choices, taxation and redistribution on the basis of earnings capacity--i.e., endowment taxation--would seem to follow.  Most liberal egalitarians are unwilling to accept that conclusion, however, primarily because of the specter of "talent slavery" under an endowment tax.  A hypothetical tax professor can illustrate the concern.  If he could earn $1,000,000 as a tax attorney but he would hate the work, and he in fact earns only $100,000 as a tax prof, then taxing him on $1,000,000 of potential earnings (at the rate of, say, 20%) might force him to work as a tax attorney to pay his tax bill--and that's talent slavery.  Kirk Stark argues, however, that the concern about talent slavery is misguided.  According to Stark, our hypothetical tax guy could spend 20% of his time working as a tax attorney, earning the $200,000 needed to pay his tax bill, and spend the other 80% of his time as a tax prof.  He claims that does not amount to talent slavery, and I agree.  The problem, though, is his assumption that the labor market for tax attorneys is perfectly non-lumpy, so that our guy can earn $200,000 with 20% of his working hours.  On the opposite lumpiness assumption--that one must work full-time as a tax attorney or not at all--we are right back in the talent slavery quagmire.  My sense is that although Tom Cruise might be able to spend two months a year making one movie in order to pay his endowment tax bill (and spend the other ten months on talk shows condemning psychiatry), for most people Stark's non-lumpiness assumption is pretty unrealistic.

It might still be possible, however, to come up with a modified version of an endowment tax, designed to approach the endowment tax ideal as nearly as possible without giving rise to talent slavery. For example, Louis Kaplow has suggested an endowment tax with one's tax liability capped at 90% of actual earnings.  It seems that something along these lines might be attractive to many liberal egalitarians, although they certainly haven't been clamoring for it.  Even with the talent slavery problem avoided, there is still a concern that earnings potential is too narrow a measure of endowment.  For example, if two people could both earn $1,000,000 as a tax attorney, but one would hate it and one would love it, there is certainly a plausible argument that they have not had the same luck in the natural lottery and that they should not be taxed the same. 

In the end, I remain attracted by the idea of taxing and redistributing on the basis of differences in brute luck, and think that policymakers should be on the lookout for opportunities to do so in ways that don't implicate the major problems associated with classic endowment taxation--a sort of slouching towards taxing endowment.  To borrow an example from Kyle Logue and Ronen Avraham (56 Tax L. Rev. 157 (2003)), suppose we had national health insurance which covered (among other things) genetically-caused diseases and which was financed by a tax which was imposed without regard to whether one had or did not have disease-related genes.  The result would be a limited sort of taxation and redistribution on the basis of differences in endowment--from those with a particular sort of genetic good luck to those with corresponding genetic bad luck.  Another interesting example of slouching towards endowment taxation is the proposal of Bruce Ackerman and Anne Alstott (in The Stakeholder Society (1999)) for a tax on economic privilege--as measured by one's parents' income during one's childhood--as a replacement for the Social Security payroll tax.

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