Why Harris and Starmer Are Coming for Your Investments

 

"Of course they're coming for your investments.

Higher taxes on capital are becoming a centerpiece of liberal politics on both sides of the Atlantic. While Democrats flirt with substantially higher taxes on capital gains (realized or unrealized), Britain's Labour Party contemplates steeper levies on capital gains and inheritances as Chancellor of the Exchequer Rachel Reeves prepares her first budget proposal for release next month.

The left's ideological suspicion of capital is only part of the story. The more important phenomenon is a profound change in the tax base in modern economies after 30 years of failed economic policies and hyperactive monetary easing.

Capital, rather than labor income, is where the money is now.

For at least 40 years, the value of American households' assets has increased faster than their incomes. Throughout much of the 1980s, household wealth hovered at or below 500% of disposable income [1], according to Federal Reserve data. If labor incomes and wealth had increased at the same rate, this ratio would have remained stable. Instead, U.S. household net wealth now stands at 785% of disposable income -- and that's off a peak of 836% in the first quarter of 2022.

This isn't a tale about real estate. Housing and other nonfinancial assets reached a recent peak at 39% of total household assets in 2006, roughly the same proportion as in the early 1980s, before retail stock ownership took off. Housing and other nonfinancial assets now account for 33% of total household assets.

This is a story instead of financial-asset ownership. The value of stocks held directly by households has grown to 163% of aggregate disposable income today from around 30% in the early 1980s. It's similar in Britain, where household wealth surged to around 700% of gross domestic product in 2019 from less than 400% of GDP at the end of the 1980s. There, too, housing is only part of the story.

What's fueling this wealth boom? Some of the drivers are big positives for the economy. In the U.S. and U.K., tax-law changes, the expansion of defined-contribution pension plans, and the rise of retail brokerages starting in the 1980s made financial-asset ownership more attainable for more households. American household net wealth stepped up toward the end of the Reagan era, to around 530% of disposable income, and financial assets as a share of household balance sheets drifted upward until the housing boom of the 2000s. This expanding pool of capital funds productive investments that produce both labor and capital incomes.

But a bigger cause of this asset explosion is policy error. The boom has occurred alongside a downward drift in Americans' personal savings rate -- to between 5% and 6% on the eve of the pandemic from above 10% in the early 1980s. Household net wealth is also growing much faster than GDP. These factors suggest that new savings and investment (including by baby boomers during their peak earning years) can't account for all of the increase of wealth, and neither can underlying GDP growth.

That leaves another probable cause: asset-price inflation, courtesy of the Federal Reserve and Bank of England. Sure enough, setting aside the tax and pension reforms of the 1980s, the biggest upward step changes in wealth track what are now recognized as significant monetary-policy errors.

In the U.S. those include the dot-com froth of the late 1990s, the too-low-for-too-long housing mania of the 2000s, and now the inflationary ultralow interest rates and quantitative easing of the pandemic era, all of which precipitated booms in net wealth relative to disposable income. In the U.K. it was the Bank of England's long periods of suppressing rates while "looking through" inflation in the 2010s and again in recent years.

Meanwhile onerous tax and regulatory policies on the Main Street economy undercut labor-income growth. Hence wages and salaries as a proportion of taxable income on individual tax returns in the U.S. have fallen to around 60% from well above 70% throughout the 1980s and '90s, according to Internal Revenue Service data analyzed for me by economists at the Tax Foundation.

No wonder cash-strapped politicians are eyeing capital taxation. Except that although this vast pool of household wealth looks like a revenue freebie, it isn't. For starters, there's no way to distinguish between the portion of wealth accumulation attributable to inflationary errors and the portion arising from productive investment. Mop up the latter while trying to absorb the former and you'll end up with no wage growth -- and no economic growth.

There's a subtler problem. While rapidly rising household wealth is a consequence of policy mistakes, it's also the only insurance households have against those mistakes. Expanding asset ownership over the past 40 years at least means that more households now own assets that are increasing in value even when their labor income isn't.

Politicians pitching "taxing the rich" should assume the middle class eventually will figure this out. Beware once those voters do." [2]

1.   "Disposable income is the total amount of money you have to work with for the month."  
  

2.  Political Economics: Why Harris and Starmer Are Coming for Your Investments. Sternberg, Joseph C.  Wall Street Journal, Eastern edition; New York, N.Y.. 27 Sep 2024: A.17.