How the Rich Spend Their Money

I’ve cleared up one concern I’ve had about Warren Buffets call to tax millionaires!

Most of us think that the current recession is largely due to a lack of private spending in our economy. So, what would a millionaires’ income tax do? Would it help or would it set us back?

Ed Hammond, in his Perspective column in the House & Home section of the Financial Times (October 8/9, 2011) wrote a piece called “Measuring the pay gap in square feet.”

European’s proposed taxes on millionaires’ homes

In Europe right now there are proposals to tax the houses of millionaires. So, Mr. Hammond, a property expert, took a look at how much money rich people spend on their houses. In particular, he wondered if rich people spend the same proportion of their income on housing as the rest of us do.

In other words, he asks “what are bosses buying compared to their workers”.

Hammond found that if the rich were to spend the same on housing as others do, their houses should be 145 times better than those of non-millionaires. What would such a house look like? Well if it were 145 times bigger or better furnished, it would be hard to know. Such properties are not widely available in urban or suburban areas of England, (or I suspect, here!)

Taxing millionaires on their personal expenditures

The implication of this is that if we were to tax every homeowner for owning a home, a millionaire would still pay proportionally less, quite a bit less, in proportion to the income they earn than any of the rest of us. This, to me, raises a sticky issue with regard to determining tax “fairness.”

There seems to be an idea that if we charge people the same or similar proportion of income earned, that would be fair. Flat and proportional taxation alike do not take into account the needs of the poorest in society. Many of those who pay no tax do so because they barely have enough or don’t have enough to even support themselves let alone pay taxes. An extra $50 of tax means far more to a family which grosses $5,000 a year than $5,000 does to a family which grosses $500,000 a year.

A study by the non-partisan Congressional Budget Office found that “The after-tax income of the wealthiest 1 per cent of US households increased by 275 per cent over the past three decades, much faster than the average growth of 62 per cent for all Americans…For the poorest 20  per cent [of Americans] growth was 18 percent. Source: “US wealth gap widens further” Financial Times, October 26, 2011 p. 2

And here’s the interesting thing Hammond found out about how much wealthy people spend on residential property compared with others. It isn’t that much more! Hammond found that the rich live differently in scale depending on where they are located. Analysts at a company named Savills figured out that Britain’s wealthy executives do not live in 145 times bigger square footage than workers do – it is closer to four times as much space. In Shanghai bosses only have twice as much space (i.e., 3,000 sq feet) as their workers. In Sydney, Australia, bosses get 10,000 sq feet, eight times as much as workers.

In other words, housing, the biggest expenditure for most other people, doesn’t seem to be what rich people in other countries spend proportionately more money on. What happens here in North America and South America? I don’t know. It would be interesting if some enterprising property company would investigate that.

Still, it doesn’t seem like a tax on houses or personal income of millionaires and billionaires is such an outrageous idea as some like to claim. That’s because the tax is hardly likely to cost the rich very much relative to what they make. In fact, such a millionaires surtax is already collected by at least seven states. In New York State a surcharge on those with incomes over $200,000 is about to expire, and even some Republicans think it should be kept. New York state has taken in $13.8 billion dollars from this tax over the past three years. (“State’s budget dilemma as surcharges on wealthy expire” Financial TImes 10/18/11 p.6)

Millionaires do contribute to growth of an economy via their higher personal spending than others, and that’s good for employment rates. Most of us have no quarrel with such spending. If some people get four houses to live in, we don’t care as long as we get one to live in.

But managing to own even one house is the key problem for a millions of Americans right now!

Given that most millionaires seem to be spending only 2 to 8 times as much as the rest of us in proportion to earning 145% more than us, it looks doubtful that a small tax surcharge on the wealthy would cause the rich to alter their personal expenditures or move to another state or country that lacks such a tax. On the other hand, a tax on the personal consumption of the rich wouldn’t raise as much tax revenue as taxing all the rest of us at the same rate would. We outnumber the rich, and they spend proportionately less on personal consumption than we do.

So, I think we can stop wondering if imposing a proposed surtax on personal income of the rich at a 5.6% rate would harm the economy by making them spend less. But even though the US would benefit from a millionaire tax, we do still need to be concerned about how to create enough growth to reduce our nation’s deficit when so many people have so little disposable income to spend.

Taxing property assets held by the rich

One other thing Hammond finds is that tons of property is being bought by the wealthy as a way to safely park their cash. With financial assets at so much risk right now, real property, like commodities such as gold, seems somehow “even more real” than investments made in stocks and bonds.

But there is a problem with this. In urban and suburban areas, the rich are pricing the middle class out of the housing market. Even renters are having difficulty, as homeowners, forced out of their foreclosed property, try to find rental housing. This struggle has implications for middle class, working class, and poor people, local tax revenues, commuter expenses, air pollution, and a sense of community in cities. And it has implications for companies in these areas looking to hire employees who can afford to live there.

Tax reformers clearly need to look at the taxes paid by the rich on investment in residential homes and commercial residential property like apartment buildings as compared to taxes paid by the wealthy on investments in other types of financial assets they own or control. This is where the wealthy can be taxed “fairly”as far as the rest of us are concerned, and in a way that encourages real growth in the economy.

Flat taxes on income and spending

The earth is not flat, and neither is our economy. Flat taxes may seem “fair” to those with limited imaginations and a lack of patience to uncover and/or explain real answers, but flat taxes aren’t a solution to social problems. One way or another, a flat tax will not have an equal impact on everyone. Before taxes can be reformed, we need to come to agreement on where we want to wind up at.

Rather than begin with simplistic solutions to tax law, and vague notions of “fairness,” we need to look at the social problems we are trying to fix with tax laws. And then make meaningful changes.