Taxing Capital to Pay for Health Care Consumption

This is not just a bad idea. It is a very, very, very bad idea.

Yet the primary way Barack Obama, Hillary Clinton and many other politicians have proposed to pay for health reform is by rescinding the Bush “tax cuts for the rich.” (Read: higher tax rates on dividends and capital gains.) No matter who wins the presidential election, this bad idea is not going to go away — even though (as previously reported here) Obama has backed away from it considerably. Here’s why: 99.9% of all the people who specialize in health policy know absolutely nothing about capital theory. They think that reversing the Bush tax cuts on dividends and capital gains for high-income taxpayers is the closest thing on God’s green earth to a free lunch.

They are, of course, quite wrong.

Let’s take Warren Buffett, who by his own admission has more money than he will ever need. Suppose we consider confiscating all his capital income and spending it, say, on any good cause you can think of. Is this a good idea? Put aside concerns about ethics, fairness, individual rights, justice, etc. Is it in our narrowly defined self-interest or the self-interest of others? The answer, surprisingly, is: no.

There are basically two things Buffett can do with his wealth: he can consume it or invest it. When he consumes, he is using up resources that are then not available to anyone else. By contrast, when he forgoes consumption and invests, he makes it possible for everyone else to consume more. Buffett’s investment adds to the nation’s capital stock. This means higher wages and more output. There will be more goods and services to be consumed and the average worker will have more income to devote to such consumption.

If you think of consumption as the end goal of economic activity, when Buffett consumes he is benefitting Buffett. When he saves and invests, he is benefitting everybody else. That’s why economists on the left and the right (at least those who think about these things) prefer to tax consumption. The flat tax, the national sales tax, the value added tax are all designed to tax consumption rather than saving and investment. There are many ways to do this. Some approaches are more progressive than others. A sensible compromise is the “progressive flat tax” proposal I developed with Larry Kotlikoff. 

I know what you’re thinking. Even if taxing Buffett’s capital is not the best idea in the world, surely the rest of us can realize some net gain from doing so. In the short run, that may be true.  But in the long run it appears not to be true. The reason: The after-tax rate of return on capital tends to be set in international markets and it tends to be independent of U.S. tax policy. That is, the long run return to capital is unaffected by how much we tax it. This implies that taxes on capital are ultimately paid by labor. In taxing capital we end up harming the very people we are trying to help.

Comments (11)

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  1. Greg says:


    You are absolutely right about health policy folks knowing nothing about capital theory. This proposal has been repeated again and again — especially by Democratic candidates — and I do not recall a single instance in the health policy literature where anyone even questioned the wisdom of it.

    To my knowledge, you are the first health policy economist to point out that a tax on capital is really a tax on labor.

  2. Ken says:

    I agree with Greg. Obama keeps talking about all the benefits he is going to provide by taxing the rich. Yet when we look more closely at these proposals we find that he really intends to “tax” the very people he claims to want to help,

  3. Joe S. says:

    Even though Barack’s ecocnomic advisors said in the Wall Street Journal that Obama would raise the tax rate on dividends and capital gains to no more than 20%, Obama’s surrogates continue to say on TV and radio and in print that Obama will pay for health care reform by “repealing the Bush tax cuts for the rich.”

  4. Nancy says:


    Obama’s Web site still says he is going to fund health refom by repealing the Bush tax cuts for the rich. The figure they give ($60 to $65 billion a year) is the same one they have been using all along. The cite is here:

    Maybe Obama never read the editorial in which his economic advisors promised everyone on Wall Street a different deal.

  5. Uwe Reinhardt says:

    You are sooo right, John.

    Look at these slides. Look at how the Bush Jr. tax cuts shifted the fraction of GDP invested in business (non-residential investment) upwards, at the expense of real estate investment. And look also how that fraction rose in response to the Reagan tax cuts. And look how, by contrast, the fraction of GDP devoted to non-residential investment fell after Clinton raised taxes.

    It is too bad that more health policy people don't understand this.

  6. John Goodman says:


    How could I have missed the obvious. And Becker and Mundell missed it too. Higher taxes on capital results in more capital! Who could doubt it?

    I know you are too young to remember these things, but the 1986 tax reform (under Reagan) raised the capital gains tax rate, raised the tax rate on capital overall, and was especially bad for real estate. By contrast, Clinton signed a very major capital gains tax cut along with other changes that were very helpful to real estate.

    It’s the taxes that count. Not the president.

  7. Uwe E. Reinhardt says:

    You should have been a priest, John. You’re such a believer.

    It would be one thing if we were talking about a capital gains tax cut for cap gains on business investments or even new stock or bond innvestments. But most of the cap gains tax benefit goes to investors in already outstanding issues.

    Besides, the Reagan cap gain tax increase came near the end of his term.

  8. Uwe E. Reinhardt says:

    By the way, John. You are telling me that Reaganomics was not supply-side economics while Clintonomics was. How delicious to associate that with your name.

  9. John Goodman says:


    If there were any legitimate economic argument for taxing capital gains, consistency would require allowing offsetting (unrestricted) deductions for capital losses. Yet, if the government did that it would never collect any net revenue from the tax.

    Clearly you have not read my debate with Michael Kinsley on capital gain taxes (which I would think should settle all these issues for time immemorial). The debate is attached.

    In the meantime, here is a question for you: How many times do you think the same income should be taxed? Three? Four? Twenty? How about taxing all income only once, at its source, when it is realized, at one low rate?

  10. Uwe Reinhardt says:

    Thanks. I shall do Talmudic studies on your exchange with Michael and will then get back to you.

    Are you learning, as you should, to say "President Obama" yet? For you its probably more difficult than pronouncing "Amadenijah".

    Old bumper sticker: "If you like the Post Office, you'll love National Health Insurance."

    My wife's idea for a new bumper sticker: "If you like the free market on Wall Street, you would just love it in health care." She'll send you one when she has got it printed–autographed, even. Best, Uwe

  11. Linda Gorman says:

    People too familiar with the financial system turmoil to make light of it on bumper stickers seem to be concluding that excessive government meddling in the free market has been a prime contributor to the severity of the market downturn. That meddling has gone on for decades with a goal of producing utopian policy outcomes without regard to their cost. What it really produced was wildly inflated asset values. We are now enduring the pain of trying to find out what those assets are really worth.

    Fannie Mae and Freddie Mac are prime examples of this. So is the mark-to-market requirement of Sarbanes-Oxley. And the huge liquidity increase pursued by the Greenspan Fed.

    The parallels with health care are quite strong–utopian thinking, thoughtless regulation, insensitivity to costs causing unintended consequences that more regulation is created to correct. Ultimately the whole system is stressed beyond the breaking point.

    To see how this operates in health care, look no farther than the National Health System in the UK. The oldest government run health system in existence, it is falling apart.