In my previous post on Landsburg's piece, some commenters were asking whether this is just an interesting intellectual puzzle, or something of practical importance. I think that there are some deep issues lurking in there, which are in fact important for current issues and policies, though maybe not exactly in the sense that Lansburg intended.
What we have concluded is the following. Suppose an individual - call her Melinda - is truly satiated, in the sense that she has sufficiently large wealth that she, her descendants, her descendants' descendants, etc., all can buy everything they could ever want, then Melinda cannot be taxed. Further, taxing Melinda can actually be irrelevant for the allocation of resources in the economy as a whole.
Why is this important? All of our competitive economic theory is based on non-satiation. Basic competitive analysis tells us that consumers substitute among goods and services at a point in time, and intertemporally as well. Change a relative price and they change their decisions. Increase or decrease their wealth and they change their decisions. Change a tax rate and they change their decisions. All of this analysis is based on binding budget constraints, due to non-satiation. We typically assume that consumers always prefer more to less. If Melinda's preferences satisfy non-satiation, then the usual analysis applies. If we increase her income tax rate, she will change her decisions, perhaps choosing to work less, perhaps choosing to work more (depending on the size of income and substitution effects), and she will be worse off. Depending on how markets work and on production decisions, by taxing Melinda more and taxing someone else less, or providing some government services, the government can make some other people better off.
But, if Melinda is satiated, all of those things go out the window. Melinda is satiated in everything, so now prices are irrelevant to her. She does not care if gasoline costs 50 cents per gallon or $50 per gallon. She does not care how capital gains are taxed. And Melinda has power. She has the freedom to ignore the government and sit on her wealth as, at the margin, taxation makes no difference to her, and it actually effectively makes no difference to society that the government can tax her.
Further, she has so much financial wealth that she could actually allocate this excess wealth in ways that matter for the allocation of resources in the economy as a whole. Indeed, if Melinda is wealthy enough, she could wield as much power as the city of Peoria, maybe the state of California, or maybe even the United States of America. In the US, we have some people who are very wealthy and use that wealth to affect economic outcomes. Bill Gates does it. The Koch brothers do it. Rupert Murdoch does it, though his case is quite different. Murdoch promotes a political view and makes a profit at the same time.
Now, there is a deep question here concerning how you deal with this level of wealth in a democracy. The government could pass laws to curtail the use of wealth that threatens the power of the state. One approach to that is campaign finance laws. But how does that square with the principles of democracy? It requires resources to effectively question the state, so restricting an individual's ability to allocate resources to politics could give the state too much power. However, we don't want an infinitely wealthy person determining how the government is to be run. That certainly is not democratic either. The Supreme Court recently came down on one side of this debate (though this is about corporations, not individuals), and not everyone agrees with it.
In other respects the government can promote or curtail the use of private financial wealth to allocate resources. The US tax code is certainly favorable to charitable giving. Certainly US institutions have benefited greatly from privately-accumulated wealth. Andrew Carnegie, for example, single-handedly changed forever US cultural and educational institutions, down to the level of local public libraries. But then there is Leona Helmsley, so that cuts both ways.