The effectiveness of the wealth tax on reducing inequality is determined by two aspects – the tax’s effectiveness in earning revenue and how the earning is distributed to increase the number of people holding the majority of wealth in a country. This essay will outline the different ways in which the effectiveness of a wealth tax in raising revenue can be limited and evaluate the practicality of the proposed solutions.
The case for using redistribution to fight inequality
In the UK, the Office for National Statistics found that in 2016 the richest 10% of households held 44% of national wealth while the poorest 50% held 9%.[1] While economic inequality is inevitable and even desirable in a capitalist society, there is a strong case for ensuring it is maintained at socially healthy level. Diminishing returns from wealth demonstrates the need for redistribution to tackle inequality. Extreme wealth inequality leads to a minority owning more money than they can spend, most of which would be invested in real estate and other non-productive assets while redistribution of this money would spur economic activity.
This suggests a strong case for taxing the wealthy to reduce economic inequality. We will now debate whether a wealth tax is the most effective way to do so.
Barriers of a wealth tax against effective revenue-raising
In 1990, twelve countries in Europe had a wealth tax. Today, there are only three: Norway, Spain, and Switzerland.
Capital flight
France’s solidarity tax on wealth, the ISF (impôt sur la fortune) was repealed in 2017. [11] One major, but predictable reason was the rampant capital flight from France. Pichet (2007, p. 21) states that from 1988 to 2007, the ISF caused capital flight equivalent of around €200 billion. Most expatriates were reported to move to destinations like Belgium which has no wealth tax and held 63,000 French tax refugees in 2005 and Switzerland with maximum rates varying from around 0.5% to 0.8%.
One solution would be to create an “exit tax” so expatriating wealth becomes the less profitable option. However, depending on the political nature of the country in question, the execution of an exit tax may prove difficult. Coming back to France’s case, in 2004, The European Court of Justice ruled that it prevented the freedom of establishment [4]. The consequential removal of the exit tax for moving capital to EU countries had a significant impact on GDP figures as Pichet estimates a reduction in GDP growth by 0.2% per annum. Other solutions for capital flight would be offering flexibility for illiquid sources of
wealth. This could see the form of payments in instalment and deferred payments for the ‘asset-rich-cash-poor’. Very low wealth tax rates like those in Switzerland can not only prevent capital flight, but even attract internationals seeking to expatriate. Wealth tax rates should also account for the pre-existing tax rates on capital income.
Depending on the nation, the political climate and public perception, one or more of these solutions could be implemented in order to tackle capital flight. Therefore, by carefully designing the taxes while accounting for political context, it should be a reasonable endeavour to try to minimise capital flight while maintaining desired revenue.
Administrative costs
India’s Wealth Tax Act 1957 was thoroughly amended over the decades to increase exemptions until it was finally abolished in 2015. For example, revisions made by The Finance Act 1992 limited the wealth tax on unproductive forms of wealth and items whose ownership should be discouraged in Social Interest. While these reforms were designed to reduce departmental costs, it tackled the wrong end of the tax base. “Unproductive assets” tended to be items of small bulk, no income yield and high value with market prices harder to evaluate like jewellery, art and luxury cars. The Irish wealth tax, which was abolished in 1979, faced administrative and compliance cost that is estimated to be 25% of the yield.[10] This was because of the low rate of tax and the method of administration. Interestingly, and in contrast to the Indian approach, the Irish exempted house contents in practice and was
still left with very high costs of operation.
While there are no obvious solutions, the OECD does recommends limiting tax exemptions and reliefs. [7] This solution appeared counterintuitive as in both India’s and Ireland’s cases there were uses of exemptions are reliefs to reduce costs of operation. The suggestion was to make the tax system more horizontally equitable, reduce distortions in investment as it favoured non-productive assets and create opportunities for tax avoidance. However, there are very real limitations to this proposal. It can be very difficult from a political standpoint to resist using exemptions and reliefs and international experiences show how interest group pressure can affect this.[10]
Both barriers are significant reasons for the repealing of wealth taxation in numerous countries. While lessons learnt have formed basis for recommendations to reduce the barriers to effective revenue-raising, their practical success remain questionable. Moreover, the conflicting nature of some of these solutions (reducing tax rates reduces capital flight but increases administrative costs for revenue collected) suggests that it may be unlikely to create a proposal that will be effective in raising enough revenue to fight inequality successfully.
The revenue-generating capability appears strong for a one-off wealth tax which would allow for higher tax rates without triggering large-scale capital flight. Ideally, this would also include proposals like deferral of payments for illiquid assets and a broad tax base. While such an endeavour can be useful to bridge the gap between those who thrived and suffered in recessions like that induced by the COVID-19 pandemic, this would only be a short-term approach to the systemic wealth inequality seen in most developing countries.
Alternatives such as the inheritance tax provides great prospects for tackling inequality from its core. Japan, with one of the lowest levels of economic inequality in the developed world, combines a high income-tax rate for the rich 45%, and the inheritance tax rate recently was raised to 55%. Although Japan’s tax policies would require serious modifications before it can be applied to any other nation, in terms of effectiveness of fighting inequality, an inheritance tax appears to be a more effective route than the wealth tax when fighting inequality in the long run.
Bibliography
[1] Ons.gov.uk. 2018. Wealth in Great Britain Wave 5: 2014 to 2016 - Office for National Statistics [Accessed 25 April 2021].
[2] Nettle, D., 2018. Hanging on to the edges.
[3] Pichet, Eric, The Economic Consequences of the French Wealth Tax (September 15, 2008). La Revue de Droit Fiscal, Vol. 14, p. 5, April 2007, Available at SSRN: https://ssrn.com/abstract=1268381
[4] See State Council decree dated 10 November 2004: “Lasteyrie du Saillant”.
[5] Eckert, J., Aebi, L. Wealth taxation in Switzerland. Wealth Tax Commission
[6] Adam, S., Miller, H. The economics of a wealth Tax. Wealth Tax Commission Evidence Paper 3
[7] OECD (2018), The Role and Design of Net Wealth Taxes in the OECD, OECD Tax Policy Studies, No. 26, OECD Publishing, Paris, https://doi.org/10.1787/9789264290303-en.
[8] Vanvari, G., TA, K. Wealth tax: India. Wealth Tax Commission International Background Paper.
[9] Advani, A., Chamberlain, E. Summers. A Wealth Tax for the UK, Wealth Tax Commission Final Report
[10] Sandford, C. and Morrissey, O., 2021. The Irish Wealth Tax: A Case Study in Economics and Politics. Dublin: ESRI, p.156.
[11] Suzuki, J., n.d. Estimating the Economic Impacts of Wealth Taxation in France. University of Berkely.