Rising income inequality is a growing issue today. The widening gap between those at the top and those at the bottom has disastrous effects on society: increased crime, lower access to healthcare, and on a macroeconomic level, can reduce growth and stability.
Despite this, little is mentioned of a more intrusive problem: wealth inequality. Research shows that wealth inequality is even more pronounced than income inequality. It is predicted that the world’s richest one per cent own forty-four per cent of the world’s wealth. This has provoked campaigns for wealth taxes from political parties and institutions from across the globe. Joe Biden has recently suggested increasing taxes on the wealthiest individuals. Angela Merkel’s Green Party has proposed a one per cent tax on wealth above two million euros. Furthermore, wealth taxes can help to repay the fiscal deficits caused by the pandemic through the revenues they create. However, there is very little empirical evidence that a wealth tax works.
For a wealth tax
The basic principles behind a wealth tax are simple: a tax on the wealth (assets minus liabilities) of individuals or firms will make it harder to maintain and accumulate wealth. This will enable those at the bottom to catch up with those at the top, creating a more balanced society with endless benefits for everyone.
Furthermore, a wealth tax is thought to boost productivity and reward entrepreneurial activity at the top of society. Consider two affluent individuals with the same amount of wealth but with no income. Earning minimal interest through government bonds, for example, may lead to a net loss after a wealth tax. Therefore, taxing their fortunes will incentivise them to maximise their productivity and returns on capital, encouraging risk-taking and entrepreneurial investments. This increase in economic activity can help drive growth in the economy while supporting jobs and businesses too. As a result, the wealth tax will raise revenue, increase economic activity, and reduce inequalities in society. Contrarily, an income tax would penalise productivity resulting in an inactive economic environment.
Additionally, they can be an effective tool in raising large sums of money in a relatively short time frame. One-off taxes can be deployed during the time of economic hardship to repay fiscal deficits. A flat rate of five per cent on all assets over £500,000 could raise an estimated £260bn in the UK if a wealth tax was introduced. This revenue could finance the massive debt that the country now faces following a period of unprecedented government intervention and spending in the markets during the year 2020. Annual wealth taxes also provide a supplementary income source for the government each year; however, this implementation method is less spontaneous and more stubborn.
Against a wealth tax
On the other hand, real-world examples of wealth taxes show that they rarely work in practice. About a dozen OECD countries have tried a wealth tax. However, now only three still have them. From a purely financial perspective, they have been a failure, generating as little as 0.2 per cent of GDP per year in tax revenues. Switzerland’s wealth tax seems compelling, raising over one per cent of GDP per year. However, this is due to their high concentration of wealthy individuals: one in fourteen of the world’s billionaires live there. Moreover, their tax has very low exemption thresholds. The reasons so many countries have aborted the policy provides evidence that they do not work.
One of these reasons is due to the high administrative costs. Calculating an individual’s wealth is an intricate and lengthy process. Assets with low intrinsic worth, such as paintings and inherited items, are hard to judge. Meanwhile, private family businesses, where most rich individuals hold most of their wealth, are rarely valued. This results in high demand for administrative positions that can cost the government money and valuable resources, which arise associated opportunity costs. Thus, the tax revenues can often be offset by administrative expenses.
Additionally, many European countries have shied away from wealth taxes due to the ability of individuals and firms to avoid them. One method by which they do this is by taking on more debt, reducing their net worth since it is defined as assets minus liabilities. This means they pay tax on a lower figure. Additionally, a hefty tax can cause people to move their assets abroad to avoid paying. This resulted in the exodus of approximately 42,000 French millionaires to leave the country between 2000 and 2012. This reduces tax revenues collected by the French government while also dampening growth and reducing the economy’s competitiveness. Finally, a wealth tax levied at one per cent is argued to reduce the tax base by up to seventeen per cent. Again, less tax is paid, which result in negligible revenues.
Another worry surrounding a wealth tax is the effects that it may have on distorting various markets for different goods. Individuals with low incomes but with high levels of wealth, particularly in illiquid assets, will struggle to find the cash to pay their fair share. This results in the forced liquidation of these assets, which in turn can affect their respective markets. A one-off wealth tax may trigger a sell-off in the real estate market as individuals raise cash to pay their fair shares and drive house prices lower. Conversely, some countries exempted artwork and antiques from the wealth tax, which created loopholes that consequently propelled the demand for these goods from wealthy individuals, leading to inflated prices.
Overall, in principle, wealth taxes provide a solid solution to the spiralling issue of wealth inequality. They also serve as an effective way for the government to raise tax revenues to fund their extravagant spending policies of late. However, in practice, they fail to work due to the costs associated with their implementation, which result in dwindling revenues. It can therefore be concluded that wealth taxes do not work yet. Designing a policy that seals all loopholes and involves an efficient administrative process will allow them to be an effective tool in battling inequality and raising funds simultaneously. Perhaps they can replace the income tax and be used as the core tax base across countries globally.
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