Weighing Up a Wealth Tax

Wealth taxes can boost investment and productivity, though the administrative challenges cannot be ignored

Introduction

Elizabeth Warren and Bernie Sanders are two advocates of a wealth tax. Thomas Piketty, a French economist, has also laid out a blueprint for the implementation of a fair and progressive global wealth tax. Some argue it can drive technological progress, others argue it will weaken it. Broader arguments surrounding a wealth tax state its ability to improve social mobility and redistribute political power that undermines democracy. On the other hand, people argue that the administrative issues and tax evasion incentives that it brings along with it make the tax redundant.

Effects on investment and technological innovation

One reason why a wealth tax might discourage investment is because today’s wealth is yesterday’s income. Hence, levying high tax rates on wealth will act similarly to an income tax, diminishing profit margins on investments and leading to lower levels of spending in the economy. Firms may cut back on R&D projects or infrastructure investment due to lower profit opportunities. Consequently, technological innovation will fall due to lower spending.

One reason why a wealth tax might encourage investment is due to the use-it-or-lose-it approach. In practice, each investment is different to the previous one, and therefore discrepancies arise in their outcomes. Inefficient or unproductive investments will be punished since the wealth tax erodes the individual’s or firm’s wealth. On the other hand, innovating and profitable investments will reward investors since they will see a net rise in their net wealth following the tax, assuming their returns are higher than the tax rate. It will promote efficiency and productivity in the economy, which results in technological innovations.

Broader effects

A broader disadvantage of introducing a wealth tax is that wealth itself is extremely hard to measure. Assets such as houses or equities may have a clear face value, but abstract art or old jewellery can often be tricky to value. Hence, the process of deriving an individual’s wealth is complex, time-consuming, and expensive. Complexity will lead to miscalculations of total wealth which will result in unfair tax receipts across society. The time it takes to calculate the assets will allow movements in the market to distort the actual figure. Finally, it is an expensive process that leads to a net loss in revenue when the administration process costs more than the tax revenue. In this case, a wealth tax violates one of the four canons of taxation, economy.

A broader advantage of introducing a wealth tax is that it improves social mobility by rewarding individuals who earn higher incomes. The current income tax system punishes high earners, regardless of their level of wealth. Someone with few assets but high income will be penalised, and the accumulation of assets is thus harder to achieve. A wealth tax allows individuals of any net worth to earn as much as they can, meaning they can climb the social ladder with more ease. Contrarily, those who are economically inactive but have huge fortunes are hit hard and forced to increase their earnings. Else, they risk eroding their wealth. A consequence of this would be higher productivity amongst the workforce which can lead to innovation. Hence, wealth taxes reduce inequality and increase social mobility, but they can also drive innovation and productivity, further benefiting the economy.

Another broader disadvantage of introducing a wealth tax is the tendency for individuals or firms to move abroad to avoid the tax. A race to the bottom scenario presents itself where agents search for minimum tax rates so they can enjoy their fruits of labour to the maximum. It has led to the formation of tax havens such as the Cayman Islands and the Bahamas. The emigration of businesses will result in lower tax revenues but also less investment spending and economic activity. Thus, the economy may slow down, and the result of a wealth tax would weaken the economic environment.

Another broad advantage of introducing a wealth tax is that it can help disperse political power and liberate democracy. High net worth individuals and firms greatly influence political parties and are willing to fund their campaigns out of their profits. It is an outright violation of democracy itself. Hence, reducing the financial capability of individuals will reduce their ability to disrupt politics. Consequently, society becomes fairer, and corruption is evaded.

Conclusion

To conclude, the main hindering factor is the costs and complexity of administration. With the rapid development of fintech, monitoring individuals’ transactions and asset purchases are becoming ever more accessible. Fintech will give governments more significant insights into individuals’ wealth and make a wealth tax cheaper, quicker, and more accurate to impose. Tax evasion, too, is an issue. While Elizabeth Warren’s proposal of an ‘exit tax’ is feasible, it will impede those who were looking to move their assets abroad regardless. Instead, global cooperation is required to set a minimum level of wealth taxation to ensure that tax havens do not inflict the introduction of the new tax.

The theory behind a wealth tax is compelling; what stands in the way is the logistical challenges. Though, as proposed, these can feasibly be overcome. All that is required is global cooperation and rapid adoption of new technology.

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A student passionate about economics and how the world works. New blog post every Monday.

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Ted Jeffery

Ted Jeffery

A student passionate about economics and how the world works. New blog post every Monday.

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