A wealth tax is what it sounds like: a tax imposed not on income, but on wealth. The standard economic definition of wealth includes both nonfinancial assets like real estate and financial assets like stocks and bonds. Thus, a wealth tax doesn\’t care if the value of someone\’s wealth went up or down in the last year/ It is not a tax on the transfer of wealth to others, like an inheritance tax or a gift tax. It is just imposed on the amount of wealth.
In the US, property taxes are a cousin of a part of a broader wealth tax, in the sense that they are imposed annually on the value of a property, whether the value rises or falls. But they are not at true wealth tax in the sense that they don\’t differentiate between someone who own their home debt-free–and thus all the value of the home is wealth–and someone who is still paying off the mortgage, where only the equity you have in your home is wealth. The inheritance tax is also a form of a wealth tax.
Back in 1990, 12 high-income countries had wealth taxes. By 2017, that had dropped to four: France, Norway, Spain, and Switzerland (In 2018, France changed its wealth tax so that it applied only to real estate, not to financial assets.) The OECD describes the reasons why other countries have been dropping wealth taxes, along with providing a balanced pro-and-con of the arguments over wealth taxes, in its report The Role and Design of Net Wealth Taxes in the OECD (April 2018).
For the OECD, the bottom line is that it is reasonable for policy-makers to be concerned about the rising inequality of wealth and large concentrations of wealth But it also points out that if a country has reasonable methods of taxing capital gains, inheritances, intergenerational gifts, and property, a combination of these approaches are typically preferable to a wealth tax. The report notes: \”Overall … from both an efficiency and an equity perspective, there are limited arguments for having a net wealth tax on top of well-designed capital income taxes –including taxes on capital gains – and inheritance taxes, but that there are arguments for having a net wealth tax as an (imperfect) substitute for these taxes.\”
Here, I want to use the OECD report to dig a little deeper into what wealth taxes mean, and some of the practical problems they present.
The most prominent proposals for a US wealth tax would apply only to those with extreme wealth, like those with more than $50 million in wealth. However, European countries typically imposed wealth taxes at much lower levels of wealth. Here\’s a table showing how much wealth is exempt from the wealth tax in European countries. Clearly, most countries with such taxes were applying them to wealth well below $50 million.
It\’s interesting, then, that in these European countries the wealth tax generally accounted for only a small amount of government revenue. The OECD writes: \”In 2016, tax revenues from individual net wealth taxes ranged from 0.2% of GDP in Spain to 1.0% of GDP in Switzerland. As a share of total tax revenues, they ranged from 0.5% in France to 3.7% in Switzerland … Switzerland has always stood out as an exception, with tax revenues from individual net wealth taxes which have been consistently higher than in other countries …\” However, Switzerland apparently has no property tax, and instead uses the wealth tax as a substitute.
The fact that wealth taxes collect relative little is part of the reason that a number of countries decided that they weren\’t worth the bother. In addition, it suggests that a US wealth tax which doesn\’t kick in until $50 million in wealth or more will not raise meaningfully large amounts of revenue.
Why do wealth taxes imposed on what seem to be quite low levels of wealth collect so little revenue in various European countries, especially during the last few decades when high-wealth individuals as a group have done pretty well? The answer seems to be that when countries impose a wealth tax, they often typically create a lot of exemptions for certain kind of wealth that aren\’t covered by the tax. Each of these exemptions has a reasonable-sounding basis. But every exception also creates a potential loophole.
Countries also often exempt the value of a business in which you are actively working, which of course means a potentially voluminous set of rules for what \”actually working\” means. As the OECD notes: \”For the business asset exemption to apply, rules typically require that real economic activities are being performed (possibly excluding activities such as the management of movable or fixed assets, e.g. Spain), that the taxpayer performs a managing role, that income derived from the activity is the main source of the taxpayer’s revenue and/or that the taxpayer owns a minimum percentage of shares in the company (e.g. 25% in France and Sweden; 5% in Spain).\”
Another common exemption is that wealth tax is usually not applied to the value of pensions and retirement savings. One can sympathize with this, but also recognize that it leads to potential issues. As the OECD notes: \”Pension assets typically get full relief under net wealth taxes. … However, this creates inequities between different taxpayers, raises fairness concerns, and creates tax planning opportunities. …. \”
What other incentives does a wealth tax create? Here are some examples that often are not included int he discussion:
1) While we often think of a wealth tax as being applied to those who have already \”made it\” and accumulated a fortune, it\’s worth remembering that when a small- or medium-sized business is trying to get established, or going through hard times, it may lead to a situation where the overall value of the asset is substantial, but profits may be near-zero or even negative for a time. But at least in theory, a wealth tax would still be owed. As the OECD report notes:
\”Under a net wealth tax, however, if income is zero or negative, the tax liability will still be positive if the capital value of the assets remains positive. In practice, new entrepreneurs which tend to generate low, or even negative, profits in their first few years of operation would still face a wealth tax liability. Thus, a heavy net wealth tax which is unlinked to income might discourage entrepreneurship relative to an income tax with (perfect) loss offset.\”
2) A wealth tax will tend to encourage borrowing. Total wealth is equal to the value of assets minus the value of debts. Thus, one way to avoid a wealth tax is to borrow a lot of money, in ways that may or may not be socially beneficial. The OECD writes: \”[D]ebt deductibility provides incentives to borrow and can encourage tax avoidance. If the wealth tax base is narrow, taxpayers will have an incentive to avoid the tax by borrowing and investing in exempt assets or – if debt is only deductible when incurred to acquire taxable assets – taxpayers will have an incentive to invest part of their savings in tax-exempt assets and finance their savings in taxable assets through debt.\”
\”Ceiling provisions or tax caps are common features of net wealth taxes. These often consist in setting a limit to the combined total of net wealth tax and personal income tax liability as a maximum share of income. They are used to prevent unreasonably high tax burdens and liquidity constraints requiring assets to be sold to pay the net wealth tax. In France, the wealth tax ceiling (often referred to as the “bouclier fiscal”) limits total French and foreign taxes to 75% of taxpayers’ total income. If the percentage is exceeded, the surplus is deducted from the wealth tax. In Spain, the aggregate burden of income tax and net wealth tax due by a resident taxpayer may not exceed 60% of their total taxable income.\”
\”[A] tax on the stock of wealth is equivalent to taxing a presumptive return but exempting returns above that presumptive return. Where the presumptive return is set at the level of or at a level close to the normal – or risk-free – return to savings, a wealth tax is economically equivalent to a tax on the normal return to savings, which is considered to be inefficient. Indeed, the taxation of normal returns is likely to distort the timing of consumption and ultimately the decision to save, as the normal return is what compensates for delays in consumption. As discussed below, it is also unfair that the wealth tax liability does not vary with returns, which implies that the effective wealth tax burden decreases when returns increase.\”
On the other side, it is sometimes argued that a wealth tax will encourage the wealthy to make more productive use of their wealth:
\”For instance, if a household owns land which is not being used and therefore does not generate income, no income tax will be payable on it. However, if a wealth tax is levied, the household will have an incentive to make a more productive use of their land or to sell it to someone who will … The argument here is that wealth taxes do not discourage investment per se but discourage investments in low-yielding assets and reinforce the incentives to invest in higher-yielding assets because there is an additional cost to holding assets, which is not linked to the return they generate.\”
directly transferrable or convertible into cash, and that there is uncertainty about the
durability of its value. Therefore, a wealth tax lowers the net return on real and financial assets relative to the returns on investments in human capital. Thus, wealth taxes encourage investment in human capital, which may in turn have positive effects on growth. Human capital is a critical driver of long-run economic growth. This implies that a wealth tax may be less harmful to economic growth than commonly believed as it can encourage a substitution from physical to human capital formation … \”
To me, many of the endorsements of a wealth tax feels more like expressions of righteous exasperation than like serious and considered policy proposals. Many of those who favor a wealth tax tend to favor a more European-style capitalism (and no, I don\’t think of any country in western Europe as \”socialist\”) that places a higher value on economic equality. But when those who favor your goal of greater economic equality have been steadily deciding that the wealth tax isn\’t worth the trouble, and that other policy tools are more effective in reaching the goal, it\’s probably useful to pay attention.
