The growing threat of wealth taxation

At the September 2014 convention of American labor unions, Senator Bernie Sanders of Vermont specifically urged taxation of wealth, asserting that, “We need a tax system which asks the billionaire class to pay its fair share of taxes and which reduces the obscene degree of wealth inequality in America.”

The self-described socialist lawmaker isn’t motivated solely by envy. He also views wealth taxation as a means of financing bigger government. As reported by the Washington Times, Sanders said that such a levy would “pay for investments in infrastructure, education, and other neglected national priorities.”

The fulminations of an obscure senator may not seem important, but the possibility of wealth taxation is very real. The idea has attracted considerable support from leftists, particularly since the publication of Thomas Piketty’s Capital in the Twenty-First Century, which specifically calls for a global wealth tax.

While it seems like the obstacles to wealth taxation would be significant, there are three reasons why such an initiative is a genuine possibility.

  1. Politicians want more money.
    The fact that the political class wants more money isn’t a terribly new or insightful revelation, but what makes the current fiscal environment different is that the combination of aging populations and poorly designed entitlement programs means that the burden of government spending soon will climb much higher in almost all developed nations. That will trigger a search for additional tax revenue. But since many nations already have pushed income tax rates close to – or even beyond – revenue-maximizing levels, they won’t be able to generate much money by making income taxes more onerous. Value-added taxes are an option for some nations, but not in Europe since most countries are at, or approaching, the 25-percent-maximum rate for EU members. Wealth taxes will be perceived as an option
     
  2. Inequality is a driving passion on the left.Wealth taxes are particularly attractive for those who are ideologically fixated on income inequality. And since these people also tend to view the economy in static terms, they reflexively think that wealth for one person must be accompanied by impoverishment for another person. This “fixed pie” mentality is demonstrably false, but facts oftentimes don’t matter in policy debates. What does matter is that income and wealth inequality are perceived on the left as societal problems that require societal responses. Wealth taxation is an obvious choice, particularly since upper-income taxpayers have considerable ability to avoid punitive income taxes.
     
  3. The erosion of financial privacy and tax competition makes wealth taxation more feasible.

In recent decades, several nations rejected wealth taxes because of concerns that such levies would simply drive productive capital across national borders. The argument against such levies was particularly strong in a world with ever-increasing mobility of capital. That dynamic may not be changing,
though, because high-tax nations, the OECD, and the G-20 have enjoyed some success in undermining privacy laws in so-called tax havens. The immediate goal of the anti-tax competition campaign has been to enable governments to tax the income generated by flight capital. But now that they have the ability to track capital, it is more feasible for them to directly tax the underlying assets as well as the income flows.

These three factors explain why there’s a lot more anxiety among savers and investors. For instance, Allister Heath, the superb economic writer from London, recently warned that governments are undermining incentives to save. And not just because of high tax rates and double taxation of savings. Heath says people are worried about outright confiscation resulting from possible wealth taxation.

“It is clear that individuals, when at all possible, need to accumulate more financial assets. … Tragically, it won’t happen. A lack of trust in the system is one important explanation. People simply don’t believe the government – and politicians of all parties – when it comes to long-terms savings and pensions. They worry, with good reason, that the rules will keep changing; they are afraid that savers are an easy target and that they will eventually be hit by a wealth tax.”

It appears that plenty of politicians and bureaucrats favor wealth taxation.

Here are some passages from a Reuters report.

“Germany’s Bundesbank said on Monday that countries about to go bankrupt should draw on the private wealth of their citizens through a one-off capital levy before asking other states for help.”

Though to be fair, the Bundesbank may simply have been sending a signal that German taxpayers don’t want to pick up the tab for fiscal excess in nations such as France and Greece. And it also acknowledged such a tax would harm growth.

“(A capital levy) corresponds to the principle of national responsibility, according to which tax payers are responsible for their government’s obligations before solidarity of other states is required,” the Bundesbank said in its monthly report. … the Bundesbank said it would not support an implementation of a recurrent wealth tax, saying it would harm growth.”

The pro-tax crowd at the International Monetary Fund has a somewhat favorable perspective on wealth taxation, relying on absurdly unrealistic conditions to argue that a wealth tax wouldn’t hurt growth. Here’s some of what the IMF asserted in its Fiscal Monitor last October.
“The sharp deterioration of the public finances in many countries has revived interest in a ‘capital levy’ – a one-off tax on private wealth – as an exceptional measure to restore debt sustainability. The appeal is that such a tax, if it is implemented before avoidance is possible and there is a belief that it will never be repeated, does not distort behavior (and may be seen by some as fair).”

The IMF even floats a trial balloon that governments could confiscate 10 percent of household assets.

“The tax rates needed to bring down public debt to pre-crisis levels … are sizable: reducing debt ratios to end-2007 levels would require (for a sample of 15 euro area countries) a tax rate of about 10 percent on households with positive net wealth.”

Many people condemned the IMF for seeming to endorse theft by government.

The IMF’s deputy director of fiscal affairs then backpedaled a bit the following month and felt obliged to point out some real-world concerns.

“… governments have rarely implemented capital levies, and they have almost never succeeded. And there are very good reasons for that. … to be non-distorting, the tax must be both unanticipated and believed certain not to be repeated. These are both very hard things to achieve. Introducing and implementing any new tax takes time, and governments can rarely do it in entire secrecy (even leaving aside transparency issues). And that gives time for assets to be moved abroad, run down, or concealed. The risk of future levies can be even more damaging; they discourage the saving and investment that generate future capital assets.”

Though these practical flaws and problems don’t cause much hesitation on the left.

Here’s what Joann Weiner recently wrote in the Washington Post about the work of Thomas Piketty, a French economist who apparently believes society will be better if higher taxes result in everyone being equally poor.

“A much higher tax on upper income – say 80 percent – coupled with a significant tax on wealth – say 10 percent – would go a long way toward making America’s income distribution more equitable than it is now. … capital is the chief culprit … Piketty has another pretty radical, at least for the United States, way to shrink the share of wealth at the top – introduce a global tax on all capital. This means taxes on not just stocks and bonds, but also land, homes, machines, patents – you name it; if it’s wealth or if it generates what tax authorities call ‘unearned income,’ then it should be taxed. One other thing. All countries have to adopt the tax to keep capital from fleeing to tax havens.”

Let’s close by looking at the real economic consequences of wealth taxation. Jan Schnellenbach of the Walter Eucken Intitut in Germany analyzed this question.

“Are there sound economic reasons for the net wealth tax, as an instrument to tax stocks of physical and financial capital, to be levied in addition to taxes on capital incomes?”

Schnellenbach makes the critical point that even a small levy on assets translates into a very punitive rate on actual returns.

“… every tax on domestic wealth needs to be paid out of the returns on wealth, every net wealth tax with a given rate is trivially equivalent to a capital income tax with a substantially higher rate. … even an – on aggregate – non-confiscatory wealth tax may at least temporarily actually have confiscatory effects on individuals in periods where they realize sufficiently low returns on their capital stock.”
He then looks at the impact on incentives.

“… a net wealth tax will have similar distortionary effects as a capital income tax. … Introducing a comprehensive net wealth tax would then, through the creation of new incentives for tax avoidance and evasion, also diminish the base of the income tax. Scenarios with even a negative overall revenue effect would be conceivable. There is thus good reason to cast doubt on the popular belief that a net wealth tax combines little distortions and large amounts of revenue. … A wealth tax aggravates the distortions and the incentives to evade that already exist due to a pre-existing capital income tax.”
And he closes by emphasizing that this form of double taxation undermines property rights.

“The intrusion into private property rights may be far more severe for a wealth tax compared to an income tax. … It takes hold of a stock of wealth that consists of saved incomes which have already been subject to an income tax in the past … Our discussion has shown that economically, the wealth tax walks on thin ice.”

In other words, a wealth tax is a very misguided idea. And that’s true whether it’s a permanent levy or a one-time cash grab by politicians.

Some may wonder whether a wealth tax is a real threat. The answer depends on the time frame. Could such a levy happen in the next year or two in the United States? Or will Piketty’s proposed global wealth tax happen in the next five years.

The answer to both questions is no.

But the wealth tax will probably be a real threat in the not-too-distant future. America’s long-run fiscal outlook is very grim because of a rising burden of government spending, and other nations are in even worse shape.

When fiscal policy begins to deteriorate, even semi-rational politicians will join their leftist colleagues in a desperate search for more revenue. In a political world where inequality is a driving force and in an economic world where other tax sources have been exhausted, people with assets will have real reasons to worry.
 

 

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Daniel J. Mitchell

Daniel J. Mitchell specialises in fiscal policy issues. He also is a co-founder of the Center for Freedom and Prosperity, an organisation created to preserve and protect tax competition, fiscal sovereignty, and financial privacy.

As a member of the Editorial Board of the Cayman Financial Review, Daniel’s biography can be seen on the Editorial Board details page.

Daniel J. Mitchell
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