Article note:
When analyzing inequality, we are looking at it from a purely financial standpoint. References to wealth tax refer to all assets belonging to an entity. Glossary after references.
Introduction to inequality climate:
There has never been a greater wealth divide. Despite unprecedented rises in unemployment and the instability we have experienced, Americas richest 614 billionaires had an aggregate net worth surge of over £670bn. In the UK, the OBR estimated that government borrowing summed up to over £394bn, a 600% increase from last year, indicative of the unprecedented economic strain governments are enduring as they try to minimize inequality and uphold the economy. Government stimuli to fight the pandemic such as the “Furlough Scheme” and “Eat Out to Help Out” scheme have itself cost over £280bn, all while there is an estimated £100bn loss in tax revenue due to the extensive unemployment claims filed. Rising loans are predicted to be met with substantially higher taxes post-pandemic, to compensate for the sizable stimuli packages. Many economists argue that to reduce borrowing we will have to cut government spending, raise taxes or both. A fall in government spending would cause a considerable decrease in the provision of unemployment benefits, which could trap us in a deflationary spiral as investor confidence and consumer confidence plummets. Consequently, we are bound to see the wealth gap expand with increased homelessness, unemployment, and a significant decrease in the standard of living. According to the BoE, the UK economy has experienced its largest contraction in over three centuries.
Difference between wealth tax and income tax?
Income tax is concerning income or profits earned by individuals, whereas wealth tax is on an entity’s holdings of assets. This includes real estate, trusts and more. Wealthy families have a lower MPC and a high MPS. Comparatively lower-income households have a high MPC. It would therefore be beneficial, to redistribute money from the high-income households to low, as we can increase aggregate demand across the economy.
Possible problems with “over-taxation”:
As illustrated on the Laffer curve, there is an optimal tax rate that maximizes tax revenue, after which revenue would decrease due to an unmotivated labour force. Investors would be cautious to invest as inefficient labour signals low returns to scale.
Figure 1 (Ref: J):
The takeaway point from this is that exploiting the rich by maximizing the tax rate will only lead to a sequence of events that will negatively impact the economy. We can ensure optimal redistribution of income by understanding the different wealth brackets and implement the tax rate accordingly. Ensuring we don’t compromise on other government objectives such as maximizing economic efficiency and employment is paramount.
Switzerland is a prime example of a successful wealth tax implementation. However, most of the burden was placed on the middle class, to spread the tax across a growing population of financially stable individuals. Switzerland’s Gini-Coefficient is 0.33, whereas the UK’s is 0.35. This raises the question of the true effectiveness of the wealth tax. As illustrated below, Switzerland has always faired marginally better than the UK in terms of equality, however, we must really question, is this due to the wealth tax or a variable unaccounted for?
Figure 2 (Ref B):
Thomas Picketty argues the rate of capital return is greater than the rate of economic growth, which causes a concentration of wealth and unequal distribution. Essentially, he is referring to how an appreciation of an asset’s value, would lead to an increased wealth tax, despite not being sold. This is known as a “dry tax” which would essentially make it unfeasible to hold assets of value long-term. For example, if a low-income earner, inherited high-value assets, they would have to liquidate these for the simple fact that they would not have the funds to pay the wealth tax. Picketty would essentially be arguing that the low-income earner are still obliged to pay the wealth tax despite not having a rise in income.
Exploring the effects of taxation on inequality, Reagan significantly cut taxes while in office, causing the top 1% to double their income, while the lowest quartile saw a decrease in their incomes. Decreased taxation would only hurt the most vulnerable. In Reagan’s term, the Gini-Coefficient rose by almost 0.035 points – a sharp increase- reaffirming the weighting taxation has on maintaining equality. Despite this being income tax, its effects could easily apply to the wealth tax. As illustrated on the Gini-Coefficient, the US witnessed its steepest rise in inequality during and directly after Reagan’s period, never returning to previous levels.
Figure 3 (Ref U):
Pros of wealth tax
A survey by the UK’s Wealth Tax Commission in May 2020 indicated that people favoured wealth tax taxes over other forms of taxation. 63% supported a one-off wealth tax on households with assets more than £2mn. The wealth tax could prove a beneficial policy for governments to allow a continuation of spending without borrowing. If the wealth tax is unexpected and one-off, this could prevent individuals from hiding their assets, eliminating tax loopholes. The tax would affect future wealth accumulation, and existing wealth, preventing a widening inequality divide. If a one-time wealth tax is implemented on the “super-wealthy”, we would see a decreased tax burden on the middle class, which could promote a more motivated labour force. Finally, implementing a wealth tax could disincentivized companies from holding onto their wealth, as a result, increasing hiring which could provide much-needed relief during the pandemic where unemployment is becoming a rising concern. According to BBC the wealthiest 1% have had a 27% rise in net worth.
Pitfalls of a wealth tax:
Over the last 11 years, UK billionaires have seen their wealth rise by 168%. The British wealth tax proposes taxing individuals with valuations over £1mn (750,000 homes), taxing 1% per year for 5 years, producing an estimated revenue of over £260bn. This could decrease the growing UK deficit of £1,876.8bn making up for over 84.6% of the GDP. It is however highly unlikely that the UK would implement such a wealth tax, as in 1974 it was rejected due to it being unfeasible. According to the OECD, out of the thirteen countries that imposed a wealth tax, only three still uphold the policy. An annual wealth tax was also proposed, however was rejected by the Wealth Commission as the administration costs would be “too great” to endure.
The underlining pitfall of a wealth tax is it could disincentivize individuals from investing domestically. Since savings are already taxed, this could lead to assets being transferred overseas, an underlining factor as to why the wealth tax was abandoned by many of the OECD members. If a one-off wealth tax were to be imposed in the UK, we could see a new stream of revenue to ensure low inequality during the pandemic. However, few hold major concentrations of wealth, so implementation of a wealth tax could be difficult as individuals can alter government policy through social and political influence. Recently, inequality has spiralled out of control during the pandemic in the UK, with UNICEF having to feed children for the first time in over 70 years, as a result of the 2.4 million (17%) living in food-insecure households, with an extra 900,000 children registering for free school meals since October of 2020.
Figure 4 (Ref M):
In California, wealth tax caused some of the state’s wealthiest residents to move out abruptly, such as Elon Musk and others. If we generalize this to the UK, we would see a decreased income tax revenue, as the wealth tax causes the wealthy to relocate elsewhere. This would lead to the short fallings of wealth tax revenue estimates and a decrease in direct tax revenue as well.
Does wealth tax resolve unequal distribution of income (conclusion)?
Wealth tax isn’t sustainable in the long run, as an additional tax introduced could disincentivize potential or existing investors. If it were implemented for a short period (5 years), we could retain high investor confidence, ensuring employment during the pandemic, preventing the wealth divide from magnifying. Alternatively, high operational costs could outweigh the benefit derived from the wealth tax, resulting in government failure, which could worsen inequality. In conclusion, if we wanted an effective implementation of the wealth tax, it is paramount to implement measures that prevent hidden assets, and a tax figure for each “wealth” bracket that doesn’t cause “wealthy” individuals from relocating elsewhere. Since “entrepreneurship” is the most mobile factor of production (due to rising infrastructure for remote working), the effects of an additional wealth tax could easily disincentivize potential and existing residence, which would cause an overall decrease in potential income tax revenue. As a result, due to the multitude of problems that the wealth tax invites, its implementation, and use is simply unjustified. Clearly, the income tax is not maximizing redistribution of income, and as for wealth tax, Switzerland has proven its effects as marginal. It is paramount that governments explore alternative policies and regulations to offset the rising inequality divide, while not compromising on other macroeconomic objectives.
References:
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Glossary:
BoE- Bank Of England
MPC- Marginal propensity to consume
MPS- Marginal propensity to save
OBR- Office for Budget Responsibility
OECD- Organization for Economic Co-operation and Development
