Why wealth taxes always fail
Almost every country that has tried imposing wealth taxes has later abolished them, with good reason says John O’Connell
Rachel Reeves’ problem tomorrow is a simple one to describe, if not a simple one to solve. How does she raise the revenue needed to fund the spending binges of her colleagues, without raising taxes on income, given this is the major revenue raiser?
A “cross party” group of 28 MPs have provided an alternative answer: why don’t we tax wealth, rather than income? After all, wealth is distributed more unequally than income and people with less wealth tend to spend a greater share of their income, so letting them keep more could bring wider economic benefits from the extra spending. They’re calling for an “extreme wealth tax” in the upcoming Budget, although this would have been less menacingly worded as a “tax on extreme wealth”. It would involve an annual two per cent tax on assets above £10m, potentially raising £24bn. Unfortunately, this ostensibly comforting theory collides with the facts in a spectacular fashion.
Wealth tax can mean a number of things. It can mean a general tax on wealth, usually net of debts and levied annually above a threshold. Or it can serve as an umbrella term to cover specific taxes on wealth, such as stamp duty, capital gains taxes, estates taxes or property taxes. Let’s consider general net wealth taxes. They have repeatedly failed and are always rare. Politicians tend to shy away from even implementing them in the first place or they get repealed. France abolished hers in 2017, Sweden in 2011 and Ireland in 1978. Similar stories are found in the United States and Australia with property taxes and inheritance tax. Why? A landmark study by the Taxpayers’ Alliance has revealed all.
Crucially, there’s a fundamental tension at the heart of wealth tax proposals, whether to go for a broad base or a narrow one. A broad base means taxing all or most wealth. The upside for the government coffers is that that implies a large potential revenue and minimal distortion between activities and asset classes. The downside is that a large number of groups are affected, including more footloose and mobile assets and individuals.
A narrow base, by contrast, can avoid many of the political and economic difficulties. Setting a high threshold will remove many sympathetic, ordinary families getting caught, likewise exemptions can remove primary residences and pensions from scope. Add in exemptions for ‘non-doms’ or corporate holdings to minimise capital flight and it doesn’t take too long before the revenue projections start to look negligible. And then, what’s the point?
It doesn’t take too long before the revenue projections start to look negligible. And then, what’s the point?
Because against those revenues come significant harms to the wider economy with costs borne by all. One study found that abolishing wealth taxes increases self-employment, a good proxy for entrepreneurship, by 0.2 to 0.5 percentage points. Ireland’s wealth tax, meanwhile, was found to impose compliance costs of 20 per cent and administrative costs of between 25 and 50 per cent of the tax take. Another study found that wealth taxes reduce long-term GDP by between four and five per cent.
Drive the rich away at your peril
The British economy is especially open due to its strengths in financial services, the productivity of a small number of high-earning professionals and an English-speaking population. That has meant that despite our punishingly high tax rate and growth stifling regulatory framework, we have been able to build a modern, thriving economy with a hugely well-resourced, albeit inefficient, public sector. But it also makes us particularly vulnerable to the concerns that caused other countries to abolish their wealth taxes. The top one per cent of earners already pay 29 per cent of all income tax. And 41 per cent of Treasury income from capital gains came from those who made gains of £5m or more, despite representing less than one per cent of capital gains taxpayers each year. Drive them away at your peril.
The top one per cent of earners already pay 29 per cent of all income tax
Indeed, when we modelled the dynamic impacts of the proposals by the 28 MPs we found that the damage done to the economy would be devastating. After ten years there would be a £45.3bn reduction in the overall tax take, completely eliminating the £28.3bn in gains that were forecast. The economy would be £97bn smaller, with annual growth down by 0.4 percentage points. Annual wages would be down by £1,107.
As economists like to say, there is no such thing as a free lunch. When it comes to taxing the most mobile aspects of the economy, that warning could not be more apt. Politicians should turn their attention instead to the duller task of making the money they already extract out of the economy work harder with sensible reforms to public services, and put aside notions of an easy fix with a wealth tax.
John O’Connell is chief executive of the Taxpayers’ Alliance