The structure of many modern tax systems may have actively contributed to inequality. What is more, the greatest tax burden is often experienced not by those at the top of the ladder but by low-to-middle income families.
Around the world, increasingly unequal—and divided—societies speak out loudly against the rules of the game in modern capitalist economies, which rely on profit-oriented, private markets to produce and distribute economic resources.
This rising popular discontent about inequality has found its outlet in the US and UK election campaigns. In the USA, several Democratic candidates in the 2020 presidential elections have unveiled plans for a far-reaching reform of the taxation system.
In the USA, Senator Bernie Sanders proposed a progressive tax on net wealth (assets less debt), with marginal tax rates increasing from 1% on wealth holdings over $32 million to 8% on net wealth over $10 billion. Senator Elizabeth Warren also put forward plans for implementation of a wealth tax, albeit at lower marginal rates of 2% on wealth holdings over $50 million and 3% on holdings over $1 billion.
In the UK, the Labour Party is said to be considering raising taxes on returns to wealth (a so-called capital gains tax) and replacing the inheritance tax (which raises notoriously low revenues) with a lifetime capital receipt tax (see Sir Tony Atkinson’s 2015 book).
The fact that concrete wealth tax proposals have found their way into political manifestos is undeniable, and this has been facilitated by vast academic research on the topic. Development of new methods and datasets has made it possible to estimate how much is paid in taxes by different people across the distribution of income and wealth. There has also been more evidence on the effects of different types of taxes on inequality and economic performance in general, with some studies going as far as to analyze the relative merits of different redistributive policies (for example, raising tax rates versus expanding social transfers, see Guillaud, Olckers, and Zemmour 2017).
At the forefront of the taxation research is the work of Thomas Piketty, Emmanuel Saez, and Gabriel Zucman. It was Piketty’s seminal book, Capital in the Twenty-First Century, which brought the idea of wealth taxes back to the mainstream of policy debates. His proposal involved introducing an annual progressive wealth tax on net wealth values over $1.35 million. Piketty was unapologetic about the necessity of such a wealth tax to be levied globally to deal with the possibilities of tax evasion.
Piketty’s original proposal has been met with a mixed response from experts. Its critics often point out that wealth taxes have been historically unpopular and easy to avoid, which explains why numerous countries have abandoned some form of wealth taxes over the past decades (for an overview of these criticisms see Steve Pressman’s 2015 book and my chapter in Rochon and Monvoisin 2019). Many of these critics also argue that reforming current policy tools such as personal income taxes, corporate taxes, or value-added taxes (VAT) would be more than enough to tackle rising inequality. If this is the case, why have wealth taxes gotten so much traction?
Part of the answer is that existing tax policies have not been doing a good job of redistributing economic resources more fairly. This was called out by Piketty in his 2014 book, where he claimed that only taxes on the stock of wealth holdings can reign in the massive accumulation of wealth by the very rich.
The fact that concrete wealth tax proposals have found their way into political manifestos is undeniable, and this has been facilitated by vast academic research on the topic.
The Doors to Tax Avoidance are the Problems
In fact, the structure of many modern tax systems may have actively contributed to inequality. There is evidence that existing tax breaks in the UK and in the USA have benefited the rich (see, for example, Levin, Greer, and Rademacher 2014 or Adam Corlett’s November 2019 report for the Resolution Foundation). In addition, the greatest tax burden is often experienced not by those at the top of the ladder but by low-to-middle income families. In their latest book, The Triumph of Injustice, Saez and Zucman reveal a shocking finding that billionaires currently pay lower tax rates than their secretaries.
The problem is not just that existing taxes are not high or progressive enough, but that the way in which many of these policies are designed opens the door to tax avoidance and regulatory arbitrage for some, at the expense of higher tax burden for others. For instance, some types of income such as capital gains from increasing asset values tend to be either untaxed or face lower rates than taxes on earnings—while they constitute a major income source for the rich.
A large part of the capital owned by the rich is not held in physical assets but in some form of financial assets. Financial wealth is more liquid and for this reason, it can easily be moved to tax havens, where it can benefit from lower tax rates.
What is more, corporate income taxes are notoriously easy to avoid. The world’s largest companies, including Amazon and Netflix, are known to have underpaid taxes on profits, taking advantage of stock buybacks and moving some of their profits to tax havens. In addition, VAT and other indirect (also called consumption) taxes have been shown to be regressive and impact mainly finances of low-to-middle income families who spend a larger part of their incomes on consumption. A striking example of this was experienced in France, where a proposal to increase taxes on fuel sparked protests of “gilet jaunes”.
While wealth taxes are an attractive alternative to the existing loophole-ridden tax system, they suffer from some serious drawbacks which need to be addressed by any future proposals. Data compiled by Oxfam show that in 2015 wealth taxes constituted only 4 % of the overall global tax revenue, even though they are not a new idea. In fact, wealth taxes had once been implemented in several countries around the globe, but they have been gradually abandoned due to low revenues and high administrative costs (see, for example, the April 2018 report by OECD Tax Policy Studies).
The Increasingly more Mobile Capital
One of the most important reasons behind the failures of earlier wealth taxes and problems with corporate income taxes is the increasingly more mobile nature of capital. A large part of the capital owned by the rich is not held in physical assets (such as property, luxury goods, etc.) but in some form of financial assets. Financial wealth is more liquid (that is, it can be sold faster than physical assets), and for this reason, it can easily be moved to tax havens, where it can benefit from lower tax rates. Tax havens are sustained by these inflows of capital, which leads to a race to the bottom between countries and among smaller tax jurisdictions. This explains why wealth taxes have been previously abandoned and why many countries are lowering corporate income taxes to encourage capital inflows.
Recent research exposes the scale of legal tax avoidance and illegal tax evasion around the globe. A team of researchers led by Zuckman estimates that each year nearly 40% of profits of multinational corporations are moved to tax havens, which corresponded to over $650 billion in 2016. This shift reduced the global revenue from corporate income taxes by almost $200 billion, which is equivalent to 10% of global corporate tax receipts. Any future wealth taxes need to reckon with this issue in order to provide a true alternative to the flawed taxation systems which are currently in place.
This is where the second part of the answer to the question of why wealth taxes have become so popular comes in. Effective taxation of wealth creates opportunities for raising the amount of tax revenue that cannot be paralleled by increases in personal or corporate income taxes. Experts estimate that Sanders’ and Warren’s wealth tax proposals have the potential to raise over $4.3 trillion and $2.7 trillion respectively in tax revenue. One potential reason for higher wealth tax revenues is that the amounts accumulated in the stocks of wealth are substantially larger than the taxable flows of personal or corporate income.
There is no one Panacea for Reducing Inequality
Wealth taxes, however, do more than that: when properly designed, they allow the capture of resources that are currently allowed to escape through the loopholes of the existing taxes. This begs a question as to what kind of wealth taxes would be truly effective. The definition of wealth embodied in these taxes needs to be scrutinized, alongside potentially perverse incentives for tax avoidance that specific wealth tax proposals may create. By themselves, a Sanders- or Warren-style wealth tax may not be enough to bring a radical and long-standing reduction in inequality. They are a good start, however, for deeper, more far-reaching reform of the entire taxation system and public spending programs.
Given the scale of tax avoidance and evasion, Piketty’s call for global reform seems inevitable—and there are ideas on how to make it happen (see, for example, the March 2019 ICRICT report on a global asset registry). An international organization such as the IMF, the World Bank, or the European Union have expressed concerns about growing inequality—and if they are serious about tackling this issue, they should consider a global strategy for taxing wealth, in cooperation with national governments. Ultimately, future policy reforms ought to be embraced by the rich. While undoubtedly difficult, this is perhaps the most effective way of discouraging regulatory arbitrage, tax avoidance, and tax evasion. Several billionaires, including George Soros, Bill Gates, and Abigail Disney, have already expressed some support for wealth taxes.
I have recently been asked an important question that has been surprisingly underplayed in the current wealth tax debates. If wealth taxes do become a reality, what would the resulting revenue be used for? When discussing wealth tax proposals, policymakers should not neglect the reform of public spending programs as societal needs are great—from affordable housing and decent social benefits to universal healthcare and childcare, and green infrastructure. Such bold proposals are increasingly on the political agenda. Proposals on improving public services make wealth taxes more viable as only such comprehensive policy overhaul can achieve lasting improvements in inequality.
In summary, there is no one panacea for reducing inequality in a sustainable way. Whether one believes that billionaires should not exist in a fair economy (like Senator Sanders), or that large wealth should only be accumulated due to one’s merit (like Senator Warren), the fact is that the vast majority of wealth at the top remains unearned. Wealth accumulates not as a result of hard work by the rich or by producing something of value, but rather thanks to asset price increases. Despite this massive accumulation of wealth, many modern capitalist economies are still feeling the pinch of the Great Recession. Radical proposals are much needed and given the current political climate and their potential merits, well-designed wealth taxes are a welcomed initiative to invigorate economies and redistribute resources in a fairer way.