What Is a Wealth Tax?
A wealth tax is a tax on the net market value of the assets owned by a taxpayer.
In simple terms, if a taxpayer owns assets that are worth $100,000 and the wealth tax is 1%, then each year the taxpayer must send a tax payment of $1,000 to the tax authorities in his jurisdiction.
A wealth tax is a controversial and rarely used form of taxation. Most countries tax annual income, not wealth. After all, after income is taxed, the taxpayer is left with assets. If these assets are taxed again, then the same assets are taxed multiple times, which is not fair.
Nonetheless, a few developed countries are proposing a wealth tax on its wealthy residents as a means to increase government tax revenue and combat wealth inequality. However, if history is any indication, these proposals will fail, and even if they do get ratified into law, the wealth taxes collected will never solve the problems they are meant to solve.
The Formula for Wealth Tax
Wealth = Assets – Liabilities
Wealth tax = Tax rate x Wealth
Assets include cash in the bank, marketable securities, bonds, stocks, private businesses, real estate, vehicles, mutual funds, trusts, and pension plans.
Liabilities include mortgage debt, credit card debt, student loan debt, and any other personal debt.
Most countries already impose property taxes on real estate. As such, a wealth tax would impose a second layer of taxation on the same real estate property.
Which Countries Impose a Wealth Tax?
As of 2022, only 5 countries impose a wealth tax. They include Argentina, Switzerland, Spain, Norway and Colombia. This number has continued to decline. 12 countries used to impose a wealth tax. The inefficiency and ineffectiveness of the tax has made it unpopular.
A few countries including the U.S. impose an estate tax. This is a tax on the net assets of a taxpayer who dies. But this generally only applies to rich taxpayers. In 2022, the estate tax only applies to an estate worth at least $12 million.
There is no estate tax in Canada. But upon the death of a taxpayer, the deceased’s assets (excluding his personal home) are deemed to have undergone a “deemed disposition” or sale. As such, capital gains taxes on this deemed disposition are payable to the tax authorities. This tax bill is often paid out of life insurance proceeds. However, in many cases, the deceased already transferred his assets to his heirs while he was alive by using an estate freeze, which triggers no tax bill.
Problems with a Wealth Tax
The case for a wealth tax is, of course, very simple. It will extract additional tax revenue from the assets of rich taxpayers, and not just from their income. Then, these additional taxes will be redistributed to the rest of the tax base in that jurisdiction.
So then the questions is: Why has it never worked?
Even in the handful of countries that still have a wealth tax, the taxes are a tiny fraction of overall tax revenue.
Wealth is Knowledge
“You do not make a poor man rich by making a rich man poor.” – Thomas Sowell
The initial problem with a wealth tax is the flawed mindset that drives the argument for a wealth tax. The wealth of a person is not in his tangible or intangible assets. The wealth is in his brain, in his knowledge – or in the brains of his wealth advisors.
The assets are simply a physical representation of the knowledge in the brain of the taxpayer. It is this knowledge that created the assets and wealth. Thus, taxing his assets does not really take away his assets. He retains his knowledge.
This is exactly why lottery winners who suddenly come into huge sums of money lose their winnings within 5 years. The lottery winner never had the brain that created the money.
You can tax assets but you cannot tax knowledge. The knowledge of the rich taxpayer will produce more assets and wealth and the wealth inequality problem will persist.
Expensive to Administer a Wealth Tax
A wealth tax must be administered and enforced. As many countries that eventually dropped their wealth tax found out, this is an administrative nightmare.
Income paid out to a salaried employee is easy to value. The value is equal to the salary payout and the payout is taxed accordingly.
However, a house or car or business does not have a universally agreed upon value. And this value fluctuates on any given day or in any given month or year. Any asset class that does not have readily-available public prices is difficult to value. This will lead to disputes between the accountants of taxpayers and the tax authorities. Legal disputes are bound to follow. This makes the asset valuation process cumbersome and expensive.
Thus, the wealth tax is difficult to administer.
Inability to Pay the Wealth Tax
Most rich taxpayers tend to be business owners. In fact, they tend to be small-to-medium sized business owners. The bulk of the wealth owned by these taxpayers is in their private businesses.
They own illiquid shares or units in their businesses. These assets cannot be easily sold to produce cash and pay a wealth tax. And most businesses do not have excess cash lying around to pay an additional tax bill.
For example, a farmer who owns valuable land and a farming business does not normally have the cash to pay a wealth tax imposed on his land or crops. His income from the land is generally small relative to the value of the land, which is often inherited from his parents.
Most small businesses cannot sell a fraction of their business each year to pay a tax bill. Small business investors and buyers generally want to buy and own the entire business, not a fraction of the business.
Local Entrepreneurs Will Leave Town
The business world is now global. Most countries have good enough infrastructure for an entrepreneur to set up his business almost anywhere he wants to. And global internet connectivity makes it easy to communicate with global vendors and customers from anywhere in the world.
As such, if an entrepreneur thinks that a wealth tax in a specific jurisdiction will inhibit his ability to grow his business and his personal wealth, he will simply leave that jurisdiction and go to another jurisdiction.
The jurisdiction that imposed the wealth tax will not only lose the wealth tax. It will also lose:
– His income taxes
– His consumption taxes e.g. sales taxes on goods that he purchases daily
– Payroll taxes that the employees of his company pay to the jurisdiction
– Consumption taxes paid by his employees when they purchase goods everyday
Overall, his knowledge, income, spending power, and business taxes are lost by the jurisdiction that imposes a wealth tax to the jurisdiction with no wealth tax.
Also, the wealth tax will repel future entrepreneurs from moving to this jurisdiction to set up their businesses in the first place.
Let’s say that you’re the next Bill Gates, you have a great business idea, and you’re looking for a place to set up your business. It is highly unlikely that you would set up your new business in a jurisdiction with a wealth tax.
No two countries will have the same tax code. There are over 200 countries with over 200 tax codes that entrepreneurs can choose from. Jurisdictions will have to compete for the best entrepreneurs. A wealth tax will reduce the competitiveness of a jurisdiction.
Rich Taxpayers Already Pay Most of the Taxes
Governments across the globe depend heavily on rich taxpayers to provide the bulk of their tax revenue. Despite the media noise about rich people not paying their fair share, the reality is that rich taxpayers pay most of the taxes in most countries.
In the United States, the top 10% of income earners pay 71.37% of federal taxes.
In Canada, the top 10% of income earners pay 54% of taxes.
A wealthy entrepreneur in the U.S. or Canada who makes $10 million a year pays about $5 million in income taxes per year. If this entrepreneur were to leave his jurisdiction, that $5 million shortfall will need to be paid by other taxpayers in that jurisdiction.
In 2021, the median individual income in the U.S. was about $44,000. Assume that this individual and the entrepreneur both live in the high-tax State of New York where the individual would pay 23% in taxes, or about $10,000.
Thus, the State of New York would need to find 500 new taxpayers who earn at least $44,000 to make up the $5 million hole in its budget.
Over time, what eventually happens in these cases is, the tax rate on average taxpayers is increased to make up the shortfall in the State’s budget.
Rich taxpayers leaving jurisdictions with a wealth tax is not a simple hypothetical argument. It happened in France. 12,000 French millionaires left France in a single year alone because a wealth tax was introduced in France that year. The tax results were so bad that France repealed the wealth tax.
Other countries like Sweden, Austria, Denmark, Germany, Finland, and the Netherlands also repealed their wealth taxes for similar reasons.
Ultimately, a wealth tax is not entirely paid by the rich. A wealth tax somehow always finds its way into the wallet of the average person.