Very high levels of wealth are not usually created by people who were saving from the income they earned. Instead, high levels of wealth usually involve assets that have increased significantly in value: land, real estate, and often shares in companies. Billionaires like Elon Musk and Kim Kardashian don't have basements full of dollar bills like Scrooge McDuck. Instead, most of their wealth is held in company stocks, and the value of those stocks increases over time.
So if you want to impose a tax that affects the distribution of wealth, raising income tax rates at the highest level is not the most beneficial answer. „how to tax wealthIMF Economist Group (Shafik Hebous, Alexander Klemm, Gerten Michelse, Carolina Osorio-Buitron, IMF points to note 2024/001, March 2024). Those people write:
This note describes three approaches to wealth taxes based on (1) returns with capital income taxes, (2) stocks with wealth taxes, and (3) wealth transfers through inheritance (or inheritance) taxes. Masu. Taxing actual earnings is generally less distortive and more fair than a wealth tax. Therefore, rather than introducing a wealth tax,
Reform priorities should focus on strengthening the design of capital income taxes (especially capital gains) and closing existing loopholes, while improving technical aspects of tax administration, including cross-border information sharing. Advances need to be leveraged to promote tax compliance.Inheritance tax is important to solve these problems
Accumulation of dynastic wealth.
Let's talk a little more about the three options.
Income from capital can come in a variety of ways, including interest payments, rent payments, dividends, stock buybacks, or pass-through companies that distribute profits to their owners. But here I would like to focus on the issue of taxation of capital gains. Again, when you look at billionaire-level wealth, that wealth is typically built based on how the value of assets, such as stock ownership, has increased over time.
As the authors explain, a common approach is to tax capital gains when they are „realized,“ that is, when the asset is sold. However, this approach raises two problems. One is that if assets are held for a significant period of time, capital gains during that time are tax-free until realized, and deferring taxes for many years can be a significant benefit.
Another issue is that capital gains can often be rolled into new assets without being taxed. In the United States, individuals can transfer capital gains from one home to the purchase of another home. If someone dies while owning the shares, there is a „step-up“ that allows the heirs to appreciate the shares at their value at the time of death, and the former owner's lifetime gains are not taxed.
The IMF authors describe the resulting problem as follows:
- Tax avoidance is encouraged because there is an incentive to convert income into capital gains to benefit from tax reductions. For example, investment funds can reinvest profits rather than distribute them, and bonds can be designed to grow in value rather than pay interest.
- Tax law and administration are becoming more complex as loopholes need to be addressed. For example, zero-coupon bonds are often taxed on their implied interest.
- Similarly, profitable investments are taxed differently depending on the form in which they are generated, reducing horizontal capital.
- As wealth and income increase, vertical capital decreases because the proportion of income earned as capital gains increases. In the United States, the top 0.001% of taxpayers earns 60% of their income as capital gains (IRS 2022). In the UK, almost 60% of the top 0.01 earners receive at least 90% of their compensation in capital gains (Advani and Summers 2020).
- A lock-in effect exists because investors prefer to hold on to assets even if their expected future returns are lower than alternative investments, as long as the tax savings from not realizing capital gains outweigh the difference in returns21 . This leads to inefficient capital allocation. Some countries tax capital gains at lower rates to reduce this effect (particularly on long-term gains), thereby exacerbating the relative undertaxation of capital gains.
- Internationally, tax avoidance and tax evasion occur even when capital gains are realized. For example, instead of trading securities directly, investors can trade depositary receipts in offshore markets where capital gains are not taxed. Similarly, rather than selling real assets directly, you can trade stocks or entire companies (registered in a separate conduit, country) that derive their value from their underlying assets. For high-value assets such as natural resources, the loss of revenue can be significant.
A final issue with capital gains tax has to do with inflation. If the increase in the value of my asset (for example, my house) over time exactly matches inflation, should this gain be treated as „income“ to me when I sell the house?
There are ways to deal with all these problems, but they are not easy.
When it comes to wealth taxes, the immediate concern with wealth taxes is that many countries that have implemented wealth taxes have decided to abolish them. Basically, a wealth tax is too cumbersome to administer because it generates too little tax revenue. The authors state:
(A) The number of OECD countries that explicitly impose a wealth tax has decreased from 12 in 1990 to just three, but the Netherlands has also effectively imposed a wealth tax as part of personal income tax. (This also applies to Liechtenstein, a non-OECD member country). And if you are employed, wealth taxes are not a significant source of revenue.
Exemption thresholds and widespread evasion are occurring amidst severe enforcement challenges (Kopczuk 2019; Advani and Tarrant 2021). Switzerland has the world's highest revenue yield, accounting for 1.4% of GDP in the 2018-2020 period, but the country imposes no capital gains tax (and its wealth concentration is high even by international standards). (Föllmi and Martínez 2017)). Existing wealth taxes are mostly modest and limited, so studying them does not necessarily suggest the impact of a more comprehensive or higher wealth tax.
I previously wrote an article about countries lowering their wealth taxes. here and hereand the case where equality-minded Sweden lowered inheritance tax. here.
You can argue on paper for taxes on the ultra-wealthy with assets of $1 billion or more. But the fact that even a lower wealth tax was difficult to collect should raise some questions. And even a substantially more aggressive wealth tax on the ultra-rich would have limited revenue impact. „The EU tax watchdog (2023) estimates that the world's top billionaires will be subject to a wealth tax of 2% in 2023 (approximately 2,800 millionaires, 30% of billionaires),“ according to the report. Of that amount, US residents can raise approximately $250 billion (0.2% of global GDP).
Regarding incentives, wealth tax applies regardless of income. Imagine a risky investment. When taxing per capita income, tax revenue increases if the investment is successful, i.e., the value doubles, but if the investment is unsuccessful, i.e., the value falls by half, the tax rate decreases. , it can even be negative. With a wealth tax, even if an investment fails, investors are liable to pay wealth tax on what is left over. Wealth taxes thus increase risk. Additionally, because wealth is typically held as assets rather than rolls of dollar bills, paying wealth taxes may require selling some of the assets themselves.
When it comes to inheritance tax, the main objective is to limit the intergenerational transfer of extreme wealth. The authors write:
Empirical evidence shows that inherited wealth represents a large proportion of total wealth, although exact figures are difficult to obtain. One difficulty is that estimates vary widely depending on whether capital income from inherited property is counted as part of the inheritance. Davies and Shorrocks (2000) suggest that a share of 35 to 45 percent is a reasonable estimate, with much higher or lower estimates based on a balance of assumptions made in the paper. I am claiming. Piketty and Zucman (2015) use more detailed and up-to-date data available for several European countries, reporting results for France, Germany, and the United Kingdom, showing that in 2010, the proportion of inherited wealth was found to be in the range of just over 50 percent. In Germany it's close to 60 percent and in the UK it's close to 60 percent. Furthermore, as Acciari and Morelli (2020) using Italian data show, heritage has become larger (8.4 to 15.1 percent of GDP between 1995 and 2016) and more concentrated over time. And it seems. According to a report by UBS (2023), new billionaires acquired more wealth through inheritance than through entrepreneurship.
The creativity of tax accountants will be a challenge for inheritance tax. What happens when wealthy people put their money into a trust? How do wealthy people keep their money in nonprofit organizations and then send their children to very well-paying jobs at those nonprofits? How do they make their wealth tax-free? How will inheritance tax be treated after death compared to large gifts given during life? Is it the right thing to do if I have to give up my farm?
In most countries, inheritance and inheritance tax collections are relatively small.
For a follow-up to this post, see. “The super rich and how to tax them” (November 17, 2020).
Wealth taxes are not raised much, typically between 0.1 and 0.33 percent of GDP.In some countries in Latin America, wealth taxes are small but help collect income taxes
inheritance tax, large amount
Empirical evidence shows that inherited wealth represents a large proportion of total wealth, although exact figures are difficult to obtain. One difficulty is that estimates vary widely depending on whether or not you have capital.