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Could capital taxes on personal wealth be part of the solution to tackling growing inequalities in society? Unfortunately, there is little research evidence to support arguments for or against the imposition of wealth taxes. However, new research shows that use of wealth taxes in the battle against global inequality is far from straightforward.
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The issue of inequality is attracting increasing attention from policymakers. High up the agenda at the annual meeting of business leaders at Davos in January 2017, the topic is also the subject of a number of popular books, and features frequently in the mainstream media. There is a sense that globalization is failing to deliver the economic benefits promised, that a wealthy few have become wealthier, while the less well-off struggle to preserve their wealth, or grow even poorer.
How can the value produced and captured by society – its wealth – be distributed more fairly?
Slowly, the conversation has turned to redressing the balance. How can the value produced and captured by society – its wealth – be distributed more fairly? Inevitably, suggested solutions include redistributing money from richer to poorer, through taxation for example. And as most countries already impose taxes on income, and many charge a levy on bequests, consequently there are calls for additional tax measures to be used.
One possibility is to redistribute wealth via specific recurring wealth taxes charged on the total value financial and non-financial assets above a selected threshold. Some countries do impose a wealth tax, however the number appears to be declining, down from 14 to 5 OECD countries between 1995 and 2014, for example. But with inequality in the spotlight, there is renewed focus on wealth taxes.
The Swiss case
Until recently there has been little research evidence to evaluate how effective wealth taxes are in raising revenue. Is it, as many opponents suggest, for example, difficult to increase revenues raised through wealth taxes because wealth holdings are revised downwards in response? Do the wealthy move location to avoid paying wealth taxes?
Now, Marius Brülhart, professor of economics at HEC Lausanne, and his co-authors at MIT and the University of Basel, have taken advantage of the taxation landscape in Switzerland, one of the few OECD countries charging a regular recurring tax on personal wealth holdings, to evaluate the efficacy of wealth taxation.
Divided into 26 cantons and some 2,500 municipalities, wealth taxes in Switzerland are raised at the individual canton and municipality level. The rate of the wealth tax charged by the cantons and municipalities varies, from some 0.13% to 1.00% at the time of the study, for example, as do the exemptions available. The taxation rates also change over time.
The wealth taxation system in Switzerland relies on self-reporting of net wealth. Residents aged 18 or over are legally obliged to submit an annual tax filing, with all non-financial and financial wealth – cash, financial assets, real estate and luxury durable goods – net of debt, subject to the wealth tax. Some asset exemptions exist, including certain pension savings. However, tax authorities do not have access to bank records, outside of criminal investigations, although there is a degree of incentive to declare assets in order to reclaim a 35% federal withholding tax levied on income from financial assets.
The researchers used two datasets, both spanning about a decade in the early 2000s. One provided aggregate data for each of the 26 cantons over an extended period of many years, the other contained detailed information on wealth holdings at an individual level for one canton – Bern. The datasets enabled Brülhart and his co-authors to examine the relationship between taxation policy and wealth disclosure, separating out the impact of variations in capital income, bequest and wealth tax rates.
More tax, less wealth
The data analysis reveals a strong link between variations in wealth tax rates and the disclosure of wealth holdings. According to the estimates, a 1 percentage point increase in wealth taxation would have resulted in a sizeable 34% reduction in declared wealth holdings in aggregate (i.e. a 0.1 percentage point wealth tax increase leads to a 3.4% decrease in wealth holdings). The aggregate data findings are supported by the Bern microdata, where the response is a 2.3% reduction, still sizeable and significant. While the exact mechanism responsible for the reduction is unclear, the magnitude of the effect is undeniable.
The research shows that there is little response to variations in wealth tax rates in terms of taxpayer mobility
Furthermore, the research shows that there is little response to variations in wealth tax rates in terms of taxpayer mobility; both in terms of movement within and across cantons. It is a significant finding for policymakers given that the theoretical ability of the wealthy to move location in order to avoid wealth taxes is often cited as a reason not to impose or raise those taxes.
There are other important findings too. While capital income tax variations had no impact on disclosed wealth, bequest tax (inheritance tax) rates did. The responsiveness to wealth taxation variation was greater for financial assets than for non-financial assets, which makes sense given the liquidity of financial assets. And, while there was evidence of changes in wealth disclosure in response to tax thresholds – suggesting a degree of movement from just above thresholds to below them – this only accounted for a small element of the response.
Wealth taxation as a redistributive tax tool may not be as effective as its supporters hope
While the research was based on data from Switzerland, the authors believe that the results are likely to be generally applicable beyond Switzerland. The overall message is that, as wealth holdings are shown to be highly sensitive to changes in wealth taxation, wealth taxation as a redistributive tax tool may not be as effective as its supporters hope. At the same time, if a wealth tax is charged the research also demonstrates how policymakers can model optimum wealth tax rates to maximize returns while minimizing the likelihood of reductions in reported wealth.
Read the original paper: Marius Brülhart, Jonathan Gruber, Matthias Krapf and Kurt Schmidheiny (2016) Taxing Wealth: Evidence from Switzerland. NBER Working Paper #22376, Boston.