The strong case for a wealth tax

For 100 years, the primary method for dealing with inequality has been the income tax. Unfortunately, this tool is becoming increasingly inadequate for dealing with the new phenomenon of super-rich billionaires.

The richest person in Canada, David Thompson, is estimated to possess family wealth of $77 billion. Imagine for a moment that society were to try to tackle this by implementing a 100 per cent income tax on his annual income, on top of which Thomson spends, say, $100 million a year on various mansions, banquets, yachts and other frivolities of the superrich. It would still take 770 years to reduce his total wealth to levels of normal people.

To meaningfully reduce inequality the income tax simply won’t cut it. We require a wealth tax.

Wealth taxes are not new. They have existed in a dozen countries in Europe over the last several decades, working decently in some cases and terribly in others. In practice, wealth taxes typically face three reoccurring obstacles:

One is accurately valuing the assets of the rich, since certain assets like artwork or private businesses might not have an obvious price.

A second is exemptions. These are deadly to the wealth tax because they lead to widespread gaming of the system. For instance, in Sweden, exemptions on business equity made it easy for rich individuals to simply shift their wealth into ownership of firms and thereby avoid the wealth tax.

The third problem is tax avoidance. Estimates of this vary widely but the most pessimistic estimate is that it can be a big problem indeed: a one per cent increase in the wealth tax lowers the amount of wealth that rich individuals declare by roughly 40 per cent after five years.

Luckily the last few years have seen an explosion of studies examining what makes wealth taxes succeed or fail in the real world.

We now know that the valuation problem is actually smaller than it first appears, since at least 80 per cent of the wealth of the top 0.1 per cent wealthiest families is in the form of assets that are regularly traded. These include publicly traded stock, bonds and real estate, and so have a clear market price. Does anyone really believe that Elon Musk can hide the bulk of his wealth when everyone can readily see the value of Tesla shares?

For private businesses, simple effective formulas can be used to approximate their value. For instance, Switzerland uses rules based on the book value of business assets plus multiples of the firms’ profits. Mistakes will happen, of course, but tax authorities can correct them by using retroactive adjustments when assets are finally sold. Taxpayers can then be refunded or debited if it turns out their assets were worth slightly less or more than originally estimated.

Avoidance can also be substantially mitigated by having a centralized tax system for the whole country, since in Switzerland and Spain the rich often avoid wealth taxes by simply moving to a different city. It’s also necessary to make extensive use of third-party reporting whereby one’s financial information is passed directly to the tax authorities by intermediaries such as employers or banks.

After all, it’s not as if the wealth of the rich is truly unknown. The wealthy know exactly how much their investments are worth since it’s meticulously recorded in their banking documents. All that’s needed is legislation requiring such information to be automatically shared from the banks and money managers to the tax authorities, as is already common practice with many people today for their regular income.

According to state-of-the-art research, instituting a centralized tax system and third-party reporting would likely reduce total avoidance in Switzerland from a disastrous 43 per cent to a sustainable 6.9 per cent.

All in all, the evidence is clear: an effective wealth tax is completely feasible as long as it is designed cautiously and carefully.

Just as the income tax was a fundamental requirement for building the welfare state in the 20th century, the wealth tax is a fundamental requirement for building a decent society in the 21st.