In this weeks blog by NERI Co-director, Dr. Tom McDonnell he discusses an Oxfam report in regards to a wealth tax.
A recent report by Oxfam has gotten significant attention this week. The report points to rising inequality globally and the supernormal gains of billionaires during the pandemic. Inequality and its consequences for social solidarity, poverty and economic sufficiency, and indeed even the impact of excess wealth inequality on the democratic process itself, have all become increasingly focal points of debate across the world. Oxfam propose the introduction of tax on net household wealth in order to reduce these inequalities. They suggest that a 1.5% wealth tax on Irish billionaires could raise more than €700 million each year and that the same rate levied on Irish millionaires above €4 million could raise €4 billion in tax revenue.
The historical experience of wealth taxes is that they have generally been introduced as a form of social solidarity in the face of major economic upheavals such as severe recessions. The political sustainability of introducing or increasing other taxes on low- and middle-income households is often determined by the perception of fairness and the idea that we are all in it together. This drives a push for taxes on excess wealth.
Economic inequality is a function of income inequality and wealth inequality amongst other factors such as the availability of free public services. While the Irish tax system does a good job of recognising and ameliorating income inequality via the progressive income tax system, it only very modestly addresses wealth inequality. A tax on net wealth that would impact upon just a tiny minority of extremely wealthy taxpayers without any risks to poverty and deprivation has to be considered given the future pressures on public spending and fiscal sustainability and the possibility or even probability that taxes will need to be broadened or increased or both.
Wealth is a function of past endowments (mainly inheritances), past income flows, past value changes, as well as past saving and consumption decisions. The distribution of wealth in the population is more much concentrated than that of income and most of that wealth has been inherited unearned across generations. Wealth inequality will also grow over time in the absence of progressive capital taxation and the taxation of acquired wealth. In addition, modest taxes on wealth (net wealth taxes, estate taxes, and inheritance and gift taxes) are likely to have minimal impacts on economic growth and poverty relative to taxes on labour, taxes on consumption, or taxes on capital income.
What is the situation in Ireland? We do have a 33% tax on gifts and inherited wealth called Capital Acquisitions Tax (CAT), albeit with a very generous tax-free threshold €335,000 for children. However, the current range of reliefs and loopholes related to CAT enables the very wealthy to minimise their liability. For example, the business and agricultural reliefs enable the inheritance of over €3 million in unearned income before attracting any liability and thus the tax-free transfer of substantial amounts of wealth across generations. This is obviously repugnant to horizontal and vertical equity and depletes the tax yield each year by close to €350 million. It is also unclear whether there is any economy-wide return on these reliefs.
A recurrent tax on net household wealth would have important political economy benefits. In particular, the perception of social solidarity would make it far easier to introduce other desired tax and welfare reforms. Even so Ireland should be extremely careful not to pursue the type of wealth tax that has tended to prevail internationally. These taxes have been characterised by high rates and numerous exemptions. The way that a wealth tax is designed will have an enormous impact on its effectiveness and fairness.
In addition, the equity goals underpinning the wealth tax imply the need to tax ‘excessive wealth disparities’ rather than ‘all wealth’. A 2013 NERI working Paper by myself McDonnell (2013) summarises the arguments for and against the introduction of a tax on net wealth with regard to the key underlying objectives of:
(A) Obtaining a meaningful yield,
(B) Adhering to horizontal and vertical equity,
(C) Minimising economic distortions and risk of capital flight, and
(D) Minimising administration and compliance costs.
I argued that the most compatible structure is one with:
(1) Either zero or very few exemptions and reliefs,
(2) A high threshold of liability (e.g. €1 million net wealth), and
(3) A flat marginal rate that is set at a low level (i.e. below 1%).
Overall, I found that such a tax is feasible as a complement to income tax and would yield in the low hundreds of millions of euro, although precise estimates are impossible in the absence of up-to-date wealth distribution data.
The ESRI’s Lawless and Lynch (without advocating one way or the other), and myself McDonnell, (2018) subsequently discussed tentative yield estimates. Lawless and Lynch describe a scenario with a 1% rate, a €1 million personal threshold (doubled if married) and an additional €250,000 per child. This would have generated €248 million in 2013 and affected just 1.5% of households. It’s worth noting that net household wealth has increased significantly in the interim period and therefore the potential yield. In practice, a rate of 0.5% might be more appropriate. As an example, a threshold of €2 million for a couple, with a marginal tax rate of 0.5% implies an effective tax rate of just 0.17% (€5,000) for a household with net wealth of €3 million.
If the core objectives of a wealth tax are horizontal and vertical equity then we can see the wealth tax as a complement to income tax, which reflects the additional taxable capacity of the wealth holder. A wealth tax with minimal exemptions could also be a valuable tool for clamping down on tax evasion. If we can ensure the net wealth tax has a minimum of exemptions and reliefs, and has low marginal and effective rates, then we can minimise distortions to economic activity.
Overall, the NERI’s view is that the tax system should be compositionally reoriented towards taxes on property and wealth relative to other tax types. Doing so would be more economically efficient than increasing taxes on labour income or capital income and would not generate the adverse inequality, poverty and deprivation outcomes from higher taxes on consumption.
There is a strong case for broadening the tax base to include an annual wealth tax – albeit only one that is carefully designed. Such a tax will be on a self-assessment basis, will recognise ability to pay, will seek to minimise economic distortions by having no reliefs but a high threshold and low rate, and should be as simple as possible.