How much could a net wealth tax bring in?

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Today’s Free Lunch wraps up our series on wealth taxes. In the past four Free Lunches, I have pointed out the strange paucity of progressive wealth taxes despite the strong growth in wealth in the past four decades. I also reported from Switzerland, where wealth taxes neither scare away the wealthy nor cause a race to the bottom.

I ventured that one reason Swiss cantons could sustain large differences in wealth tax rates was because different cultural preferences also determined where people lived. On cue, Raphaël Parchet has alerted me to his new study with Beatrix Eugster, which measures the respective roles of social preferences for different policies and of tax competition between French- and German-speaking Swiss cantons. They confirm that while tax competition exists, cultural differences still translate into different policies, except right at the cultural border. “Our estimates indicate that tax competition . . .  significantly constrain the tax choices of jurisdictions that prefer higher taxes for approximately 20km, a distance we show to be consistent with moving and commuting patterns in Switzerland.”

I want to finish this tour of net wealth taxes with some reflections on why they are desirable. The point of a wealth tax is not just to increase taxation on capital in line with the growth of capital itself (relative to economic activity). This could, after all, be done by increasing more common taxes on capital, such as dividend income or capital gains. Nor is it just to make sure that capital taxation itself is fair, reflecting both the increased concentration of wealth in fewer hands and that the very rich hold less of their wealth in the most heavily taxed form: housing. There is another added advantage to the net wealth tax, which is that it may be the least harmful way to tax capital, even to the point of boosting productivity growth.

As we pointed out in earlier articles, there is little reason to fear that a wealth tax will hurt wealth accumulation much (certainly not more than other capital taxes). But beyond incentives for saving, we should note the incentives it creates for ways in which savings are invested. Because net wealth taxes are levied without reference to actual returns on capital, they in effect penalise low-return investments and reward high-return ones. So even if a significant wealth tax reduces the overall amount of capital in an economy, that capital will be more productive, and high-productivity will accumulate faster, raising the rate of productivity growth overall. This, then, is a method of taxing capital that grows the economic pie even as it redistributes.

How much could a net wealth tax raise? To fix ideas, suppose a tax applied only above the amount of net wealth that puts a taxpayer in the richest 10 per cent of the population — in other words, 90 per cent of taxpayers would not face it at all. In large western economies, the top 10 per cent hold a bit more than half of all private wealth, while in the US the share is 77 per cent, according to the World Inequality Report. The wealth threshold to be in the top tenth, meanwhile, is strikingly similar across countries: about twice the average wealth level in the US, the UK, France and Spain. That implies the taxable wealth above the threshold is about one-third of total private wealth in most rich countries, and slightly more than half of total private wealth in the US.

As the chart above illustrates, total private wealth amounts to about six times’ annual national income in rich countries. In the US and Germany it is a bit less, but there it is more unequally distributed, so more of the total wealth would be taxed under this hypothetical system. It means 200 to 250 per cent of annual national income is a fair estimate of the total wealth that would be subject to the tax in most western countries. So a 2 per cent annual levy should raise 4 to 5 per cent of gross domestic product.

That is a large sum — between one-tenth and one-fifth of most governments’ tax revenues. It would create enormous room for manoeuvre, which could be used to dramatically reduce other taxes on capital, or reduce taxes on labour and consumption, or remove the prohibitive effective marginal tax rates on low incomes caused by means-tested welfare systems, or finance productivity-boosting public goods. Add a smart tax reform of any of these four types to the fact that the wealth tax itself should increase productivity, and the wealth tax begins to look as close to a free lunch as economic policy ever gets.

Solape Alatise contributed to this article

Other readables

• A long read for the weekend: I have written an essay on “the other Brexit question” — how leaving the EU will affect Britain’s economic model and the domestic political-economy tensions that caused Brexit in the first place.
• A shorter read: Rummaging through the bazaar of unexpected Brexit casualties, what should I find but the travails of a German supplier of luxury bathrooms to Britain.