Is Wealth Tax Is Better Than Income Tax

Do you want to move money from the wealthy to the poor? Then, tax WEALTH.   A wealth taxis generally conceived of as a levy based on the aggregate value of all household holdings actually accumulated as purchasing power stock (rather than flow), including owner-occupied housing; cash, bank deposits, money funds, and savings in insurance and pension plans; investment in real estate and unincorporated businesses; and corporate stock, financial securities, and personal trusts.

How Would a Wealth Tax Work?

Given the excessive degree of wealth inequality in the Pakistan, its phenomenal increase in recent years, and the importance of wealth as a source of social and political power, it seems incumbent upon us to consider the possibility of extending the tax base to include personal wealth holdings. Such an extension may not only promote greater equity in our society — particularly, by taxing those more able to pay taxes — but may also benefit the economy by providing households with an incentive for switching from less productive to more productive forms of assets.

Few Arguments

There are four lines of argument in favor of a tax based on household wealth. The claims are that such a wealth tax improves the fairness of most tax systems, effectively raises government revenue, can further economic growth, and could have desirable secondary, social effects by reducing economic inequality.  

Fairness: It is generally held that taxes should be commensurate with ability to pay, and the tax laws of nearly all nations reflect this to a greater or lesser extent. A household’s wealth, its net worth, along with its income, are usually considered the best measures of socioeconomic status and so ability to pay. Net worth is also a good measure of the extent to which a household has profited from the economic infrastructure provided by governments, that is all taxpayers. For instance, it can be claimed that a wealthy investor or business owner has profited more than average citizen from the public education (of the work force), roadways (for carrying on commerce), financial security for the elderly (consumers), a judiciary to enforce commercial agreements, financial regulation, government subsidies to and rescues of corporations, and so on.  

It is argued that a wealth tax would improve the fairness of a tax system particularly to the extent that it replaces taxes that are less commensurate with ability to pay and profits from government-provided financial infrastructure. Sales and value added taxes are generally regressive as to income or wealth, since the wealthy spend a smaller fraction of their income and wealth than the middle class and poor. Real estate property taxes are generally regressive on overall wealth since the tax is a fixed percentage of the full value of the home. For young, middle-class families especially, this full value is often many times their net worth, while for the very wealthy it is generally a small fraction of their net worth.  

Income taxes are often a progressive tax on “taxable income,” but they generally do not tax unrealized capital gains from investments. Unrealized capital gains are likely the largest source of investment gains, but they are generally not defined as income for purposes of taxation. Therefore, for instance, an individual with a million Rupees in an equity mutual fund may have the value of that holding increase Rs.100,000 in a year, but can pay little or no taxes on that gain (in some cases even if he redeems shares from the fund).  

Taxing unrealized capital gains directly is impractical since it would result in massive yearly swings in tax revenue for governments and even large payouts from the government in years that equity markets are down. However, a 1-2% tax on household wealth above an exempt amount of several hundred thousand Rupees, (coupled with elimination of taxes on dividends, realized capital gains and estates) would amount to a roughly 25% tax on typical investment income/gains of 4-6% (including unrealized capital gains). This tax rate would be similar to typical tax rates on income from work or interest on savings accounts. For example: The Netherlands imposes a 1.2% tax on net worth, which is justified as a 30% tax on an assumed (“deemed”) investment return (income) of 4%. This justification could be used to answer criticisms that wealth taxes represent “double taxation” or “confiscation of property.” In the United States the same construction could be used to defend a federal wealth tax as a form of income tax, which is authorized by their Constitution.  

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We have to formulate a long term policy and should propose a rate of wealth tax on the net worth of individuals, that should this be used to eliminate the national debt. 

The reduction of wealth condensation in the investing class and bringing tax rates for investment returns closer to tax rates for work could reduce excessive investment and risky investment, which create investment bubbles, which in turn often contribute to the formations of some recessions. The reduction in regressive taxes, like property and sales taxes, would reduce the tax burden on newly unemployed workers, who owe these taxes despite having no income. This would help maintain their spending power and could prevent a recession from spiraling deeper. It has also been argued that a wealth tax could encourage the investment in assets that are more productive.  

It is argued that more financial resources in the hands of the poor and middle class would improve the educational opportunities for their children. This would promote social mobility, mean more citizens reach their full potential of productivity, and so improve the economy. More economic equality has been correlated with higher levels of innovation. Increased government revenue from a wealth tax could be used to promote public investment in services like education, basic science research, and transportation infrastructure, which in turn improve economic efficiency. Increased government revenue from a wealth tax coupled with restrained government spending would reduce government borrowing and so free more credit for the private sector to promote business. A strong, steadily growing economy could in turn increase tax revenues further, allowing for more deficit reduction, and so on in a virtuous cycle.

Details

Some governments require declaration of the tax payer’s balance sheet (assets and liabilities), and from that ask for a tax on net worth (assets minus liabilities), as a percentage of the net worth, or a percentage of the net worth exceeding a certain level. The tax is in place for both “natural” and in some cases legal “persons”.  

In France, the net worth tax on “natural persons” is called the “solidarity tax on wealth”. In other places, the tax may be called, or be known as, a “Capital Tax”, an “Equity Tax”, a “Net Worth Tax”, a “Net Wealth Tax”, or just a “Wealth Tax”.   Most of the governments levying this net worth tax are welfare states with a relatively high government spending to GDP rate.  

Some European countries have abandoned this kind of tax in the recent years: Austria, Denmark, Germany (1997), Sweden (2007), and Spain (2008). On January 2006, wealth tax was abolished in Finland, Iceland and Luxembourg. In other countries, like Belgium or Great Britain, no tax of this type has ever existed, although the Window Tax of 1696 was based on a similar concept.  

Existing net wealth/worth taxes

 France: A progressive rate from 0 to 1.8% of net assets. In 2006 out of €287 billion “general government” receipts, €3.68 billion was collected as wealth tax. See Solidarity tax on wealth.
 Switzerland: A progressive wealth tax with a maximum of around 1.5% may be levied on net assets. The exact amount varies between cantons.
  Netherlands: Interest income is taxed like a wealth tax, i.e. a fixed 30% out of an assumed yield of 4% is a rate of 1.2%. 
 Norway: Up to 0.7% (municipal) and 0.4% (national) a total of 1,1% levied on net assets exceeding NOK. 700,000.
 India: Wealth tax is 1% on wealth exceeding Rs 30,00,000. However, non-residents returning to India are given exemption for seven years.

Wealth tax causes far less market distortion, and hence, much fairer than income tax. Wealth tax hurt productivity less. If you live in a capitalistic country, then your income is yours fairly. However, wealth might not be traceable to productivity. Wealth through inheritance gained through slavery, or genocide. The link between wealth to productivity is less than the link between incomes and productivity. Hence, wealth tax discourages productivity less than income tax.  

Wealth tax also has meritocratic justification that can actually increase productivity. Property rights are effectively contracts between a person and the society. Part of the contract is that the society will protect the person’s property.  

Well, if you protect land, you should get paid right? Wealth tax is then effectively protection fee we pay to our local gangs we call governments. How much a society should get paid for protecting wealth? Natural pricing schemes will be of course something proportional to the amount of wealth protected.  

Let’s examine this issue. Wealth Tax as Protection Fee

The year is somewhere in 13th century. Kublai Khan attacked China. The peasants don’t bother fighting. Why? Because all they have, their life, they can take with them in refugee. The lands belong to landlords anyway. So just let the landlord fight.  

The Sung emperor realized this. So, the Sung court provided land sharing to peasants. Now the peasants have something worth dying for, land. However, it’s kind of late. Also, that enraged the land owning landlords who switched side to the Mongol. There goes Sung dynasty, the most prosperous country in the world at that time.  

Say a foreign investor puts 1 million dollars in 2 countries each. The first 1 million go to, hmmm… Let’s see…, No I would not say Pakistan!! Let say Somalia, where the money just goes away through local warlords. The next 1 million goes to Singapore with its strong laws and commitment to meritocracy. In which country the $ 1 million produce higher return? In Singapore of course.  

Now, say Singapore taxes wealth by 1% but gives 16% return. Say Somalia has no wealth tax but provide 0% return. Where do you want to invest your money? In Singapore…

At the end, any country that can provide return on to investors will motivate investors to invest money on that country.  

Countries will compete with other countries in trying to give better protection for investors. Countries that do it well can get away with more wealth tax and still be very attractive for investors. Investors will still put money in that country even though the country taxes a small percentage of wealth tax.  

If governments’ spending can be slashed, the rest can be given as dividend to all citizens in equal share for everyone manner. Karl Marx would love this, am I a commie or what? That’ll provide incentives for citizens all over the world to vote in favor of free market, privatization, or anything that gets money in. The more investor-friendly the countries are, the more money gets in, the more dividend those citizens will get.  

Some special arrangements should be around to prevent citizens from abusing the system by just making more kids to collect more dividends, but that’s easy to solve.  

Less Market Distortion

Say you’re equally poor. However, you’re more diligent than your peers. Then you wouldn’t pay much higher tax than your peers because you’re equally poor. Hence, wealth tax do not punish the diligent as much as income tax.  

When you’re richer, you can build factories rather than mansions. You don’t pay extra penalty for gaining income. So, you will pay the same amount of tax whether you build factories or mansions.  

It takes the same amount of military power to protect a mansion and a factory. So why in the earth factories pay more tax?  

Less Repulsive Than Income Tax

Will you invest money in a country with 30% income tax or in a country with 2% wealth tax? Well it depends. If you have a good business plan, then wealth tax is preferable than income tax. Good business plan means good returns on your investments, which means high productivity, income or profit. However, if your business plan is lousy or you just want to put your money for mansions that produce no return then income tax is preferable.  

Exchanging income tax into wealth tax will hurt incentives for good business plan much less. You’re not going to be penalized for having better business plan and earning more profit.

Higher return of investments are better not only for investors but for everybody. When businesses collapse, the ones that collapse first are usually the ones with lower returns that’s just above the margin. Things go a little wrong and those bad business plans will collapse. Income tax encourages all businesses to be like that. Wealth taxes do not penalize profit and hence will increase profit.  

If wealth tax is done in exchange of income tax, good investors would love it more and invest more money. Bad investors that governments will end up bailing out with IMF’s help can invest somewhere else.  

Doesn’t Go Berserk

No people in any country, in their right minds, would demand too much wealth tax. Why? Because too much wealth tax will simply drive investors away. Some countries can demand bigger wealth tax but only if they do their homework well, such as maintaining security and explicit consistent rules.  

At the end, there will be a nice supply and demand relationship where all countries try to provide the best capital protection and efficient economic and capital growth at the least possible cost or tax. The citizens in such countries can simply pocket the difference, which will be called profit. When citizens think like stock holders, then politicians will think like CEOs.

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