#4 – Wealth Taxes
This article has taken me forever to write, mainly in small chunks of available time. Incidentally, the picture above is a Beverly Hills property available for sale on Zillow for a mere USD 160 million if you’re interested. Thought it was topical.
In early September I read that California was possibly planning to introduce a wealth tax. This was interesting to me for two reasons:
- I’d been looking for a good segue (pronounced “segway”, which has always confused me) from my last blog to talk about wealth taxes and their interaction with inheritance taxes in a bit more detail and this presented a perfect opportunity!
- Quite frankly, it’s astonishing that an American state is considering such a measure so I wanted to explore it.
I mean, there was talk of a 2+% US federal wealth tax on wealthy taxpayers early in the US election campaign, primarily from Elizabeth Warren, with a similar proposal mooted by Bernie Saunders. However, Warren was not a mainstream contender, so whilst it was a good opportunity for journalists to talk about wealth taxes generally (and there were a LOT of articles produced in the US focused press during the Spring of this year covering the topic and implying it was doomed to failure), it was never really likely to become a reality on the “other side of the pond” as we Brits like to call the part of the world we tend not to ship tea to any more.
I want to take the opportunity with this article to set out here a general discussion about wealth taxes and to some degree, inheritance taxes, by reference to topical events such as the California wealth tax proposal, and doing a round-up of similar proposals and existing wealth tax regimes, to discuss their suitability for revenue raising and why some countries have shown some reluctance in the past in implementation such taxes. I also compare wealth tax to the other obvious tax on wealth: Inheritance taxes. In this article I have no objective other than to discuss these taxes conceptually and set out my own views as to their suitability in the current economic environment, affected as it is by the impact of Coronavirus. There will be no explosive conclusion, so apologies now for any disappointment. It’s just a walk in the park.
California’s revenue woes
Now, California seems to have been looking for extra ways to bring in revenue for the past couple of years, and, as with a number of other jurisdictions, it seems that things have become more urgent as the financial cost of Coronavirus has made its effects known and, in June 2020, a budget deficit of USD 202 billion was signed off by California’s governor.
Attempt 1 – State estate tax
An attempt was made to introduce a state estate tax last year (SB 378), although nothing came of it. The idea was to cover the difference between the levels that the US federal tax free allowances had been at a few years ago (let’s call it “about USD 3.5million”, because what’s a couple of thousand dollars between friends?) and where US federal inheritance currently bites (about USD 10million for an individual). A helpful summary of the history of US federal estate tax thresholds and rates can be found in this article. California is one of the majority of US states which currently does not charge a separate state estate or inheritance tax, but it has charged it in the past. Until researching this article I hadn’t even realised that some states levy a separate estate tax in addition to the federal estate tax. Currently 17 states and DC do have a state estate or inheritance tax! This article is a great summary of the various state regimes currently in force.
For anyone not familiar with US estate tax, when it does bite, it bites hard. The tax is charged at the rate of 40%.
Incidentally, US tax thresholds are complicated because of inflationary adjustments, so for the remainder of this article, when talking about US taxes, I’m just going to talk about the unadjusted amounts because it’s easier, but if you really want to know the exact thresholds, Google is your friend, and it’s not hard to find :).
Attempt 2 – Income tax surcharge
In the meantime, California has also been trying to introduce an additional income tax increase in the top state personal income tax rates under bill AB-1253, applicable to incomes of over “about” USD 1m, with the highest rate, when added to the current rates, bringing state income tax up from 13.3% to 16.8%. This doesn’t sound like such bad income tax to many non-Americans who might not realise this is on top of federal income tax, as well as any city taxes and property taxes. Top federal rates of income tax are currently at 37% for taxpayers with income of $500,000+, so the combined top rate of tax is already slightly over 50%, before any supertax is added.
Attempt 3 – That Wealth tax proposal
Assembly Bill 2088 sought to introduce a wealth tax, targeting extra revenues of USD6bn. I’ve set out more detail below so I’d rather not take up space by summarising it here.
Quick commentary before we continue...
Let’s consider the approach as a whole though, as there are some common themes in each of the above proposals (besides the fact they weren’t actually passed). I think we can surmise that whilst California is clearly trying to increase its tax revenues, it is trying to do it in a targeted way which increases the burden at the levels of wealth and income that most people think can afford a little extra burden. Dead people with assets over USD 3.5million, couples with over USD 30 million and anyone with income over USD 1 million don’t exactly cause tears of sympathy for the overtaxed, so the proposers of these Bills are taking care to avoid hitting the middle classes that perhaps would feel the effects of any additional taxes in their wallets each month, and focusing on those who have some healthy reserves.
California wealth tax proposal
So, let’s get to it. California’s proposal for a state wealth tax was a 0.4% annual wealth tax on pretty much all asset classes, including holdings in a business, financial assets and moveable assets (chattels). It would apply only to assets exceeding USD 15 million per individual or USD 30 million for married couples filing jointly, and applies exclusively to the wealth over the threshold (i.e. if you have USD 40 million in assets held together with your spouse, you lucky thing, you only pay the tax on the top USD 10 million). We’ll have a look at other countries’ wealth tax charges later on and in the international context, it’s a relatively modest wealth tax. Perhaps the counterargument is that the overall taxation in California is already pretty high…
Interestingly the tax does not cover directly held property (real estate). This initially might seem to be a really generous loophole, and perhaps still advantageous for those with out-of-state property, but then California already charges a 1% property tax each year (for everyone) so I think it’s fair to say that any wealth tax on top of the same assets could be accused of taking…”liberties”.
Reactions to the proposed tax have been surprisingly negative. This would be the first ever introduction of a wealth tax in the US. On the one hand, people in the rest of the US may be just used to dismissing what goes on in California, but most press coverage I could see ranged from “don’t do it, because it will make rich people leave” or “don’t do it quickly – it’s complicated and you’ll probably mess it up if you rush it through” or a combination of both.
This balanced article from the LA Times from last month suggests that that tax might need a little bit more thought before pushing it through the state legislature, showing a perceptive approach to how these things work in practice. And they are right to point this out, but presumably these are details that can be figured out if needed, should the tax ever look likely to become law. Even the Europeans have managed it…
To put the tax in context, an unmarried person with USD 30 million in non-real estate personal wealth, after deducting the first USD 15 million, is going to be paying USD 60,000 annually in wealth taxes. I would hope that for most people in that wealth bracket, this is an affordable sum and can be met with liquid assets without forcing a sale of anything, but of course there are people who are cash poor and asset rich and this needs to be considered as well. It can’t be the intended outcome of a tax to make people start selling possessions with an emotional value just to pay taxes.
I noticed a recent article on Forbes suggesting that Elon Musk’s personal wealth had just gone up to about USD 85.9bn (up from a mere USD 68bn a week or so before). Should this tax ever take effect, he’s going to have to find about USD 344 million annually to pay the tax. Famously Mr Musk’s wealth is pretty much all tied up in his businesses. Fortunately, provisions in the wealth tax bill had even provided for a situation like this, allowing a deferral of wealth taxes where a taxpayer has all his wealth tied up in illiquid assets, so at least there’s that aspect covered. I’m sure Mr Musk is feeling a lot less worried now.
On the other hand, whilst this, objectively, is a lot of tax to pay on a taxpayer’s static asset base, on top of property taxes and income taxes, my inner leftie suggests that perhaps that’s more wealth than anyone or their family will ever spend in a number of lifetimes, and perhaps that’s a level of personal wealth concentration that could be usefully dissuaded for the public good. Given that, when government can’t cover its proposed expenses, whilst the electorate shouldn’t be signing a blank check to finance general silliness, if the poor can’t pay, perhaps the rich should.
Don’t get me wrong, I also don’t think that the wealthy should be tapped every time government can’t plan its budget properly, and I believe in moderation in most things, including taxation and public spending. However the current situation has made governments and citizens rethink their principles. It’s also exposed the already marked gap in some countries between the haves and the have nots. I’ve lived all my life in Europe so I identify with the concept that the government should step in and provide a social plan when things go wrong. When the government is spending sensibly and trying to balance the various interests involved (ensuring people can afford to eat, and trying to support business), especially when something like Coronavirus comes up, I think it’s legitimate to approach those who can afford to contribute a little more.
So, for good order, we’ve set out what the California wealth tax would have been, had it passed in the current legislative session, and perhaps may be reintroduced next year, and now I’d like to take a step back and look at the general nature of wealth and inheritance taxes and do a comparison.
Death and taxes, and taxes without death…
Taxes on wealth have generally not been a popular tax for politicians to introduce for quite some time. Above all, beyond a couple of exceptions, governments tend to feel that, if they’re going to tax wealth, they would either make a small annual tax (a wealth tax), which can be complicated to assess, and pretty unpopular, or charge a one-off tax when the taxpayer doesn’t need the money any more (an inheritance tax or estate tax). After all, heirs are voters too, and they feel the money being taken out of their inheritance by the state. Also, there’s a practical cashflow issue: if we don’t know when someone is going to die, we don’t know when the tax is coming in, so an annuity income (annual wealth tax) might be preferable to a one-off hit. In fact, the tide had been generally turning against wealth taxes over the last decade or two with a number of countries abandoning their wealth taxes (France, although it swapped it for a property tax), rather than introducing new ones.
Given the general policy background to taxing wealth (assuming we don’t see these as poorly considered opportunistic taxes) it’s fairly unusual that a government would feel they could tax capital on death and on the same wealth on an annual basis. Both taxes tend to stir up deep resentment among those who have to pay it, and also generally do not produce anywhere near the levels of revenue as income taxes, sales taxes or corporation taxes. So the question for governments might often be: Is it worth all this trouble for such a small additional tax? Most wealth tax, and indeed inheritance tax, rarely provides revenues about 0.2% of GDP (with the notable exceptions of Switzerland, Luxembourg and Norway), which is really peanuts compared to pretty much all other taxes.
However, it seems the direct and indirect costs associated with Coronavirus is forcing governments to be creative and find new sources of revenue, every penny counts, and countries appear to be looking to the wealthy, who can afford to shoulder the burden.
So, who has successfully pulled it off in the past? And why do we tend to associate such taxes with socialist European countries?
Wealth tax in Europe
Of 12 EU countries that had wealth taxes in 1990, only 7 of them have one now, some on a more targeted basis than others. Those European countries currently charging a wealth tax (in some form or another) are:
- Switzerland has had wealth taxation since 1840. It’s levied by the cantons, not as a federal tax, at rates between 0.3% and 1% – it raises around 3.5% of total Swiss tax revenue (CHF 9.2bn in 2018)
- Norway, dating back to 1892, taxes wealth at a rate of 0.85% on investments over EUR 150,000 – raises around 1.1% of Norway’s total tax revenues (EUR 1.9bn in 2018)
- Spain, at rates between 0.2% – 2.5% on wealth exceeding EUR 700,000 – raises around 0.5% of total tax revenues, EUR2.2bn in 2018)
- Belgium, at a rate of 0.15% on assets over EUR 500,000 (EUR 1bn in 2018, but less than 0.5% of total taxes)
- Italy taxes at a rate of 0.2% on financial investments and 0.76% on overseas properties, raising EUR 0.2bn in 2018
- Netherlands levies an income tax on wealth by charging 30% on a presumed income and also a wealth tax on certain assets over EUR 30,360 at between 0.18% and 1.68%,
- Luxembourg raised EUR 1.7bn in wealth taxation in 2018, which was an impressive 7.2% of total tax revenues that year, raising 2.9% of GDP (for comparison purposes). The tax rate there is 0.5%.
- France (kind of), although technically it scrapped its wealth tax in 2017, but the replacement property tax still generated EUR 1.8bn in 2018 revenues according to OECD data (albeit rather less than the EUR 5bn in 2017)
Incidentally, Germany ruled its own wealth tax unconstitutional in 1995 on arguments connected to state confiscation of private assets, and this is something I want to get back to later particularly where wealth tax can be an emotive topic when it cuts into capital. The dividing line between taxing wealth and confiscation is always going to be a matter of degree and perspective.
I should point out a couple of things:
Firstly, many of the above countries have an inheritance tax as well, but most civil law countries charge different tax depending on the connection between the deceased and the heir. For example in Switzerland most cantons don’t charge tax in these circumstances, France charges 15% on transfers to direct descendants and Italy’s highest rate of inheritance tax for unconnected persons is 8% (for descendants it’s 4%) so whilst it is unusual for countries to charge both inheritance tax and wealth tax, and I appear to have contradicted myself here, it’s a matter of context. Inheritance tax in the UK and US is charged at 40%, irrespective of how close the family connection is. Therefore, for those countries above that do charge a tax, it’s not a significant one for transfers within families, and higher rates are more a policy disincentive to transferring wealth outside the family than a revenue raiser.
Secondly, it’s unusual for wealth taxes to be charged above 1%, and really unusual for it to go above 2%.
Sources: Tax Foundation ; Business Insider ; OECD Statistics
Wealth Taxes in the Americas
Of course, the Europeans are not the only ones who already know the concept of wealth taxation. Outside of Europe, specifically in the Americas. Argentina, Uruguay and Colombia also already charge wealth taxes.
In addition to the recent (significant) increase to Argentina’s Personal Assets Tax, which was just tripled (raised from 0.25% to 0.75%,) but for reasons other than Coronavirus, following last year’s default on sovereign debts, there is talk of some additional countries in Latin America (potentially behind paywall) perhaps introducing such a charge:
- Brazil is talking about finally introducing a tax that has been in the pipeline for years, at rates between 0.5% and 2.5% starting at quite modest levels of wealth (USD 0.5m including real estate)
- Chile is mooting a similar tax but, like California, is focusing on taxpayers with higher levels of wealth. It is considering a fairly high rate of tax at 2.5% on wealth over USD 22.5m. This is projected to bring in around USD 6bn.
So is wealth taxation a good way to raise revenues?
A wealth tax, if done in a targeted way, could be a useful tool, especially now, when sales taxes, income tax and corporation tax increases could have negative effects on the economy. However, it would need to be set at a level that it doesn’t cause liquidity problems. For example, at the moment business owners with limited liquid assets may struggle to cover wealth tax charges from their other assets, especially where interest on savings accounts yields basically nothing and investment yields are volatile. Those with separate investments (for example an informal backup plan for retirement may be forced to dip into those savings to pay wealth tax on a theoretical value on their business and potentially real estate) and where tax levels are set so that this would be the outcome then the tax could be accused of being wrong-headed.
Does it then make sense to introduce exclusions (like the value of an operating business, pensions, family home)? If so, is it an invitation to abuse? If I had USD 100m and didn’t want to pay wealth tax on it, would it be bad if I invested 80% into a business to save the tax? And here we can afford to get a little philosophical. If the purpose of a wealth tax is to help cover the cost of keeping people in employment so they can contribute to the economy and be self sufficient, is it a bad thing for wealthy families so support business?
Also, the levels of wealth tax generated from the masses (I guess we could say here estates of under USD 5 million) is probably not worth the administration cost and bad feeling such a tax generates.
The other problem is of course valuations. If a tax were introduced in a country that didn’t already have an obligation to report net wealth to the tax authorities, the immediate problem becomes valuing the interest you have in an asset for wealth tax purposes. For example, the privately held family business with a variable track record (the balance sheet isn’t necessarily the market value), real estate (do you really need to get an appraisal each year, just to confirm you don’t have to pay the tax?), that painting you inherited from grandma…is it worth the hassle? I’d argue, no, not for modest wealth levels – just agree a level below which a realistic estimate that assets don’t exceed that level and confirm no filing is necessary. I spend hours collecting valuation documents for my Swiss tax return, only to prove I don’t have to pay the tax, and my tax affairs aren’t that complicated. Add a foreign property, a share in a small business, or a difficult-to-value personal item? Eek!
So what's the intended effect?
Are governments making me transfer money to my children? Or taking money away from them? This will always be a personal decision, and a matter of degree, and a question of planning, depending on the taxes in place, as well as collateral taxes like capital gains tax, that can make a transfer more expensive because it triggers more taxes.
Obviously the government can’t make anyone do anything with their wealth. However, governments who introduce wealth taxes, depending on the harshness of the tax, incentivise the transfer of wealth, in the same way as tax breaks on income, gift taxes and inheritance taxes incentivise charitable giving. It’s no more than that. It’s a gentle encouragement.
Inheritance and gift taxes penalise the transfer of wealth, whereas wealth taxes discourage the accumulation of wealth. Is there a clever way to reduce wealth tax on your estate? YES (potentially, bearing in mind gift and inheritance taxes that might apply, rates, annual exemptions and applicable time limits etc)! Give some of it away and only keep what you need. Does this mean you have to put assets in the hands of spendthrift children? Not necessarily.
Firstly, trusts, foundations, insurance policies and other devices such as cleverly designed corporate vehicles allow the transfer of assets to family members without necessarily risking these assets being lost in bankruptcy, divorce or other unplanned dissipation of assets.
Secondly, you are endowed with the power of choice. The tax tail shouldn’t necessarily wag the dog. If it’s better to pay a modest tax charge than put money in the hands of someone who’s not prepared for wealth, that’s still an option. But also consider the long term. There are a number of education programs out there designed precisely to educate the children of wealthy individuals to get used to handling money. One option is to give them a responsible role in making grants from the family charitable foundation (if there is one) and let them have a chance to build a track record in handling financial decisions responsibly before placing wealth directly in their hands.
Wealth tax vs confiscation
There is another argument as to why some governments may have been hesitant to charge a wealth tax. Think of a natural progression like this:
- Government charges income tax (no cause for alarm)
- Government introduces reporting obligation to understand the asset base (ostensibly to check the income tax is plausible) (We have this in Switzerland. It’s annoying but I’m not worried)
- Government knows the wealth you have, and either introduces:
- Asset control rules preventing the transfer of wealth out of the country (a tried and tested route for countries with stability issues to get assets under their control)
- Wealth tax at modest rates, let’s say anything up to 2%
- Wealth tax at very immodest rates (we might call this confiscation if we were minded to), let’s say 10% upwards
In some countries, where governments have, in the past, taken people into custody on trumped up charges (or extrajudicially) and simply confiscated opposition’s assets with minimal formality it’s probably a legitimate fear based on past experience, that a new face on an old regime might tackle things in a more apparently sophisticated way.
Or consider white-owned farms in Zimbabwe, or South American countries with a history of coups d’etat or populist political agendas (and empty treasuries). Alternatively the idea of a solidarity tax on investors in Cyprus a few years ago, on a slightly different scenario considering taxing foreign investors.
So where is the dividing line between taxation (generally accepted as legitimate revenue collection for the greater good) and confiscation (less acceptable)? This is always going to be a tricky call, but potentially depends on the long term impact and how quickly the tax bites into your wallet. Clearly a wealth tax of 50% is unacceptable. A no-brainer. What about 1%? Possibly ok. 20%? Rather not. Total elimination of wealth in 5 years. What about 5%? See the problem? Added to which, taxes like this are always going to be emotive. The poor think the rich should be taxed more, the rich think the government is penalising successful wealth generation and creation of jobs, and move away. Always a delicate balance.
So consider the California approach for a moment. A modest percentage tax only on wealth which significantly exceeds normal levels of accumulated wealth, at a time when some of those who can afford it are willing to help, and those who can’t afford it have no safety net. I think it’s not a bad approach. Consider that lots of detail needs to be worked out to make it so that (1) it actually meet the intended policy goals, (2) avoid messy valuation discussions, (3) doesn’t drive away taxpayers into lower tax neighbouring jurisdictions (a frequent issue in Switzerland where, for cantons, tax competition is fair game to attract wealthy taxpayers and balance the books), (4) anti-avoidance is addressed but fair planning opportunities are available and (5) the cost of administering it doesn’t outweigh the revenues it generates (appropriate targeting).
So, keep it reasonable (don’t charge much more than 1%) and keep it focused on real wealth (USD 5/10 million and above), and it might work on a sustainable way.
If it’s not unconstitutional under the US Federal constitution (unreasonable seizures or deprivation of property without due process, but who knows if a challenge based on this would be successful) then let’s see if it comes back in the next session.
All in all, it’s not evil, and the time is right for radical measures to fill many budget gaps and try to address the wealth gap. Maybe it’s worth a thought after all!
PhilG
Thank you, next please!
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