A Comprehensive Study on Wealth Tax

Wealth Tax is a type of Direct Tax which is generally levied on the super-rich people of the country. It is not a tax on income but rather a tax on the wealth of an individual. Wealth and Income are often confused with one another but they refer to two completely different things. Income generally refers to the annual inflow of money, we receive for the work we do whereas Wealth is the total value of all the assets that a person possesses which includes but not limited to houses, cars, jewelry, and income as well. Therefore, Wealth tax is a tax on a person’s assets or generally called the net worth of an individual. In other words, Wealth tax is a tax on what we have, as opposed to income tax, which is a tax levied on what an individual earns. Most politicians and some economists see Wealth tax as a tool to curb the inequality between the super-rich and poor people of the country. It is a reality that in every country of the world, most of the country’s wealth is concentrated in the hands of a very small percentage of people.

In 1990, 12 advanced economies had a tax on household wealth but in the present there are only four economies (Spain, Norway, Switzerland, and Belgium) that are following the Wealth tax regime. Many factors have been put forward by the countries that repealed the Wealth taxes to justify their stand. The main arguments that have been put forward are related to the efficiency costs and the risk of capital flight. There have been several studies that suggest the net wealth taxes have often failed to meet their redistributive goals as a result of a very small tax base and also due to tax avoidance and evasion. To some extent the limited revenue collected from wealth taxes has made their elimination more acceptable and feasible from a political point of view.

More recently, the concerns pertaining to the increased wealth inequality, combined with the need to increase the Government revenues, we can see a renewed interest in wealth tax across the world. Iceland, which had repealed the wealth taxes in 2008 reinstated it as an emergency measure from 2010 to 2014 and similar was the case in Spain. Moreover, from a practical perspective, tax administration improvements and the significant progress that has been achieved on international tax transparency and the exchange of information has made arguments such as ineffectiveness of the wealth taxes, high operational costs and many more arguments less convincing. Switzerland Model of wealth tax implementation has emerged as an exception as tax revenues from individual wealth taxes has always been increasing on yearly basis.

In most of the countries of the world, private wealth is very much unequally distributed among the population of the countries. In the 18 Organization for Economic Co-operation and Development (OECD) countries for which comparable  data is available, the bottom 40% own only 3% of total household wealth and on the other end, the top 10% of the wealth distribution hold half  of the total household wealth and the wealthiest owns almost 20% of the total wealth of the country. Similar is the case in India as well, in India the top 10% wealthiest people own approximately 56% of the total wealth of the country. Wealth inequality is a much greater concern than income inequality as many of the households do not have any wealth or even in some cases has negative wealth. The association between the income and wealth tends to be high at the two extremes of the distribution. The data collected from the World Wealth and Income Database compares the evolution of the top 1% net personal wealth share in France, the United Kingdom, and the United States and it also confirms the trend towards greater wealth inequality in recent decades, in particular in the United States, reversing a long term decline throughout the 20^th  century.

There are various factors that account for cross-country differences in the composition of wealth. For an instance, the share of financial assets (bank deposits, holdings of shares and bonds) as compared to real assets (houses, cars, etc.) tends to be higher in countries which have large private pension systems, higher level of financial development and greater levels of financial education. The share of financial assets may also be higher in countries that have large housing sectors which tends to discourage ownership of homes as a report of the International Monetary Fund (IMF), 2014. Trends in asset values are also major factors affecting the composition of wealth across the world.  Thus, differences in taxation will surely influence the composition of household assets. A large share of wealth in the financial assets serves a better purpose and is very important for the development of the country.

All over the world, Capital is being taxed in the form of income taxes and property taxes. Capital income taxes are levied on the flow of income from assets whereas the property taxes are generally levied on assets. Property taxes can further be subdivided into two major categories of taxes- taxes levied on the transfer of property and taxes which are levied on the use and ownership of property. Sometimes the boundary between the net wealth taxes and these capital taxes becomes blurry. A key difference between the net wealth taxes and capital income taxes is that the wealth taxes are imposed irrespective of the actual returns. Net wealth taxes do not tax the actual returns earned on assets but are equivalent to the taxation of a fixed return. 

This further implies that, if we compare the wealth tax with the capital income tax, a net wealth tax implicitly imposes a lower effective tax on the return of high yield assets compared to low yield assets. A net wealth tax is more comprehensive than a capital income tax. As opposed to capital income taxes, under a net wealth tax, even the assets that do not generate monetary returns are generally taxed such as artworks, luxury cars, yachts, etc.

Similarly, net wealth tax is also very different from property taxes that are levied on the ownership, transfer or use of the property. As opposed to other taxes on wealth holdings, in particular recurrent taxes on immovable property, net wealth taxes are levied on a broad range of capital stock or property. Net wealth taxes are levied on immovable property, movable assets, and financial investments. The main rationale argument in support of wealth taxes is that total wealth stocks are a better of taxpayers’ ability to pay the taxes. Wealth taxes are also very different from the inheritance taxes levied in the name of property taxes as net wealth taxes are levied on both inherited and self-made wealth. Under a net wealth tax there is no difference between wealth resulting from the personal effect and lifetime savings of an individual, inherited wealth, or even the increase in asset values or luck.

The case for wealth taxes:

• Reducing wealth inequality and promoting equality of opportunity

As discussed above, private wealth is very much unequally distributed among the population of the country and wealth inequality has always been on the rise in recent years. One of the main reasons for this is the Consumption tax which is levied on the everyday products and services that people render; the tax is the same for the poor as well as the rich which makes the rich save more as compared to the less fortunate and poor people. These recent wealth distribution trends have strengthened the idea of taxing the wealth of the super-rich individuals. The existing capital income taxation system does a very poor job in meaningfully taxing the top super-rich citizens of the country. Thus, a net wealth taxation system can be very useful source of increasing the revenue of the Government and would further help in reducing the wealth inequality and will also promote equality of opportunity.

• Net wealth taxes could also be an efficient substitute for capital income taxes

Net wealth tax in substitute for capital income taxes could help in encouraging the taxpayers to use the assets more productively and efficiently. For instance, if an household owns a land which is not used and does generate any income, no income will be levied on it but on the other hand, if a wealth tax is levied, the household will have an incentive to make a more productive use of the land. Indeed efficiency gains can occur because capital is reallocated to high return individuals and this further can motivate them to saving larger amount of wealth. The argument being put forward is that wealth tax does not discourage the investment per se but eventually discourages the investment in low-yielding assets as compared to high-yielding assets.

• Wealth taxes helps in promoting human capital investment

Human capital is always exempt under net wealth taxes. This result from a number of considerations which includes the fact that the valuation of human capital is really very difficult, human capital is not directly transferrable or converted into cash and also the durability of the value of human capital is also very uncertain. Thus, a wealth tax lowers the net return on real and financial assets as compared to the returns yielded from the investment in human capital. This further implies that a wealth tax may be less harmful for the economy than commonly believed as it can encourage a substitution from physical assets formation to the human capital formation on a very large scale.

The case against wealth taxes:

• Double taxation

One of the most common objections to individual wealth taxes is that they are unfair because they generate double (or sometimes even triple) taxation. If wealth is being accumulated from wage earnings, savings, or personal nosiness, then these cash flows have already being taxed. The validity of the double taxation argument also depends on countries’ overall tax the burden on capital of an individual and also on the design of the wealth tax. From various studies it has also been established that a wealth tax that is levied on the very wealthy might not generate much double taxation in actual practice. This underlines the importance of considering the wealth tax as part of a very broader tax system and of assessing how the wealth tax actually interacts with other forms of taxes levied on income and property.

• Negative effects on entrepreneurship and risk-taking 

Another efficiency related to the argument is that a net wealth tax reduces the amount of capital available which can further affect entrepreneurship and business creation as access to capital is one of the most essential determinants of an individual’s ability to start a new business. The situation can be more gruesome if business assets are also being taxed under the net wealth taxes. Taxation is generally believed to discourage risk taking capacity of an individual as it takes away part of the return to risky investments made by an individual.

• Tax avoidance and evasion 

Increased capital mobility over the decades has also enabled tax avoidance and evasion across the world. The increasing mobility of financial assets as well as the use of tax havens further combined with the advancement in information and communication technology and the elimination of barriers on cross border capital transfers have allowed taxpayers to move their capital offshore without declaring it and have made the enforcement of the capital income taxes and wealth taxes extremely difficult. Also, the increased capital mobility has played a very major role in the reduction of tax rates on capital in the last few decades.

Domestic tax avoidance and evasion is also a possibility under a net wealth tax as there are a vast number of asset classes that are highly susceptible to non-disclosure and underreporting. Some forms of wealth are extremely difficult to value or can also be easily hidden from tax authorities and the capacity of tax authorities to check non-disclosure and underreporting is often limited. Typical examples of such assets are household goods, vehicles, jewelry, artwork, etc. In addition, avoidance strategies are also encouraged by various exemptions and reliefs that are provided by the Government policies under net wealth taxes. There are number of diverse justifications for keeping some assets out of the tax base or for taxing certain assets preferentially, but these exemptions and reliefs, in addition to narrowing the tax base, open up tax planning and avoidance opportunities.

• Valuation and other administrative issues 

In addition to the difficulties with tracing back wealth ownership, many forms of wealth are difficult to value. Valuation is particularly difficult in case of non- or infrequently traded assets. Partly as a  consequence of valuation issues, many of these assets whose valuation is difficult is being exempted from wealth taxes which has not only eroded the tax base but has open up several opportunities for the individual to avoid taxes. Valuation issues arise more significantly in relation to non-listed firms and closely-held companies and are greater for assets that are held by an individual overseas. Moreover, regularly updating the value of the assets is also very difficult as it is costly both in terms of tax compliance and administration.

The Date of valuation of assets can also raise several issues. If assets are valued on 1^st January of every year, then the net wealth tax is partly levied on wealth that will be consumed later in the year. This further distorts the timing of consumption decision as taxpayers will have an incentive to bring their consumption forward to the end of the previous year. A lot of consumption occurring at the top of the distribution is likely to consist of buying physical assets which would be taxed under a broad net wealth tax. On the other hand if the assets are valued at the end of every year, taxpayers may be taxed on wealth that they have accumulated during the year which would imply that their savings is being taxed twice within the same year.

There has been great increase in the number of discussions and debates pertaining to the implementation of a wealth tax on the wealthiest people in the United States. Democratic presidential candidates namely, Elizabeth Warren and Bernie Sanders have raised the issue of levying taxes on the wealth of the super-rich in their election campaigns and also with the massive expenditure being incurred by the US Government to fight against the Covid-19 pandemic, the Government has to find ways to increase the revenue, the discussions on wealth tax has seen a rise. As the economic burdens of this calamity are more devastating for the poor people, the income inequality has only become more glaring. There is a big question mark on the constitutionality of wealth taxes raised by many US Scholars but unfortunately the answer to this question is very elusive. The main argument put forward by the scholars is the 16^th amendment as it  limits  the  scope of  the  Congress to  raise  taxes  on incomes only and  does not  authorize the wealth taxes.

Another argument put forward is that under the US Constitution, a state’s tax burden, for a direct tax, is to be determined by the size of its population which means that since New York accounts for 6.1% of the US Population, it would have to pay 6.1% of the total tax burden of the nation and on the other hand, Utah has 0.9% of the US population, it would have to pay only 0.9% of the total burden of the country. In order to make it possible the tax rates would have to be higher in some states than in others and it is very unlikely that the US Congress would agree to it. Several economists in the The United States has also warned about the negative impacts of the wealth tax on the economy of the country. They fear that if a wealth tax similar to the proposal of Elizabeth Warren is implemented in the United States, the economic growth of the country would slow down 2-3% in the next 10 years and decrease investment by more than 4% if it were used to lower national debt.

In India as well, the discussions on wealth tax saw a rise when a group of IRS Officers published a report named FORCE (Fiscal Options & Response to the Covid-19 Epidemic) and suggested to levy a wealth tax for those with over Rs 5 crore annual incomes or an additional cess on the income of the super-rich. India also levied wealth tax under the Wealth Tax Act, 1957 but this act was revoked in the budget session of 2015 and the reason given for the same was that the administrative cost of collecting the tax was higher than the benefits derived from the revenue generated through it. Many researches are also been conducted in order to draw the specifications of the wealth tax model for India. One such research was done by Dalberg, if a tax of 0.4% is levied on the wealth of the top 10% of richest families in India, then it could fund the bottom 50% for 3 months, as they own about 56% of the total wealth of India. Another research carried out by Scroll.in that has analyzed the data of Hurun list, that provides data of families whose wealth is above 1000 crore rupees and currently has 953 families in it, has stated that 4% tax on the wealth of these families will generate a revenue of about 1.16 % of the GDP of India which would be higher than the economic package given by the Government of India in response to the fight against the Coronavirus pandemic.

Wealth Tax can be very advantageous for the Indian Government in the present scenario as it can generate significant tax revenues for the Government by taxing a small minority of individuals and can greatly improve the financial condition of the Central Government. However, the implementation of wealth tax in India has its own challenges including the difficulties of measuring of wealth, tax evasion and avoidance by finding loopholes in the system as India’s administrative capacity is not very good, immense political power held by the rich in India which makes the introduction of wealth tax even more difficult and finally the economic effects as we have seen in several countries across the world.

We know that with the passage of time the responsibilities and functions of the state have been increased manifolds and therefore, the financial requirements to fulfill these functions and responsibilities have also been raised to a larger extent in the past few decades. The inclusion of new functions left no option to the state but to generate the financial resources through taxation. Wealth tax on the super-rich can serve as an excellent option for the countries across the world to increase their revenues and at the same time can also help in reducing the economic inequality among the citizens of the country. Like every economic decision has its own benefits and hardships, similar is the case with the Wealth Tax. The number of countries who follows the wealth tax regime has reduced over the past few decades but the countries in which it is still being practiced has shown a significant level of growth over the past few years.

Spain has been utilizing the revenue accumulated from wealth taxes to develop their healthcare & education system and also making sure that these facilities are being provided to each and every citizen irrespective of their financial conditions. There are various other successful models of wealth tax across the world including Norway, Switzerland and Belgium.

If the Governments of countries throughout the world are able to adapt to the successful models of implementation of wealth taxes by making necessary changes in order to make it compatible with their own countries, wealth tax can emerge as the best option for the Governments to increase their revenue and to increase for the most essential sectors for the public such as healthcare, education and various other community welfare programs. Challenges in the way of implementation of wealth tax are very huge and real but the Governments shows Political will, all these challenges can be overcome and the ultimate target of a better, prosperous, healthier future can be achieved in its actual sense.
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by-   
       Gaurav Sahni and Gaurav Narvar, 1st-year law students at Symbiosis Law School, Noida, both are currently pursuing B.B.A LL.B.