INTRODUCTION At the rate of one millionaire a day, France is losing its wealthiest citizens and entrepreneurs. The exodus includes leaders and shareholders from Peugeot, Champagne Taittinger, Carrefour and Darty, as well as others from the high-tech industry. They are leaving France in order to escape taxes, particularly the wealth tax, ensuring France’s continuing top rankings on Forbes’ yearly Tax Misery Index. Some estimate the tax rate to hover at around 72 % for some, though efforts have been made to limit all taxes to be no greater than 60 % of income. As France continues with its economic struggles, the flight of its top business leaders to other countries heightens the country’s dilemma. Eric Pinchet estimates that although the wealth tax has brought France $2.6 billion a year, it has cost more than $125 billion in capital flight in the last eight years (Moore 2006).In contrast, neighboring countries are placing less importance on wealth tax as a part of total government revenue.1 In some countries some taxes on wealth have been abolished altogether (for instance, the net wealth tax in Austria 1993, Germany 1997, Denmark 1997, Netherlands 2001, Finland 2006, the capital gains tax on sales of corporate crossholdings in Germany in 2002, the estate tax in Italy in 1998). Although it appears that wealth taxes are no longer favored as a means in increasing revenue, those who favor wealth taxation continue to make proposals, arguing for solidarity and appealing to populist sensibilities.
Wealth taxes are portrayed as being fair, and a rather painless way to increase funding for strapped government programs. So then, why should we consider wealth taxes? To what extent are these taxes a matter of justice and to what extent are these taxes a matter of economics? Are wealth taxes harmful or helpful to an economy? Are wealth taxes fair obligations belonging to the entrepreneur or unjust claims made by society? To answer these questions we will proceed as follows: First, we will analyze the arguments given to justify wealth taxation. Then, we will analyze the effects of wealth taxes (i.e. taxes on accumulated capital) contrasted with the effects of income taxes. After this we will explore the effects of wealth taxes upon the economy, such as wealth transfer taxes, property taxes, net wealth taxes, and capital gains taxes. We will then conclude in determining whether we should consider wealth taxation as a viable approach to revenue.
2. WHY TAX WEALTH?
Several arguments are commonly provided in favor of wealth taxes. These include the encouragement of a productive use of wealth, investments in human capital, the breaking up of wealth accumulations, fairness in the paying for and receiving of government services, and egalitarian justice.
2.1. Encouragement of a productive use of wealth Sometimes proponents argue that wealth taxes inspire a more productive use of wealth (Rakowski, 2000, p. 49; Sanford, Willis and Ironside, 1975, p. 8). This is similar to the argument that in the taxing of workers’ incomes, workers will become more productive to compensate for the loss in net monetary income. Analogically, with the institution of wealth taxes, wealthy individuals might sell their luxury cars, yachts, and jets to invest in industrial production of non-luxurious goods, yielding a monetary income that helps to cover their wealth tax payments.
There are a few responses to this argument. First, the shift of resources into production of non-luxurious goods is not necessary. Individuals might just as well sell and disinvest in production facilities in order to be able to keep their luxury items. Second, we must take into account that the switching from lower monetary income yielding (and possibly very illiquid) assets into higher monetary income yielding assets also entails costs.
Moreover, the maximization of the production of non-luxury items entails a shift of resources from one economic sector, the luxury goods industry, into other industries. Why would this distortion of free market choices and the structure of production be something desirable? The “more productive use of wealth” is a subjective preference of those individuals proposing the tax. Furthermore, the possible decrease in the production of luxury goods ensures that those goods remain luxury goods instead of being converted by mass production into non-luxury goods. That implies that in the long-run not only is the welfare reduced for those who are being taxed for enjoying luxury items, but also for those who might have otherwise eventually profited from a mass production of those items.
2.2. Investments in human capital Another argument states that wealth taxes would spur investments into human capital (Hansson 2002, Heckman 1976). As wealth taxes reduce the net return on financial investments, investments in human capital would become more attractive relative to financial investments. However, this is not necessarily so. The profitability of human capital investments can in certain cases even be reduced, because human capital relies on physical capital. If the amount of physical capital is reduced by a wealth tax, the profitability of investments into human capital also shrinks. Moreover, we should not forget that in many cases physical capital (for example, schools or computers) is needed to improve or instruct human capital. This means that instead of a shift of investments from financial into human capital, there might rather be a shift into consumption. As in some cases, relative profitability of human capital investments versus financial capital investments increase and in other cases decrease. The only certainty of wealth taxes in this respect is that there is a distortion.
2.3. Breaking up of wealth accumulations that pose problems for democracy and the market economy
Some consider wealth taxes an advantage in that they break up concentrated holdings of wealth,2 thereby, preventing undue influence on representative democracy and the market (Rakowski 2000).
The wealthy can influence representative democracy in two ways. First, they can use their money to propagandize political views. It is true that the wealthy can use their wealth to pronounce views and convince others of those views. This point that such influence might be used for the advance of harmful or unjust policies must be granted. However, more problematic seems to be the political propaganda of political parties, whose own means in some countries stem from taxation. Second, wealthy individuals can secure the partiality of officials by offering support to their friends and families through employment opportunities or by helping them to win or stay in power. This is also a point well-taken. Yet, as not all use their wealth to obtain advantages from politicians, it seems harsh to punish all wealthy individuals by a wealth tax. Moreover, groups of poor people might, and in reality, do organize to gather enough money to promote political propaganda and secure partiality of officials. Examples of such interest groups are labor unions, as well as consumer or environmental organizations. It seems to be more an inherent characteristic of the democratic system in itself that it is possible to gain personal advantages at the cost of others by securing influence over politicians.
The second claim that people with significant wealth accumulation could “manipulate markets and reap supercompetitive returns at the expense of less muscular market actors” (Rakowski 2000, p. 42) is without any substance and lacks a proper understanding of the market process. No one in a free market can “manipulate” the market. Entrepreneurs who satisfy the necessities of consumers better than their competitors will reap profits. In this respect, it does not matter how much wealth the entrepreneur owns, as external financing can be secured with a good idea and persuasiveness, but rather how well in relation to his competitors he is able to satisfy consumers.
In reality, it is exactly the opposite of “supercompetitive returns” with increasing wealth that occurs. There is a tendency that the more wealth an individual owns the harder the realization of extraordinary returns becomes. A return of 40 % on a wealth of 1000 Euros is possible, as in a dynamic economy profit opportunities are numerous. Yet, a return of 40 % on a wealth of 1000 billion Euros is more complicated as the whole economy is not growing at such a rate. And even if a person with enormous wealth reaches such a return on her wealth this is only possible because she is creating a vast value for consumers.
One cluster of wealth tax arguments concerns fairness in the paying of taxes and receiving of government services. One argument for wealth taxes says that such taxes are appropriate or fair because the wealthy can afford to pay them.3 As wealth (and not merely income) portrays the ability to pay taxes for government services, this supposedly implies that wealth should be taxed. Thus, Kaldor (1956, p. 20) offers the example of a beggar with no wealth and no income and a maharaja holding all his wealth in non-income generating gold and jewelry. Kaldor argues that in this case income is not a good yardstick for the ability to pay taxes and, therefore, wealth should also be taxed. The problem with this argument is that it proves far too much. Being able to sustain some treatment, does not imply that such treatment is just. It might be the case, that the treatment is unjust. For example, if some people are able to sustain a certain amount of torture this does not mean that they should be tortured because they are able to endure torture.
Related to this critique is the argument that all people should be treated equally and therefore all kinds of income and assets should be taxed. In other words, people who only have an income and no additional assets such as savings or land are taxed on their income, which represents all of their holdings. However, those who have significant assets are taxed only on their income and escape having to pay taxes on the rest of their holdings. Therefore, in order to make taxes more fair, wealth taxes should be introduced. The problem is that to treat people equally is not something inherently good. Taxes cannot be justified by an appeal to fairness via equal treatment. If this were the case, we might imagine all sorts of actions or policies that require equal treatment. For instance, if one group of innocent people is executed a claim of equal treatment would require that all innocent people would be executed. The equal treatment doctrine assumes implicitly that equal treatment is just. If however, taxation is not just, then the ability to pay argument and the equal treatment argument fails.4
A similar fairness argument claims that the wealthy receive more government services government than poorer people, which means that they should pay higher taxes for the services received (Rakowski, 2000, p. 3). For example, the larger the wealth of a person the more the government must allegedly spend to protect this wealth. Several problems accompany such a view. First, of course, is the inherent irony in such a situation. Regarding the “service” of protecting wealth one might wonder, what kind of protection it would be to tax the wealth being protected. A second and more fundamental problem is that it is simply not true that with an increase in wealth the use of government services always increases. Many government services are used even less as individuals become wealthier. Such services include public education, public libraries, public health care, or unemployment benefits. Third, and more importantly, taxes are coercive transfers from individuals to the government. On the free market a service provider might say: “If you want additional or higher quality services, you have to pay more.” However, government services do not constitute and cannot be analogically interpreted as services receiving voluntary payment on the free market. Government services are by virtue of the use of coercive power always disconnected from the amount of taxes that are paid. The analogy, therefore, fails as the government provides no market “service.”
2.5. The egalitarian argument The arguments in the previous section on fairness in the paying of taxes and receiving of government services are in some sense ethical arguments, in that they appeal to fairness in determining how taxes should be structured. Yet, in these arguments the end or goal of wealth taxes in not necessarily equality but rather a certain revenue obtained fairly. In this case, it is argued that wealth taxes are a fair means to obtain such revenue. However, there is another ethical argument often made in favor of wealth taxes, one in which equality of human beings is the end goal. In this case, the end goal is not a certain revenue obtained fairly, but rather a more equal distribution of wealth. The more equal distribution of wealth is implicitly assumed to be something desirable5 and more just.
The main problem with this argument is the underlying egalitarian ideology.6 In order to justify a more equal distribution of wealth (or a totally equal distribution of wealth, for that matter) one must subscribe to the idea that it is somehow good if people are (more) equal. Yet, normally an ethical justification is never given for why a more equal distribution of wealth would be better than an unequal distribution of wealth.
Actually, there is no clear reason why all men should be equal in their resources. Human beings are from their very nature unequal in many ways; they are heterogeneous. They have different ages, physical appearance and capacities, health, talents, relations, political powers, etc.. Humans are unique and with the advance of civilization and the division of labor they become more and more unequal due to different jobs and income. In fact, it might be argued that such a division of labor and the subsequent rise in the living standards is made possible by the contributions of people who are different with respect to resources and abilities. Only in death, which seems to be the logical result of the egalitarian doctrine, men are more or less equal.
More fundamentally, a redistribution of wealth by wealth taxes does not even fulfill the end of making people equal, the logical end of egalitarianism.7 There are basically two meanings of the sense in which people are supposed to be made equal. The first meaning implies that all people should own the same market value of wealth. There are some problems with this first meaning. First, it is very difficult and arbitrary to determine the market value of some goods if they have not been exchanged for a long time, like houses, unique paintings, and jewelry. Second, the market value changes continuously, requiring a continuous redistribution back and forth leading to total insecurity about property rights and consequently a break-down of social progress. In this context, it must be pointed out, that the redistribution itself changes the market value of certain goods. This is so, because due to the redistribution people are equipped with a different purchasing power which allows them to bid up or to bid down certain market values. If we take from Jones to give to Smith, the market value of the goods and assets Smith desires increases and those of Jones´s decreases. Thereby another redistribution becomes necessary and so indefinitely on, without ever attaining that point in which all people own the same market value of wealth. Third, this redistribution would have a fatal consequence on the incentives to generate wealth in the first place. Why should I work, invest, and save if, in the end, I am able to obtain the same wealth by comfortably watching TV all day long?
The second meaning of wealth equality for people is that people enjoy the same “happiness” or “satisfaction” derived from the wealth they possess. Wealth taxes are, in this sense, an instrument for arriving at the same “well-being.” For instance, Wolff (1996, p. 8) in his case for wealth taxes implicitly makes the point that it is for the equality of well-being: “Two families with identical incomes but different levels of wealth are not equivalent in terms of their well-being, since a wealthier family will have more independence, greater security in times of economic stress, and additional liquidity for advantageous purchases.” Indeed, it is not the material thing of the wealth, in itself, the stones forming a building, the chemical elements forming jewelry, digits in the bank accounts that are important to the individual. Rather, the subjective value or satisfaction that an individual receives from that wealth is important, giving him a peace of mind, social status, a sense of “power,” or some other kind of satisfaction.
This second meaning would have to take into account that people value different goods or assets differently as the valuation of goods or assets is a subjective process. In fact, attaching to the goods their market value as a measure of utility is unscientific. Someone might not value a Picasso painting more than a sports car, because he does not like Picasso paintings, even though it has a higher market value than the car. Moreover, this second notion of equality would have to take into account that all parts of wealth influence well-being. The immaterial wealth would have to be considered, as well. Immaterial wealth consists in valuable assets such as an education, experiences, talents, a good sense of humor, a charming smile or a kind look, a network of friends, a family, etc.. To make people really (more) equal would require consideration of material and immaterial wealth.
The second and more consistent approach leads to even more problems than the first approach that only takes market values of material wealth into account. The insurmountable problem for achieving equal well-being through wealth taxes is that one cannot measure “happiness” and utility. Nor can one add up the utility derived from different assets or subtract the utility of some expropriated assets from a previous number. Further, different persons value the same assets differently. And the utility one enjoys from certain assets varies over time. Another difficulty arises from the fact that the existence of the redistributional process itself affects the well-being as some people will like the process and others not. One can therefore never know if wealth (material and immaterial) is distributed in a way that all people are (more) equal in the sense, that they enjoy an (more) equal amount of well-being or satisfaction. And even if it would be possible to measure satisfaction derived from wealth, the proposed equalizing seems to be unjust from a common sense point of view: One would have to take from someone austere, who is content and happy with a small amount wealth in order to give to an insatiable avaricious miser.
In short, regardless of the meaning of equal wealth, it is impossible to achieve an equal distribution of wealth by wealth taxes. However, a more equal distribution of material wealth might be achieved, though this would still involve relentless challenges in maintaining incentive, and measuring wealth, as well as operational problems due to ongoing redistributions. In addition, it is hard to see and seems to be scientifically unjustifiable that the objective of a more equal distribution of material wealth would be a desirable aim in the first place. Finally, it must be added that even if we grant the end of making people more equal or totally equal, there might be more efficient or less harmful ways to achieve this. In the next section we will consider such a possibility, analyzing the effects of wealth taxes in comparison to income taxes, as wealth taxes are widely considered alternatives to income taxes.
3. WEALTH TAXES VS. INCOME TAXES An income tax reduces the (realized) net income of factors of production - be it wages, interest, ground rent, or profits - while a wealth tax taxes the value of certain assets. As taxes on wealth and on income can be viewed as alternatives, we will now turn to a comparison of the effects of both taxes.8 Even though there are differences one should first be reminded, that some general effects of taxation are shared by both income and wealth taxes. As Rothbard (1977, p. 86) states:
Taxation always has a two-fold effect: (1) it distorts the allocation of resources in the society, so that consumers can no longer most efficiently satisfy their want; and (2) for the first time, it severs “distribution” from production. It brings the “problem of distribution” into being.
And while the total level of taxation in regard to the strength of those effects is a decisive factor, the analysis of the effects of income and wealth taxes is worthwhile, since they contain some important differences.
An income tax reduces an individual’s entire living standard (Rothbard, 1977, p. 99). The individual will spend less money on consumption, savings, or additions to his cash balance than in the absence of the income tax. When capital income is taxed, the incentives for savings and investments are reduced with the result that marginal savings and investments are not undertaken. As savings and investments spur economic growth and enhance living standards, the tax on capital income impoverishes society.
While taxes on income have pernicious effects for living standards, taxes on wealth (or accumulated) capital are even more harmful. Wealth taxes are more harmful, because they tax capital stock, which is the source of our present and future income. The higher the capital stock, and the more capital intensive the production processes, the higher our income is.
To visualize the different effects of taxes on wealth and income, imagine Robinson Crusoe being subjected to an income tax of 20 % by a native tribe on his island. As he collects with his bare hands 10 berries per day, he has to deliver 2 of them to the tribe, which leaves him 8 for his consumption or savings. Assume that he consumes 6 berries and saves 2, until after one month, he has accumulated 60 berries. With his usual consumption of 6 berries a day this enables him to live for 10 days, which we assume is the time period necessary to find a stick and fashion it into a tool allowing him to collect berries more efficiently. Now with the help of this tool, he is able to collect 20 berries a day, from which 4 will be taxed away by the tribe. This greatly improves Robinson´s standard of living as he can spend more time on other projects, and therefore, has to spend only half the day collecting the 10 berries that he had been collecting with his bare hands. But now imagine that the native tribe begins to tax the accumulated capital or wealth of Robinson. He must now deliver 5 berries every day for owning this tool. This discourages the replacement of the tool when it breaks, and also discourages further capital accumulation. Moreover, if the wealth tax had been in place at the beginning of our scenario, Robinson possibly would have never crafted the tool in the first place. Without his tool Robinson is impoverished. The same is true for our modern society. A wealth tax implies a discouragement of capital replacement and capital accumulation and an encouragement of capital consumption. It thereby discourages increases, or even leads to decreases in the quantity and quality of goods produced. In short, society is impoverished.
In addition to impoverishment by reducing the incentive for capital accumulation, there are other characteristics of wealth taxes that partly separate them from income taxes. First, they entail a double, or more precisely, multiple taxation.9 Already taxed by an income tax, Robinson’s berries, now transformed into a tool, are taxed again and again. This would not have happened, if Robinson had consumed the berries.
Second, in a world of tax competition, high wealth taxes may lead to an exodus of individuals and companies, especially of capital intensive companies, into countries with lower or no wealth taxes. Along with them, human capital, creativity, employment opportunities, technology, and other resources leave the country. Potential growth is thereby diminished. As noted earlier for example, the French net wealth tax entails such effects, as on average, at least one millionaire leaves the country every day, taking up residence in more wealth-friendly nations.
Third, another challenge of wealth taxes, is dealing with the severe practical and administrative problems in the disclosure and valuation of the net wealth, properties, gifts, bequests, etc.. (Rothbard, 1977, p. 113). Due to the problems of disclosure, the evasion by under-reporting is difficult to identify. The other problem consists in determining the value of the wealth. This problem is especially harsh if the property in question has not recently been sold on the market and no recent market price exists. Moreover, a market price is a historic exchange relationship and as such only an arbitrary determination of a present value. The value ascribed to the properties, hence, always remains arbitrary. An army of public estimators must evaluate the properties, implying high costs for the government.10 Naturally, this valuation process opens the doors to favoritism, nepotism, and bribery.
In addition, it is difficult to assess all wealth without severe intervention into and controls of the economy. A proponent of wealth tax, Mortimer Lipsky (1977, 173-76), imagines a totalitarian system to get hold of all wealth. He argues for recalling all paper currency, replacing it with new currency to keep record of the money each person had. Among other things he also argues for a prohibition to own gold and an obligation to report all purchases of $10,000 and higher to the government. Strangely enough, Sanford, Willis and Ironside (1975, p.11) see an advantage in the necessity of a control system: “A fiscal advantage of a wealth tax is that is generates data, which can be cross-checked with other information collected by the [r]evenue authorities, to tighten up tax administration as a whole and enable evasion to be more readily discovered and therefore reduced.” It might be this control of the economy and citizens accompanying wealth taxes that appeals to politicians and might be one reason for the subsistence of wealth taxes.
Fourth, entrepreneurial activity will move away from the satisfaction of consumer wishes towards the avoidance and evasion of wealth tax payments.11 Due to administrative problems in disclosing and valuating wealth, it is often easier to successfully avoid and evade wealth taxes than income taxes. As such, the redirection of entrepreneurial activity and genius from satisfying consumer wants to protecting wealth occurs to a greater extent in the case of wealth taxes than in the case of income taxes. Actually, one might make the observation that easy avoidance and evasion of wealth taxes is an advantage. When wealth taxes can be avoided or evaded they do not have their pernicious effects on capital accumulation.
Fifth, wealth taxes make obtaining bank loans more difficult than they would be otherwise, reducing the chances of starting a new business. This is so, because wealth taxes reduce the market value of the wealth an individual or company can use to back a loan. If a potential entrepreneur wants credit backed by his wealth, which was reduced by wealth taxes, he might get only a smaller loan or no loan at all. This especially penalizes potential new companies rather than established companies who can resort to internal financing via retained profits. Financiers of these small start-ups are often faced with more uncertainty and asymmetric information than when they finance well-known established companies. Thus it becomes difficult for small start-ups to reach external financial sources (Hansson, 2005, p. 1). Available credit, therefore, will finance more established enterprises and fewer newcomers than would have been the case in the absence of the wealth tax. In accordance with this argument Hansson (2005, p. 2) shows empirically that wealth taxes have lead to lower self-employment rates.
Sixth, as there is much wealth in illiquid form, there are substantial costs inflicted on those who are to pay them as they have to undergo the process of transforming a part of the wealth into liquid form. If an elderly couple owns a house in the center of the city, which has sufficiently high market value, and this couple has next to no income, they might be forced to sell the house and move into another smaller one, in order to pay the tax. This, evidently, places a great burden on the couple. Of course, (some of) the property might be excluded from a wealth tax through threshold or exemptions. Nevertheless, the example illustrates a problem that exists with wealth taxes, especially inheritance taxes.
Seventh, taxing wealth targets a particular life-style, making it relatively less attractive, affecting standards of living in the long-term as well as cultural achievements. More specifically, luxury goods, art items, and the glamorous buildings of the very rich are taxed. However, many things which are now inexpensive were in the past luxury items affordable only to a small minority, willing to buy them at high prices. Taxing wealth discourages the production of these luxury goods and assets, which might later become mass-produced items. In addition, by destroying the wealth of the wealthiest, these taxes discourage the production of artistic and other cultural goods. This has an impact on culture, reducing the production or maintenance of paintings, sculptures, antique buildings, and extravagant creations by architects. One might argue that the government would use the taxes to sustain artists or public libraries, as well as organize public architecture and art competitions. In this case, however, the government finances cultural activities.12 Cultural development is no longer a spontaneous, voluntary, competitive, and dynamic process. Instead, cultural development stagnates, subsidized by the will of government officials.
Eighth, the wealth tax is often more visible than an income tax, which can be administered in a way that tax payers only receive their income after taxes without having to pay the tax out of their cash balance. Instead, a wealth tax must be paid out of the available income. Wealth taxes are even more keenly felt if property must be sold to pay for them. This explains the strong resistance to wealth taxes by tax payers in countries with particularly heavy wealth taxes. A summary and comparison of some characteristics and effects of income and wealth taxes is provided by Table 1.