We recently talked about the capital gains inclusion rate and how increasing that could lead to a variety of negative consequences. In that article, we referenced one other potential tax change which could be the implementation of a wealth tax.

There have been a lot of countries that have implemented wealth taxes, and many have since removed their wealth tax. Now there are politicians in Canada (and more prominently in the USA) that would love to impose a wealth tax. Thus, we thought it was a good idea to cover a topic that could drastically affect the financial lives of many people.

I am in favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it’s possible.”

Milton Friedman

If you are curious who Milton Friendman is, he won the Nobel Memorial Prize in 1976 in Economic Science for his research on consumption analysis, monetary history and theory, and the complexity of stabilization policy. He is best known for explaining the role of money supply in economic and inflation fluctuations.

Seems like he might be a valuable voice to listen to when considering today’s economic environment. We currently have supply chain and consumption issues, inflation is no longer just a concern, and a massive increase in money supply over the last 18 months.

What is a Wealth Tax

Normally when we think of tax or speak on it, we are referring to income tax. This means that is only levied when income is actually received or deemed to have been received. This means that if you own something and it accrues in value, you only pay tax on the gain once that piece of property is sold and the income is received.

A wealth tax is radically different. A wealth tax is a tax that is levied based on the market value of assets owned by a taxpayer while that asset is still held. Another way to think of it is a tax on a person’s net worth (assets – liabilities). Assets that would generally be taxed under a wealth tax include cash, bank deposits, shares, fixed assets, personal cars, real property, pension plans, money funds, owner-occupied housing, and trusts. As you can tell it is very inclusive.

Based on my research, there are only 7 countries that currently impose a wealth tax; Spain, Norway, Switzerland, Belgium, Argentina, Netherlands, and Italy. Each country has slightly different rules and tax rates, which we won’t get into here. Argentina implemented its COVID wealth tax in December of 2020.

Many countries have also repealed their wealth tax; Austria, Denmark, Finland, Germany, Iceland, Luxembourg, and Sweeden have all abolished their wealth tax in the last 30 years recent years. Reasons for repealing the wealth tax generally included limited revenue collection, administration and compliance costs, tax avoidance, and evasion.

Proponents of a wealth tax believe that it is a more equitable way to tax people than income tax alone. Some politicians, namely Elizabeth Warren south of the border, believe that imposing a wealth tax to pay for the entire $3.5 Trillion spending bill that the Democrats have put forward.

The main proponent of a wealth tax in Canada, the NDP party led by Jagmeet Singh, would like to impose it on anyone with more than $10 million in assets. This tax would be a 1% tax on net worth above the $10 million thresholds. Let’s also not forget that a wealth tax would be in addition to income tax, not a substitution.

Wealth Tax in Theory

In theory, it might sound great to some. Those that are super-rich should pay more tax. On the surface that doesn’t sound bad, but we also have a progressive income tax system that is supposed to deal with that. As your income increases, a higher proportion of each dollar you earn is paid in taxes. However, they would argue that there are too many ways to hide income or increase a person’s net worth without increasing their income.

In a sense, they would be right. However, the only way to increase your net worth without increasing your income would be to take on risks with income that you have already paid tax on. There are also some people with a very high net worth but with very few liquid assets or income.

Issues with a Wealth Tax

Let’s assume that a wealth tax will increase tax revenue. However, what is the cost of doing this? will it be sustainable? Will it actually produce as much as what some people project? These are hard questions to answer and there are experts with strong opinions on both sides of the aisle.

Taxation of The Same Dollar in Perpetuity

There is a general understanding that the same dollar earned should not be taxed multiple times. This would not be the outcome if a wealth tax is implemented.

Let’s assume that someone has $10 and will never earn another dollar. At the same time, there is a wealth tax of 1% implemented on every dollar. This means that in year one our friend will have to pay $0.10 in wealth tax. That $10 has now been taxed twice already; once through income tax and once through a wealth tax.

Now in year two our friend only has $9.90 left but again is subject to wealth tax. This year he will have to pay $0.10 (0.099 rounded up). This same $10 has now been taxed three times. This process will happen in perpetuity. This means he will have to pay tax on that same $10 every year for the rest of his life if he doesn’t spend it.

That leads to the next point but before we get there you may be thinking that the above example doesn’t make sense because the wealth tax is only above a certain threshold. You would be partially right. However, after the wealth tax has been implemented, there is now a precedence set to tax wealth. If the government deems that they need more money because their revenue isn’t keeping up with their rampant spending, what’s stopping them from lowering that threshold?

Disincentive to Save

Due to the fact that a dollar can be taxed in perpetuity, it is a huge disincentive to save. Your two options are either that you save the money and lose it to tax or you spend the money.

That being said, a wealth tax could increase consumer spending slightly. People would likely rather spend their money on things they want than slowly lose it to taxes. At first, that doesn’t sound so bad. More consumer spending and economic activity are generally good.

However, in an environment where there are supply shortages, more spending could just exacerbate those shortages. Additionally, if there is a disincentive to save for the future, when people get to retirement there will be more people dependant on the government.

Illiquid Assets

As mentioned earlier, there are some people that have high net worths but have very little in the way of liquid assets. This is the case for farmers, real estate moguls, etc.

People with all or the majority of their wealth in illiquid assets (land, real estate, private businesses, etc.), could be forced to sell a portion of their assets to pay the tax. However, because the assets are illiquid, selling them can come with some difficulties. It may be difficult to find a willing buyer. There may be exorbitant selling costs. The assets may have to be sold at a steep discount to actually make a sale.

Asset Valuation

Another issue comes when you are dealing with the valuation of assets. The market value of an asset is not only hard to determine but it can also change drastically. In order to implement a wealth tax “fairly,” you have to obtain accurate market values of all assets.

Things like publicly traded securities, and bank account values are easy to determine a market value. However, private business, collectibles like art, and farm assets can be extremely burdensome to value. A lot of a private business’s value can be attributed to the owner being present in the business. If that owner is no longer running the show, that business may be worth virtually nothing. Or if we look at artwork, the value of art can be extremely arbitrary.

Many people assume that the wealthiest people just have huge investment accounts. Although that may be true, that is not the primary driver of their wealth. According to data from the federal reserve publicly traded assets only make up one-fifth of assets held by the top 1% (excluding tax-exempt accounts). Whereas, private business assets represent more than one-half of their assets.

Capital Flight

The last point we want to cover is capital flight. Capital flight is the occurrence of people moving from one tax jurisdiction to another. This has happened in America where people have moved from states with high-income tax burdens to states will less or in some cases no income tax.

It makes sense. If I have to pay more tax where I currently live, why wouldn’t I move somewhere if I can pay less tax there? Granted, tax shouldn’t be the only consideration, other things that impact your quality of life are likely equally or more important. But all things being equal, if the quality of life is the same in both countries, the one with a lower tax burden is likely more appealing.

Conclusion

In the last 30 odd years, many countries have implemented wealth taxes, and only a few remain. Of the ones that remain, they report collecting less than 1% of GDP except in Switzerland where it raises almost 1%.

In order for the wealth tax to raise what many progressives claim it will raise, the tax will have to be much higher than other current wealth taxes around the world. If that is the case, not only can we expect to see the above-noted issues, they could be much more severe than what other countries have reported.

In the end, if Canada or the US implements a wealth tax, it would not be shocking to see it fall well short of projections. It also would not be shocking to see a decrease in business activity, entrepreneurship, tax evasion, and capital flight.

Leave a comment down below, do you think a wealth tax is a good idea? Would it be a net positive or a net negative? Let us know!

Sources:

https://www.cato.org/tax-budget-bulletin/taxing-wealth-capital-income#wealth-taxes-in-europe

Analysis of Sen. Warren and Sen. Sanders’ Wealth Tax Plans