Examining the case for a wealth tax

I have pointed out previously that the huge fiscal tightening imposed on the UK over the past eight years has come about through huge cuts in spending and relatively little by way of additional taxation (most recently here). Now that the balance between current spending and revenue has been restored, there is no serious rationale for further swingeing spending cuts. Undoubtedly this was one of the factors supporting the announcement by Theresa May earlier this week that additional funding will be made available for the NHS.

Whilst this is a welcome development, the pressure on public finances has not suddenly gone away now that the deficit on current spending has been eliminated. If anything, as the population ages, the demands on healthcare and social services will continue to rise. It is not just the health system that is struggling to cope: The benefits system is under pressure too, and there is a huge wedge of people at the lower end of the income scale who are struggling to gain access to the benefits to which they are entitled.

What the government has not outlined is how much additional funding will be provided nor where it will come from. After eight years of grinding austerity, raising existing taxes to fund the additional resource requirements will not be acceptable to taxpayers who would regard it as yet another kick in the teeth for the squeezed middle. Indeed, raising income taxes appears to be a non-starter. In any case, efforts to compensate low-paid workers for the curbing of their benefits via an increase in personal income tax allowances is already estimated to have cost a cumulated £12bn in foregone revenue in FY 2017-18. Having raised VAT to an already-lofty 20%, the scope for raising indirect taxes is also limited. It would thus be sensible to look for alternative revenue sources, and two apparently radical fiscal suggestions have been given more prominence in recent weeks. One is the possibility of some form of wealth tax and the other is to introduce a hypothecated tax to fund such items as the NHS.

In this post I will consider only the option of a wealth tax and will come back to hypothecated taxes another time. The rationale for a wealth tax is that incomes, which form the basis of most direct taxes, have remained stable relative to GDP over the past three decades whereas wealth holdings have significantly increased. Thirty years ago, UK household net financial wealth holdings were a multiple of 1.2 times GDP but today the multiple stands at 2.3. The picture looks even more favourable if we add in wealth held in the form of housing. Financial and housing wealth together amount to around 5 times GDP compared to a multiple of 3 in 1988 (chart).

But why should this windfall gain be subject to tax? One strong argument is that taxes on income do not take into account the claim on overall resources that wealth confers. For example, there is a difference in the ability to pay a bill of (say) £1,000 between someone who earns £20,000 from labour income and someone who earns £20,000 as a return on a wealth stock of £1 million. As a result, a wealth tax will raise the overall progressivity of the tax system by taking account of the additional taxable capacity conferred by wealth. But wealth holdings are already subject to tax in some form or another. For example, liquidating wealth holdings subjects individuals to capital gains tax. Moreover, the flow of income accruing to a stock of financial wealth is liable to income tax. In addition, even if the wealth is untouched and generates no direct financial benefit to the individual, if it is passed on as a bequest to future generations it is subject to inheritance tax.

In any case, there are a huge number of practical difficulties associated with introducing a wealth tax. To name just a few: How much should it raise? On which assets should it be levied? At what rate should it be set? Should it be set at a single or graduated rate? Howmuch (if any) of an individual’s wealth should be exempt? Even if we could agree on these issues, once such a tax has been implemented, two of the biggest ongoing problems are disclosure and valuation. The disclosure problem is obvious: It is easy to hide many forms of wealth (think how simple it is to hide small but precious items such as diamonds). As a result, compliance becomes a problem and even honest taxpayers have an incentive to cheat if their fellow citizens are not playing ball. In addition, the valuation problem is often underestimated, particularly if the absence of a market transaction makes it difficult to establish an appropriate valuation metric. It is for all these reasons that the proportion of OECD countries levying a wealth tax has fallen over the last three decades. In 1990, half of them did so (17) but by 2010 only France, Norway and Switzerland levied them on an ongoing basis.

Despite all the practical difficulties, there is a genuine case for some form of wealth tax on grounds of inter-generational fairness. For example, older generations tend to hold the vast bulk of the wealth whilst benefiting from additional public spending on areas such as the NHS. It is for this reason that the Resolution Foundation recently put forward a series of proposals to reform property taxes, including the introduction of a progressive property tax to replace the existing Council Tax and raising taxes on highest-value properties.

Such measures will clearly not be popular with Conservative voters, and is one reason why they will not be implemented any time soon. But as the fiscal debate increasingly switches away from deficit reduction and focuses more on what the state can reasonably be expected to provide, the issue of inter-generational equity will inevitably rise up the list. We may not want to talk about wealth taxes today but it is an issue that is unlikely to go away.