Why wealth taxes are a political graveyard

A true wealth tax, however, doesn’t target the return from capital, but the capital itself. In other words, the state simply takes some or all of what somebody owns.

Before getting onto the problems with this, let’s look at the main reason for the resurgence in support for wealth taxation, which is the increasingly unequal distribution of wealth in western societies.

This trend is documented in Thomas Piketty’s 2013 bestselling book, Capital in the 21st Century. At the heart of his analysis is a devastatingly simple formula:

r > g

Here, r stands for the rate of return on capital, while g stands for the rate of economic growth. The relentless logic of r > g is that an ever greater share of economic output will go to the owners of wealth, leaving an ever smaller share for everything else – including wages for workers.

Of course, by properly taxing income from wealth we could turn r > g to r = g or even r < g. But wouldn’t it be more straightforward to tax the wealth itself? If you take someone’s capital away it can’t earn them any money, can it?

However, this fails to distinguish between the kinds of capital investment we do want in the economy and those we don’t. The kind we do want is investment in genuinely productive enterprise and innovation – the root of economic growth. This is capitalism at its best: wealthy investors exposed to the downside when new ventures fail (pushing down r) while society shares in the upside when new ventures succeed (pushing up g).

Capitalism at its worst is when the upside is privatised and downside is socialised – as exemplified by the banker bail-outs of the financial crisis. If we truly want to reform capitalism we should be much more concerned about the distribution of risk than of wealth.

Indeed, wealth taxes could make things worse, because the easiest wealth to tax is patient capital that stays in one place for an extended period – as is the case with long-term investment in a particular enterprise. In contrast, capital devoted to get-rich-quick speculation is highly mobile, easily moved from one country to another to avoid wealth taxation.

Could we design a wealth tax that exempts the entrepreneurial investment we want to encourage? This would put the burden on assets such as property and low risk savings – not in itself a bad thing. Except that, as mentioned, these are assets that the very wealthy can easily move around. Therefore it would be ordinary people who bore the brunt – people with the effrontery to build up equity in their own homes and to put their own money aside for the future.

For government to regard people’s homes and savings as a potential source of revenue violates several principles of good taxation. First, it constitutes double taxation, i.e. taxing assets that have been paid for out of taxed income. Secondly, it punishes virtue – i.e. provident self-reliance. Thirdly, sensible exemptions for certain assets (e.g. pensions) would provide opportunities to game the system. Fourthly, it would be regressive within the category of people subject to it – because those with access to the best financial advice would pay least. Fifthly, there’s no relationship to ability to pay unless the liability incurred is directly related to any profit made when an asset is sold: in which case, we’re talking about a capital gains tax not a wealth tax (see above).

Finally we come to that special form of wealth tax, the inheritance or estate tax. Could this be extended? Almost certainly not up the wealth scale – because, as with wealth taxes generally, avoidance is a constant factor. Any extension therefore would go down the wealth scale.

One approach would be to tax recipients rather than the estate – treating all bequests as if they were a form of (taxable) income. For the sake of consistency and to preempt avoidance strategies this would have to include gifts made within the giver’s lifetime. It would also be consistent for wealth taxes to apply to non-monetary gifts in the same way that income taxes apply to ‘payments in kind’.

This is all in the cause of ‘fairness’, you understand. If you think that someone inheriting a house from their parents is ‘unfair’ because it isn’t earned, then the same applies to gifts of money before the day of bereavement. Or what about a significant haul of wedding presents, what’s ‘fair’ about one couple getting a comfortable start to their lives together, while another, without well-to-do friends and relatives, struggle to furnish their first home? And, if blessed with issue, is it ‘fair’ that some parents get free childcare from grandma and grandad, while others have to pay nursery fees?

Once you start taxing the help that family and friends give to one another, where do you stop? Will we have to account for every monetisable expression of love and solidarity? “I’d like you to have your grandmother’s wedding ring, sweetheart, but don’t forget to declare it to the relevant tax authority.”

There is no obvious limit – not unless you recognise a realm of family, privacy and self-reliance that ought to be beyond the intrusion of the state. A free society is one in which this is taken seriously. But the logic of wealth taxation, especially when applied to the not-so-wealthy, is one of violation.

For all of the reasons I’ve given here – and many more – I think that wealth taxes are a dead-end, indeed a political graveyard. There is no short-cut to the reform of capitalism, no way forward but to defeat cronyism, corruption and exploitation. Win those battles and the only wealthy people will be those who deserve it.

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Peter Franklin is Associate Editor of UnHerd. He was previously a policy advisor and speechwriter on environmental and social issues.

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