Taxing the Rich versus Taxing the Wealthy

Wealth is fundamentally different from income. It is expressed in the value of assets. And as every wealth manager will tell you, the value of assets can go down as well as up.

Tax systems have always worked on the basis of taxing realized income. If you buy a share, whether it goes up or down does not affect your spending power — until you sell it.  At that point, you will have realized a quantifiable gain and have the funds to pay the required taxes. Any earlier than that, you, the taxpayer, will not have made any gain. And if you were taxed on unrealized income and the share price dropped back to where it started, would you receive a full refund in year two?  

Paying your fair share

Many who claim that the rich pay less taxes than their staff overlook the fact that if no tax is paid on unrealized gains, and those unrealized gains are much larger than the salaries paid to staff, the percentage tax rate might be relatively low but the absolute amount of tax on the income will be high.  

The capital gains tax will likely be paid eventually — it’s just a question of when. For example, if a tech start-up has performed well, and the founder’s shares have risen from USD 100 million to USD 200 million in year one, should they pay USD 20 million in tax? Bearing in mind that they have earned only USD 200,000 in that year, to do so they would have to sell some of their shares. And if their USD 200 million of shares dropped back down to USD 100 million in year two, could they claim back their USD 20 million? Or, as they only had USD 180 million of shares because they had to sell some, they would get back USD 18 million and no longer have 10% of the shares that they initially owned. When viewed from this perspective, it could appear that the rich pay more than their ‘fair share’ at times.

Economist and director of the EU Tax Observatory Gabriel Zucman’s proposal for a minimum tax on billionaires at the G20 summit in Brazil earlier this year recognizes this and suggests that instead of a 20% tax on the gain there is a 2% tax on the gross value of the assets. In the case of our tech start-up, that would be an apparently much lower USD 4 million. But if you consider that this is an annual tax, that would be USD 4 million every year.

A reasonably cautious wealth manager might make you 5% per year, so perhaps it doesn’t seem a lot — but it is 40% of the growth, which has itself also been taxed. Forcing people to sell illiquid shares to meet a tax bill that might not ultimately crystalize would be a new approach that would have its own unintended consequences.

Inheritance tax — the final reckoning

Most OECD countries that had a wealth tax have repealed their wealth taxes in recent decades for good reasons. Spain is the largest country still to retain one, but the rates are lower, many assets such as real estate are valued at their original cost and not marked to market, the exemptions cover most middle-income families, and there is a specific exemption for family businesses to ensure that those enterprises that generate wealth and jobs are not disturbed. Norway increased its wealth tax and suffered an outflow of its ultra rich (some of whom went to Spain).

Even the richest of the rich don’t live forever, and as they retire, capital gains tax will ultimately be payable when they sell their shares or pass them on. Inheritance taxes will catch up with everyone at some point.  

The elusive ideal tax system

Of course, no tax system is perfect. The beauty of democracy, when it works, is that individual populations can choose which services they would like to be funded publicly versus privately and levy their taxes accordingly.

Nation states that had the one-time freedom to design their tax systems from scratch in the early 1990s ended up with different philosophies. Countries such as Czechia and Estonia that have low, flat tax rates with minimal exemptions have been among the fastest growing for a reason and still have decent public services.

The UK’s abolition of its non-domicile status means that many wealthy foreign nationals are looking for new places to go, and Italy and Greece, with their maximum tax of EUR 100,000 per annum, are looking to be among the net beneficiaries. Ironically, in both cases they designed their systems to be based in part on the UK’s regime that is being abolished. 

The world faces many challenges at the moment, but a ‘majority’ decision to levy higher taxes on a small minority will only go so far. Taxing wealth has too many practical challenges. We should note though that when the G20 proposed combatting corporate tax evasion by multi-nationals after the 2008 financial crisis, that culminated many years later in a global minimum corporate tax rate. That was the result of years of technical discussion and was internationally agreed upon at a minimum rate low enough for most countries to bear. There are rarely simple solutions to highly complex problems, but a greatly diminished tax base doesn’t raise much tax regardless of the tax rate.