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Wealth Tax Is the Worst of All Taxes

April 22, 2013

It doubles the effect of the cancer currently eating away the substance of the West's prosperity.
According to the Daily Telegraph's Ambrose Evans-Pritchard, senior advisors to Germany's Chancellor Merkel are pushing for a wealth tax, to be applied to citizens of those weak sister eurozone members forced to undergo bailouts from German taxpayers. You might think that, having criticized sternly the malefactions of the super-rich, and of the economic and political system that got them there, I would favor this. You would be wrong. It's notable that the German government is attempting to apply the tax to her weaker EU trading partners, and not to Germany itself. For in reality it is truly damaging—indeed the most economically and morally destructive of all mainstream taxes.

Wealth taxes can be defined as taxes levied on the value of assets rather than income, generally at a low annual rate (though in this context estate duties, payable on death, are also a form of wealth tax). Apart from those for whom any blow to the rich is welcome, wealth taxes are beloved by some economists, because they are thought a spur to efficiency—those who achieve a high return on their capital pay relatively less of their income in wealth taxes. Thus the entrepreneur who can achieve a high return on his wealth is benefited relative to the parasitic third and fourth generation heir, who has only perhaps a 3-4% return on his wealth and hence suffers badly from a wealth tax set at 1-2% of capital (the French wealth tax is currently set at a top rate of 1.6% annually on wealth above 16.8 million euros – about $21 million).

Even for the entrepreneur, this assumed benefit of wealth taxes fails to take account of liquidity. Generally an entrepreneur's return on capital may average a very high rate, but it fluctuates violently, often being negative in periods of recession. What's more, an entrepreneur's wealth is often tied up in one company, which may not be publicly quoted and whose value is then estimated by a process of dispute between the tax authorities and the entrepreneur's accountants. Given the tendency to assess tax in arrears, this then lands the entrepreneur with a substantial risk that a huge tax bill, relating to the previous prosperous year, may arrive just as his net worth has collapsed and banks are especially unwilling to lend him money. At the entrepreneurial end of the spectrum, therefore, a wealth tax exacerbates the business cycle and is a generator of extra bankruptcies and business failures, surely not economically optimal.

The most pernicious effect of a wealth tax however occurs when it is combined with a Bernankeist policy of low interest rates. With 10-year U.S. Treasuries yielding 1.7% as today and fully taxable at the Federal level, even a modest Federal tax rate of 28% deducts 48 basis points from their return, leaving only 1.22%. It will then be seen that a French-level wealth tax of 1.6% would leave the luckless investor with a return of minus 0.38%. Add to that the cost of another 2% or so from the ravages of even current levels of inflation, and you will see that any investment other than wild speculation in order to receive a higher yield is completely futile.

Simplistic analysis of the wealth tax, however enjoyable, is however bedeviled by the fact that France's savings rate is in the 14-16% range, far above those in the U.S., Britain and even Japan, where no wealth tax exists (though France measures savings on a gross rather than net basis, which must account for some of the difference). That's certainly one reason why French interest rates remain low at 1.79%, comparable to the yield on U.S. Treasuries and far below the yields on Spanish and Italian debt, in spite of the fact that France's budget deficit, debt levels and economic performance are quite close to the feeble Spanish and Italian levels.

There are of course contrary effects here. Household credit is only 48% of GDP in France in 2011, compared to 98% in Britain and 87% in the U.S. Thus Frenchmen need to save in advance for automobiles, weddings, mortgage down payments etc. in a way that's not necessary in the credit card-addled Anglo-Saxon countries. Similarly French medical and retirement systems differ from those in Britain and the U.S., and may also encourage saving rather than spending all your assets and depending on social security.

Of course, imposing a wealth tax on Spain and Italy while avoiding one on its own citizens would be something of a double whammy for the German authorities. It would provide funds for Spain and Italy that could be used to close the funding gap that had caused a bailout to be necessary, while at the same time attracting the wealthy and productive to leave Spain and Italy and settle in Germany, within the Schengen border agreement that allows them free movement, and where the currency is the same and the economy is growing in a much healthier fashion.

The principal defect of a wealth tax, however, is its encouragement to short-termism. Since it falls disproportionately on capital invested for modest long-term returns, it benefits strategies that use high leverage and aim for a quick hit, and penalizes the patient Soames Forsyte approach to accumulation of substance. This is precisely the problem with Bernankeism also; a wealth tax thus doubles the effect of the cancer currently eating away the substance of the West's prosperity. A society that obsesses over the effect of global warming a century hence should realize that a wealth tax can eat away the foundations of our current civilization much more quickly than that. Wealth taxes, like Bernankeism, are both economically destabilizing and socially destructive.

A wealth tax also works against the natural human life cycle. Even if we extend the retirement age a few years to fix Social Security and Medicare, there will inevitably be many people in their 70s and 80s, whose declining health, physical strength and mental agility no longer allow them to participate productively in the workforce. A wealth tax drains the money they have saved for retirement, and falls most unequally on those who have accumulated their own pension savings compared to those blessed with a company or even better government plan, index-linking and all. By falling most severely on those who have saved, it reduces the incentives for saving and increases the costs of to society from the population's penurious old age.

Other forms of tax don't have the disadvantages of a wealth tax. Income taxes attack income, as and when it is received. Thus an income tax has little long-term impact; once the income has been taxed it's yours. A wealth tax, on the other hand is a permanent erosion of your financial position, when it has been removed, the remaining wealth is still there to be taxed again in the following year.

Sales taxes and VAT, on the other hand, are often positively beneficial for the economic system because they tax consumption and not wealth accumulation. Ebenezer Scrooge benefits from a sales tax, because it falls on his spendthrift neighbors, whereas a wealth tax attacks him directly. Since in my view Scrooge is one of the few truly moral examples in classic fiction, it thus follows that a wealth tax is morally destructive to a greater extent than income tax, and in a way that a sales tax isn't. The standard objection to sales taxes, that they are regressive; can be fixed by applying them at a higher level to luxuries than to necessities, perhaps imposing extra high "sumptuary taxes" on forms of consumption that are excessively offensive (such as $100,000 electric cars that don't work properly, but not 32-ounce soda bottles!).  

The obvious solution to the euro crisis is to break up the euro; its continued existence brings no benefit commensurate with the damage it appears to be causing. However, even if the German government wishes to continue inflicting pain on its poorer neighbors, it can at least as a matter of simple charity avoid afflicting them with a wealth tax.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

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