I was once on a tour in Provence that included the house where Nostradamus used to live, which features several windows that have been bricked over. “That’s because the government used to tax you based on how many windows your house had,” I volunteered to the group, trying to be informative. “And that’s why wealth taxes don’t work,” I added, trying not to be annoying.
I am not sure the tour guide — a proud Marxist, this was France after all, I expected nothing less — appreciated my editorializing. But it’s a relevant issue again as France considers a wealth tax , which would be as nonsensical today as it was 500 years ago.
Over the next decade, almost every rich country will have to face fiscal reality. All have expanded their welfare state to serve not only the needy but also the middle class, with expensive pensions, health care and worker benefits. But with an aging population, slower growth and rising interest rates, the math just doesn’t add up. Something has to give. In the meantime, US and European politicians are grasping at one strategy they hope will allow them to avoid hard choices: soaking the rich.
Both France and the UK are debating a wealth tax, hoping that it will provide enough revenue to avoid a broader tax increase or benefit cuts. France has so far been unable to reduce the number of bank holidays, never mind cut pensions. But one policy that has popular support is taxing wealth of more than €100 million by 2%.
But wealth taxes, like the window tax, don’t work . First, it sounds small, but a 2% tax on wealth is the equivalent of a 50% capital gains tax, assuming a 4% return on assets, and wealth taxes need to be paid even if someone’s investments lose money. Second, by removing so much capital from markets and reallocating it to the government, a wealth tax could lower growth and distort incentives.
The primary problem with a wealth tax, however, is that it is just very hard to implement. It gives the rich an incentive to either move somewhere with lower taxes or put their wealth in hard-to-value assets, such as art or private equity. That seems to be why UK Chancellor of the Exchequer Rachel Reeves has rejected the idea.
In the US, wealth tax proponents are less prominent, but there is a growing “eat-the-rich” populist movement on the right and left. The probable next mayor of New York City is planning on limiting the profits of landowners by requiring them to freeze rent on the city’s rent-stabilized units — an effective cut once inflation is accounted for. He also wants to increase corporate taxes and has proposed a 2% flat tax on New Yorkers who earn more than $1 million. He also plans to use the revenue to provide many new benefits for the middle and upper middle class — rather than fund existing unfunded obligations, which will probably get worse under his plan.
It is a risky strategy. New York finances are dependent on a handful of high earners . A flat tax, as opposed to a marginal tax levied on different tiers of income, is not considered optimal by tax experts because it creates perverse incentives — mainly to keep your earnings below the level at which all your earnings become subject to higher tax. California did not have much luck with (better constructed) tax hikes on its high earners, as many left the state.
Of course, if the economy booms and there is no recession or financial crisis in the next decade or so, a wealth tax could work (though even then it probably wouldn’t raise much revenue). Rich people, like all humans, respond to incentives — and there just aren’t enough rich people to pay for everything. And there is no getting around the fact that governments, both national and local, have been overpromising and undertaxing for years. Not only will the rich have to pay more taxes, but so will everyone else.
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