The conceptual difficulties with wealth taxation

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I mentioned  some particular answers to the problem of taxing wealth yesterday which had something in common. This was that all were transaction based. They were not, as a result, pure wealth taxes as such. This point is important, even if a little technical but is key to wealth (and other) tax design.

To understand this it has to be appreciated that the vast majority of taxes are levied on transactions. This is obviously true in the case of indirect taxes, such as value added tax. There a sale takes place and a tax is charged at that moment. The link is obvious.

But the link is almost as obvious in so called direct taxes. A sale subject to a direct tax takes place. It automatically gives rise to a potential tax liability, subject to whether or not allowable costs have been incurred to offset the income arising. The complication is no more than that: instead of the tax due being decided by a single event it is decided by two or more (or the aggregate of many thousands upon thousands) of events. But in fact those events have something totally in common with the event that gave rise to the indirect tax charge. A boundary was crossed: possession of goods or services changed hands and a potential tax liability was triggered as a result.

And the simple fact is that the vast majority of taxes are charged when title to goods or services changes hands. This is why, in my mind, there is little conceptual difference between direct and indirect taxes: both are in fact transaction based. All that differs is the degree of aggregation of those transactions before a liability is calculated. This, when understood, has profound consequences for tax design in my opinion. It does, for instance, mean that profit is a virtually meaningless concept in taxation, but the discussion of that is for another day. The point for now is that true wealth taxes are exceptions to this general rule of taxation because they are not transaction based.

Compare, for example, a land value tax (LVT)and the current English and Welsh council tax. To some degree (albeit approximately, and poorly at that) the council tax is a transaction tax. It has implicit within it a charge. That is why, for example, it is capped. There can be no other justification for that. LVT on the other hand has no such constraint. It is a tax on wealth. It does, therefore, impose a tax on the rental value of the undeveloped land i.e. the pure wealth element of ownership. And it does so without consideration as to whether or not the value has been realised. In other words, value can be assessed to tax without any transaction having arisen.

This is exceptional. A wealth tax is also exceptional for the same reason. Inheritance tax is charged on a transfer of title. It may be imperfect but it is quite clear why liability exists: the benefit of property has changed hands. But in a pure wealth tax that need not be the case. Possession of title, and not its transfer, is the basis of charge.

Indisputably this gives rise to conceptual difficulty in charging any such tax. One of course is how to atrribute value, although in practice this is rarely insurmountable. Another is how to reconcile the difficulty of having possession of title but incapacity to pay; i.e. how to address the liquidity issues such a tax can gI’ve rise to. But again, if roll up is permitted until title passes then this is, again, rarely insurmountable. So these are not the reasons for the conceptual difficulty. That lies in the fact that implicit in these charges is something much more philosophically difficult, and challenging, in assessing such changes because what they represent, in my opinion, is a tax on what might best be called economic deviance.

This is not a term widely used. Indeed, deviance is not a term generally used in economics, although quite familiar in sociology and other social sciences. Without wishing to discuss the theoretical derivation of this idea here, let me instead suggest what it means. Assuming any wealth tax is progressive (and I presume even an LVT would have that intention) then what is implicit in the charge is a belief that there is a sufficient, or normal level of wealth that will not just adequately, but quite possibly more than adequately, sustain a person in the society of which they are a member. It is then assumed that increasingly significant deviation from this norm then imposes a number of costs on society that are in need of correction through the tax system.

One such cost arises from the  control that significant wealth may create, which control may challenge the norm upon which society is constructed. This is particularly relevant in a democracy where the principle of each person  having value in their own right is implicit in the structure of society. When a peson’s control of wealth threatens this principle of broadly equivalent (and I stress the latitude that society appears to tolerate within that broad equivalence) personal value a wealth tax addresses the externalities that the deviation from the norm that a person’s wealth represents in terms of the restrictions that it might impose on others might create.

The second significant deviation is in cost. This cost arises in a number of ways. One is in terms of cost of capital: it is very clear that the person already in possession of fortune has a lower cost of capital than the one a person without capital will suffer. This is very obviously an externality  needing price correction.

Another is in terms of rate of return: in the modern, imperfect, economy rates of return to those with significant wealth have been much higher than those to people of lesser wealth because of tax abuse, market control through exercise of monopoly power and other reasons. A wealth tax corrects for that.

Next, there is an opportunity cost. As Brooke Harrington has explained in her book Capital Without Borders, a characteristic of modern capital accumulation has been it’s extreme risk aversion, which is a trait accentuated by the role of professional trustees and risk managers in the management of many modern portfolios. This has reduced the amount of capital exposed to entrepreneurial activity, with implications all too obvious in the world economy where, as I suggested in my book Dirty Secrets, this risk aversion is killing capitalism from within.

And perhaps last for now (although I am very open to persuasion that there are issues I have not listed) is the fact that those with wealth have, come what may, lower marginal propensities to consume meaning that society cannot be indifferent to the distribution of wealth beyond certain limits if it is interested in maximising well-being.

Put these together and personal wealth beyond a certain point does, precisely because of its deviance from the norm as established by the majority of the population, challenge collective well-being. It is this deviance that does, then, justify the tax charge in itself, and on a progressive scale in particular.

That said, the charge is not trying to necessarily elminate the deviance, but to reduce it. And precisely because the deviance is measured as being at a level where the wealth holdings is not necessary for the enjoyment of a high level of well-being then the liquidity issue can be assumed in many cases to be capable of being ignored: capital disposal to fund the tax payment (or, alternatively, to make settlement in kind) is an outcome considered acceptable within the parameters set by society. A progressive charge that is sufficient to maintain an orderly  market for capital realisation is obviously desirable in this situation: the possibility of suggesting optimal rates with this in mind is not hard to imagine.

There is, however, an inherent cause of conflict in this suggestion. It would seem that some who own what may be considered by the majority to be deviant levels of wealth are often unaware of that fact (as are most of those on very high earnings also usually apparently unaware of their good fortune). In other words, they do not share the perception of deviance. Alternatively, there are others who appreciate that the deviance exists but who are more than happy to justify it: it is their argument that society is dependent upon their aberrational wealth to provide the capital that it requires and that to destabilise this relationship would be to destroy the value on which society is built. In particular they argue that a majority cannot use democracy to impose their will to tax on  a minority who happen to be in possession of a fortune because that imposes a tyranny of taxation to which the consent of the owners of wealth has not been given.

Implicit in this difference of view is a prescription for conflict that is hard to avoid. This brings up the question as to why this has not been an issue of concern to date. Wealth taxation has, to date, been difficult for two reasons. One has been the practical problem of simply seeking to locate wealth that could until now all too readily, and at a moment’s notice, be relocated to a secrecy jurisidiction, never to be reliably traced again. That problem has now been tackled: automatic information exchange from tax havens is the beginning of the end for this abuse which will, no doubt, become progressively harder to undertake over the next few years as these systems become a familiar part of the tax landscape. The old conflict, between the tax authority and the owner of wealth to simply locate the assets to be taxed is going to be won by tax authorities.

But with that practical problem solved the conceptual issue of justifying the wealth tax charge becomes more readily apparent. I believe this impossible without a theory of deviance and resulting costs requiring correction by taxation. But that requires a clear ethical justification. This has to be human rights based. But it also has to be readily explicable to those not well versed in philosophy and ethics, and that means that a concept of fairness has to be use to underpin this. But that is not a fairness based on jealousy, because that is not an ethic at all. Instead it has to be based on positive regard. Such a principle is, thankfully readily available, and is that of treating others with the regard one would expect from those dealing with you. This principle, found in all major wisdom traditions as well  as Enlighemment thinking, has within it the principle  of reciprocity that can underpin the concept of deviance implicit in the basis of taxation of wealth that I suggest. But, and this is most important, that needs clear explanation and a robust defence to the challenge that far-right groups are used to bringing to all such debates.

Wealth taxation is essential if the challenges our world faces are to be addressed. And I think it fair to flag up that the transaction based approaches I suggested yesterday are a necessary first step. But that means that the actual intellectual challenge of developing real wealth taxation has to follow on from them, and that requires new undertsanding that’s a long way from being available off the shelf right now.