Why Wealth Taxes Are Not Enough

CAMBRIDGE – Should advanced countries implement wealth taxes as a means of stabilizing and reducing public debt over the medium term? The normally conservative International Monetary Fund has given the idea . The IMF calculates that a one-time 10% wealth levy, if introduced quickly and unexpectedly, could return many European countries to pre-crisis public debt/GDP ratios. It is an intriguing idea.

The moral case for a wealth tax is more compelling than usual today, with unemployment still at recession levels, and with deep economic inequality straining social norms. And, if it were really possible to ensure that the wealth levy would be temporary, such a tax would, in principle, be much less distortionary than imposing higher marginal tax rates on income. Unfortunately, while a wealth tax may be a sound way to help a country dig out of a deep fiscal pit, it is hardly a panacea.

For starters, the revenue gains from temporary wealth taxes can be very elusive. The economist once the imposition of capital levies in the aftermath of World Wars I and II. He found that, owing to capital flight and political pressure for delay, the results were often disappointing.

Italy’s armada of Guardia di Finanza boats would hardly forestall a massive exodus of wealth if Italians see a sizable wealth tax coming. Over- and under-invoicing of trade, for example, is a time-tested way to spirit money out of a country. (For example, an exporter under-reports the price received for a foreign shipment, and keeps the extra cash hidden abroad.) And there would be a rush into jewelry and other hard-to-detect real assets.

The distortionary effects of a wealth levy would also be exacerbated by concerns that the temporary levy would not be a one-off tax. After all, most temporary taxes come for lunch and stay for dinner. Fears of future wealth taxes could discourage entrepreneurship and lower the saving rate.

In addition, the administrative difficulties of instituting a comprehensive wealth tax are formidable, raising questions about fairness. For example, it would be extremely difficult to place market values on the family-owned businesses that pervade Mediterranean countries.

Wealth taxes that target land and structures are arguably insulated from some of these concerns, and property taxes are relatively underused outside the Anglo-Saxon countries. In theory, taxing immobile assets is less distortionary, though taxes on structures obviously can discourage both maintenance and new construction.

So what else can eurozone governments do to raise revenue as their economies recover? Most economists favor finding ways to broaden the tax base – for example, by eliminating special deductions and privileges – in order to keep marginal tax rates low. Broadening the income-tax base is a central element of the highly regarded Simpson/Bowles proposals for tax reform in the United States.