Why Wealth Taxes Are Not Enough

In Europe, efficiency would be enhanced by a unified VAT rate, instead of creating distortions by charging different rates for different goods. In principle, low-income individuals and families could be compensated through lump-sum transfer programs.

Another idea is to try to raise more revenue from carbon permits or taxes. Raising funds by taxing negative externalities reduces distortions rather than creating them. Though such taxes are spectacularly unpopular – perhaps because individuals refuse to admit that the externalities they themselves create are significant – I regard them as an important direction for future policy (and I intend to suggest other ideas along these lines in future columns).

Unfortunately, advanced countries have implemented very little fundamental tax reform so far. Many governments are giving in to higher marginal tax rates rather than overhauling and simplifying the system.

In Europe, officials are also turning to stealth taxes, particularly financial repression, to resolve high public-debt overhangs. Through regulation and administrative directives, banks, insurance companies, and pension funds are being forced to hold much higher shares of government debt than they might voluntarily choose to do. But this approach is hardly progressive, as the final holders of pensions, insurance contracts, and bank deposits are typically the beleaguered middle class and the elderly.

There is also the unresolved question of how much the periphery countries really should be asked to pay on their debilitating debt burdens, whatever the tax instrument. Although the IMF seems particularly enthusiastic about using wealth taxes to resolve debt overhangs in Spain and Italy, some burden sharing with the north seems reasonable. As the economists Maurice Obstfeld and Galina Hale , German and French banks earned large profits intermediating flows between Asian savers and Europe’s periphery. Unfortunately, arguing over burden sharing creates more scope for delay, potentially undermining the efficacy of any wealth tax that might finally be instituted.

Still, the IMF is right – on grounds of both fairness and efficiency – to raise the idea of temporary wealth taxes in advanced countries to relieve fiscal distress. However, the revenues will almost certainly be lower, and the costs higher, than calculations used to promote them would imply. Temporary wealth taxes may well be a part of the answer for countries in fiscal trouble today, and the idea should be taken seriously. But they are no substitute for fundamental long-term reform to make tax systems simpler, fairer, and more efficient.

Kenneth Rogoff, a former chief economist of the IMF, is Professor of Economics and Public Policy at Harvard University.

Copyright: Project Syndicate, 2013.