The problem with wealth taxes
Taxing the rich is a tantalising prospect for the cash-strapped UK government — but imposing a levy that is both fair and effective is fraught with difficulty
The UK government is under a lot of financial pressure. A heady mix of US tariffs and the added costs for British businesses imposed in last year’s Budget have prompted a downgrade in the UK’s economic growth forecast. This is heaping pressure on the government to revisit the financial calculations it made only three weeks ago at the Spring Statement in order to balance the books.
In reality that means more spending cuts or higher taxes, but the government has ruled out increases to income tax, VAT and employee national insurance contributions — which are HM Revenue & Customs’ main revenue earners.
So what about a wealth tax?
It would have an appeal to many on the Labour party’s left, who are unhappy with the drift of government policy. Such a tax is a tempting option because wealth disparities in the UK are wide and the rich, by definition, have a lot of money.
The most recent survey by the Office for National Statistics showed that the wealthiest 1 per cent of the population owned as much wealth as the bottom 50 per cent combined. Since total wealth was more than $13tn, this means that the top 1 per cent have more than £1.3tn between them — a juicy target.
This wealth is more unevenly distributed than income. The Gini coefficient monitors the distribution of income (or wealth); a score of 1 means one person has all the money while a score close to 0 means near-equal distribution. For income, the ONS found that the UK’s Gini coefficient was 0.36, but for wealth it was 0.59.
The UK, of course, is not that different in terms of wealth disparities from many other developed nations. And that similarity leads to an obvious objection to the idea of the tax; other nations haven’t pursued it. Indeed, many have retreated. According to Stuart Adam, a senior economist at the Institute for Fiscal Studies, out of 12 OECD nations that had a wealth tax in 1990, nine have since dropped it. And as Dan Neidle of Tax Policy Associates, a think-tank, says: “When any new tax is proposed, look at the previous efforts to create something similar. There is an extreme record of failure.”
There are four big problems with wealth taxes. First is deciding which assets to include; the fewer exemptions, the more money raised, but the greater the volume of complaints. Second, valuing the wealth that is being assessed; a lot of wealth, for example, is tied up in private companies without a stock market quote. Third, trying to ensure that the tax does not distort economic behaviour, encouraging the wealthy to shift assets into tax-free categories (as happened with inheritance tax and farms). And fourth, preventing the wealthy from avoiding the tax by moving their money abroad.
On the latter point, substantial wealth taxes were levied in Japan, France and West Germany in the wake of the Second World War, but this was at a time when the need for national rebuilding was clear and, under the Bretton Woods system, the scope for moving capital out of the country was extremely limited.
In the modern world, liquid assets can be moved across national boundaries with a click of a mouse. So that suggests the best option would be to catch the wealthy by surprise.
A report in 2020 by the Wealth Tax Commission, a panel of experts, suggested that a one-off wealth tax of 5 per cent (payable over five years) could raise £260bn if levied on assets of more than £500,000, or £80bn if applied to assets of more than £2mn. Such a tax would be difficult to avoid if the levy was applied to wealth on the day the tax was announced.
An annual tax would be much more expensive to administer because of the need for regular valuations. And there would be more scope for avoidance because people would adjust their behaviour to reduce their bill. One obvious way to do this would be to split the assets among family members; another, for the wealthiest, would be to move abroad.
The commission also proposed that all wealth would have to be included when calculating the levy. This is sensible from both an economic point of view (to avoid distorting incentives to invest in one type of asset over another) and to reduce tax avoidance. Such an approach would maximise revenues but would have huge political dangers.
With a floor of just £500,000, the tax would catch some 8mn Britons in its net, many of whom would not consider themselves to be that well-off. In particular, the tax would hit homeowners in south-east England, where million-pound homes (equating to £500,000 each for a couple) are quite common. A £2mn starting point would still catch 626,000 taxpayers, including (no doubt) some farmers, who are already angry at the recent changes to inheritance tax.
An obvious answer would be to exclude a citizen’s main home from the levy, but this would reduce the revenue by 30 per cent if the starting point is £500,000 and by 15 per cent at a threshold of £2mn.
That brings us to another substantial source of individual wealth: pension rights. Anyone under age 55 cannot touch their pension pot without incurring a 55 per cent tax penalty. The commission suggests that the money could be taken out of the lump sum on retirement, which means a long wait for the government before they get their money (and assumes that lump sums will still be tax-free in the future). Exclude pensions from any wealth tax and the potential yield falls again. The IFS estimated in 2022 that housing and pensions comprise about 80 per cent of household wealth.
In short, many citizens may be asset rich but cash poor. If you are a 50-year-old with a house in the Southeast and a pension pot built up over 30 years, you may appear rich on paper, but that doesn’t mean it would be easy to meet a sudden bill of £75,000 (5 per cent of £1.5mn), even if spread out over several years.
Some of these complications would be avoided, and the political backlash reduced, by raising the minimum threshold for the tax to £10mn. This would only affect 22,000 taxpayers and raise £43bn over five years (based on a 5 per cent levy payable in five increments), according to the Wealth Commission.
Many of these wealthier people, however, will own small businesses, which would need to be valued — not an easy task for private companies. Independent valuation of each of the estimated 5.5mn private businesses in the UK would be a long, cumbersome process. Private businesses are valued every year for inheritance tax purposes, but this happens on a much smaller scale, as only 4.4 per cent of UK estates pay inheritance tax.
One answer would be to get owners to value the business themselves and audit a proportion of them in an attempt to deter cheating. But the instances of tax avoidance would still be high. Aiming the tax at the very wealthiest also means attacking those with the very best accountants and lawyers. Neidle points out that large estates only pay inheritance tax at half the rate incurred by smaller estates. The wealthy are also likely to own assets such as art or jewellery, that may be difficult to value or easy to hide. The government might find itself tied up in court for years as the super-rich challenge the basis for their taxation.
Despite these objections, some countries are able to impose wealth taxes. Switzerland has taxed wealth since the 18th century. The tax is levied annually at regional level and generates around 3.8 per cent of the state’s annual income. However, overall tax rates in Switzerland are low, around 27 per cent of GDP, compared with 37 per cent in the UK, for example. High-income individuals can enjoy a low marginal tax rate if they move to the right canton (the top federal rate is just 11.5 per cent). Contrast that with the UK, where the top marginal tax rate is 45 per cent.
Spain’s wealth tax, meanwhile, which reaches 3.5 per cent on the biggest fortunes, exempts assets under €700,000, the taxpayer’s principal residence and some types of family business. The levy raised €632mn in 2023, close to just 0.25 per cent of the Spanish government’s total tax revenue for that year of €272bn.
The UK’s annual tax revenues are a little under £800bn, so a levy that raised an additional 0.25 per cent would be worth around £2bn — not enough to make a big dent in the annual budget deficit of about £137bn for the 2024-25 financial year.
Given all these problems, one can understand the government’s reluctance to act. The amount of money raised would not be worth the political storm that would result, with all the talk of “socialist confiscation” in the press. This would especially be the case if the tax was announced as a one-off surprise with the aim of preventing avoidance.
As with inheritance tax, many people who would not actually pay the tax would still see it as a threat to their aspirations. Wealthy foreigners, some of whom have already been deterred from living in the UK by changes to their tax status, would be even more discouraged.
Finally, given that the government is aiming to generate economic growth and attract business investment, an additional tax on those who are successful would seem an odd choice.
In any case, both capital gains tax and inheritance tax are, in effect, already a tax on wealth. The government already tightened some of the IHT reliefs in last year’s Budget, notably reducing the relief on assets worth more than £1mn.
Neidle thinks further progress could be made by closing exemptions in return for a reduction in the rate charged; many people try hard to avoid that tax because the 40 per cent rate is seen as punitive. He also thinks CGT could be reformed. The rate could be equalised with income tax, but only applied to “excess” returns — those that are higher than the yield on government bonds.
At the IFS, Adam thinks there is scope to raise more revenue from IHT by tightening the exemption that allows people to give away assets during their lifetimes. And there is also room to raise more money on the wealthy through council tax, the rate being a much smaller percentage of the value of expensive properties than cheaper ones. Scotland pushed through such a change in 2017.
It seems more likely that the UK government will attempt to raise money through reforms along these lines rather than push through a new and controversial tax.
Mind you, recent events have illustrated that the threats to individual wealth are more likely to come from the decisions of the US president than those of the domestic government.
