Here’s How a Revamped Wealth Tax Could Fuel the COVID-19 RecoveryCo-Founder of IFG.VC and Islamic Finance Guru
Earlier this month, Millionaires for Humanity, a group comprising 83 of the world’s richest people, called on governments to increase their taxes in the wake of COVID’s economic fallout.
The idea is promising, but to be truly successful, it must be implemented in such a way that gains broad support from the rich. Otherwise, it will simply incentivize them to take their capital — and their residency — elsewhere.
Wealth taxes — where the rich are taxed on the assets they own rather than their earnings — represent one of the most popular new policy ideas in the last year. American senators Elizabeth Warren and Bernie Sanders both suggested the idea in their respective campaigns for the 2020 Democratic Party primary.
In the U.K., the opposition Labour party has made a wealth tax one of its flagship policies, with public debt reaching record-breaking levels due to COVID-19 relief schemes.
Risk of Capital Flight
Despite strong arguments and some high-profile advocates for wealth taxes, many countries have, in fact, moved away from them recently. In 1990, 12 OECD countries had a wealth tax. By 2018, it was intact in only three countries.
This is, in part, explained by poor economic returns from wealth taxes. French economist Eric Pichet estimated that France lost double the actual revenues gained from its version of the wealth tax due to capital flight — it was abolished in 2017. It seems that the only effective wealth tax is a wealth tax “by consent.”
Not an Attack on Capitalism
Left-wing support for wealth taxes can create the impression that they are an attack on capitalism. But smart wealth taxes can preserve capitalism in its most sustainable and meritocratic forms by increasing innovation, entrepreneurship and wealth creation, rather than simply wealth preservation.
Although a wealth tax appears to be a “new” policy idea, it is, in fact, a traditional — and some would say intuitive — form of taxation. The ancient Greeks levied the eisphora wealth tax on the richest Athenians, particularly during times of war. Given that the pandemic and the response to it has been likened to a war by many leaders, perhaps there is readiness for a modern day, post-COVID “eisphora.”
More recently than the ancient Greeks, Zakat alms functioned as a 2.5% wealth tax on liquid assets throughout Islamic history and are a key part of the aim of Islamic economies to facilitate free trade while limiting inequality. This model has been replicated in non-governmental form by organizations like the National Zakat Foundation in the U.K. and the Zakat Foundation of America.
By combining the specific and short-term features of Eisphora and Zakat, we can craft wealth taxes that the richest as well as the poorest benefit from.
Tax on Cash Only Would Free Trapped Wealth
Rather than taxing all assets, a tax on liquid assets only (e.g., cash or very liquid cash-like instruments) above a certain threshold would mean that the wealthy are not being penalized for their assets per se, but rather are being encouraged to circulate trapped wealth. Such a wealth tax would effectively be punishing the risk-averse and rewarding the enterprising who are willing to invest that money into the real economy to the benefit of all.
There is $80 trillion in “broad money” (i.e., cash or very liquid cash-like form) in the world. Currently much of this is effectively untaxed. If there were a levy of, say, 2% on this, that would raise $1.6 trillion a year. To give you an idea of how transformational that would be, it could cost as little as $7 billion to eliminate world hunger.
But the real benefit of a wealth tax that focuses on cash and liquid assets is not in the money it raises for governments, but in the money it circulates for the economy.
For example, if someone has 2 million pounds in cash and doesn’t invest it, the government will raise 40,000 pounds on a 2% tax. But if that same person wants to avoid the tax, a full 2 million pounds could well end up circulating in the economy instead — an outcome that is 50 times better than 40,000 pounds.
This benefit could be even more significant if governments incentivize investments in particular areas where they can deliver the most change.
For example, investing in venture capital will be more important than ever as this type of entrepreneurship is particularly suited to addressing societal problems and leading innovation in areas that need long-term patient capital — like biotech, infrastructure, climate change and edtech.
Addressing Societal Problems
This increased investment can also help social mobility and social cohesion by widening access to funding for excluded groups, e.g., only 3% of financed startups in the U.K. have a Muslim founder.
Assuming that the wealthy affected by this tax can find a mildly profitable investment for their cash, they will end up net winners compared to the status quo. Governments will need to provide low-risk, medium-return investments like green bonds or Sukuk that can make the transition to a wealth tax economy painless and profitable for the rich.
Choice of Being Taxed or Invest
If given the choice to be taxed or to invest and circulate their wealth, many of the wealthy will choose the latter. And if this is recast as a socially responsible or even philanthropic thing to do with one’s wealth, they will feel good about it for more than one reason.
“Sharing the wealth” doesn’t only mean giving it away to charity — it can also mean investing it so that the benefits of growth can be enjoyed by all. And smart, workable wealth taxes can make that happen at a time when the world needs to search for new solutions.
This article was first published on the World Economic Forum’s Agenda blog.