A wealth of options: shifting tax away from earned incomes

Inequalities in wealth are far greater than inequalities in income on which most tax policy discussion has focused. However, different kinds of wealth require different kinds of taxation, and there are a range of potential policy options we can consider, from a site value tax on property to a local income tax to replace regressive council tax. Each option faces obstacles, but each provide the opportunity for a fairer society and more efficient economy, in the interests of everyone.

A powerful case can be made for shifting the weight of taxation from earned income to wealth, such as property, land and financial assets. This case rests not just on claims of fairness but on economic efficiency. Taxing work but not taxing rising property values creates perverse incentives to invest in property not work. And letting private owners reap most of the rewards of public infrastructure investment restricts the optimal scale of major projects. Ultimately, the whole economy loses. But fairness matters. Inequalities in wealth are far greater than inequalities in income on which most tax policy discussion has focused. Those on the cusp of being in the top 10 per cent of incomes receive four times the income of those in the equivalent bottom tenth position: for wealth that figure is 70 times. Furthermore, in the years between 2010 and 2012, one in ten households had less than £15,000 of savings or assets, while the top one per cent had on average £1.2 million.1

There are significant consequences for such inequitable wealth distribution. Young adults brought up in families lacking savings suffer in later life. Not to possess any assets minimises families’ capacity to plan ahead and take risks, change career and train, or move house to find work. And the extreme wealth of a few can pervert the political process via influential vested interests.

These are not arguments that should resonate only with a few lefty socialists. They should matter to all who care about creating an open and efficient society. Yet European governments’ record on taxing wealth has been lamentable. In the post war period, UK taxes on inheritance amounted to 1.5 per cent of GDP. This has fallen to about 0.2 per cent today. Taxes on net wealth, property, inheritance and gifts amount to just over 4 per cent of national income but less than 1 per cent of total national wealth. Moreover, most of that revenue comes from council tax which is levied in a regressive way on renting residents, not home owners.

In the OECD as a whole, taxes on assets, property and inheritances amount to only 2 per cent of GDP each year, as Table 1 shows. Nowhere are taxes on wealth of much revenue significance.

Yet wealth has been growing faster than incomes in most countries as well as becoming more concentrated. In France and England, for example, the sum total of their wealth was equivalent to three times their GDP in 1980 and five times in 2009. What exactly constitutes ‘total wealth’ differs somewhat in different countries, as the last column in Table 2 demonstrates, but the general trend is clear.

Even so several countries have abandoned taxing annual net wealth (Sweden, Netherlands, Germany and Finland), and/or have reduced taxes on inheritances.

Difficulties in regularly assessing wealth holdings, for fear that such taxes lead to flights of wealth, may partly explain this. But so too may the sheer political power of wealth. Whatever the reason it is a stark reminder that taxing wealth properly will not be easy.

Promises by the new Conservative government in the UK to raise the threshold for inheritance tax on the value of owner occupied homes and the new ability to hand on unused pension capital to one’s children will further reduce the yield of these taxes and increase the growing scale of inherited wealth.

So what are the options for reversing these trends? It is clear that a range of measures will be needed in combination. Different kinds of wealth require different tax measures.

About half of net wealth in the UK takes the form of property and land. Taxing this sensibly would bring economic benefits. Land is given. It is not (mostly) created by human effort. Its value is largely created by public action – building roads, putting in sewers and properly policing the urban areas created. Value is created by the state giving planning permission to develop. Here there is a case for a range of potential reforms.

A site value tax – a percentage tax on land above a minimum value – would ensure that when an owner of a plot of land was given planning permission to develop, tax would be levied on the new market value that has been generated by granting planning permission. This would encourage its timely development. It would bring future tax benefits to the state and facilitate infrastructure schemes. Town planning rules do enable limited, one off agreements for developers to make planning gain payments at present but this would be automatic under a reformed tax regime. Such taxes exist in some other countries including Denmark, parts of the USA and Australia. (The Mirrlees Review lucidly argued that the whole system of property taxation in the UK was an illogical and inequitable mess.)

There should be no exclusions, such as forests or owner occupied houses. Such loop holes only encourage over investment as a way of avoiding taxes, pushing up the price of houses, for example. The state has good data on who owns land. We also have good data on sales values to make valuation and regular revaluation much easier than it was in pre-digital days.

This proposal, however, would have a knock-on effect on council tax. It would be unpopular and inefficient to have two taxes levied on the same house – a major source of unpopularity around the proposed mansion tax. As such, council tax could be replaced by a tax on the value of the buildings, paid by the occupier and service user – distinguished from the value of the land, paid by the owner. This would be technically feasible using the valuations for building insurance.

Another option would be to replace council tax with a local income tax. Those with incomes below the tax threshold would effectively have their tax paid by central government and the local authority could be compensated by the central government grant. There are obstacles to this route – high income residents moving to low tax areas – but the logic of replacing the council tax flows from introducing a site value tax as the Mirrlees Review argued.

Next in line could be the full taxation of capital gains, at the same rate as income tax and employee national insurance contributions taken together.

Capital gains should also be taxed prior to assessing inheritance. Nor should owner-occupied property escape capital gains entirely. Not to tax it has resulted in people using housing as a way of preserving their wealth. This practice would only increase if other forms of wealth were effectively taxed. This results in higher house prices, excluding those on lower incomes from the housing market.

Pension assets are another major source of wealth and one that is perversely subsidised by the general tax payer – the higher your income the greater the tax subsidy. A reduced cap has been placed on this subsidy but there is a long way to go, and there may be a case for tax encouragement for small savers but not rich ones. The boundary line between capital and income for tax purposes has also been eroded, providing potential avenues of reform. It is possible for directors of companies to limit their tax liabilities by taking their income in the form of capital gains and dividends which are taxed at a lower rate than income. One way would be to revert to the regime that applied between 1988 and 1998 with real (after inflation) capital gains taxed at the same rate as an individual’s marginal income. Returns on investment above a given ‘normal rate’ could be taxed like any other income, as the Mirrlees Review suggested.

So far I have avoided what some see as the obvious solution, including Thomas Piketty – an annual tax on all personal assets. Labour’s 1974 election manifesto promised to introduce such a tax, but did not do so upon election. Contemporary Treasury and Inland Revenue files suggested they were right to do so, as my research has shown.4 This was because the cost to individuals and government of valuing wealth assets annually, with concurrent Inland Revenue checks, out-weighed much of the likely revenue yield, not to mention the difficult science of calculating the appreciation of wealth’s value.

Moreover, there is a better way and it has been advocated by Piketty’s mentor Sir Tony Atkinson and others including John Stuart Mill. Instead of having the state impose a compulsory asset and wealth tax, principally at the point of death, we should give individuals and families the choice of how to use their wealth, while strongly incentivising them to spread their wealth widely. The best way to do this is to tax recipients, via an accessions or donee tax.

In this model, gifts or transfers over a minimum sum would be taxed – initial small sums could be excluded but as gifts mounted over a period they would be taxed. Gifts to properly defined charities would be excluded.

There are difficulties with this arrangement, of course. Revenue from inheritance tax is currently rather small, but under this model it would disappear completely. However, if this model worked, its virtue would be that accumulated wealth would not steadily accumulate in fewer and fewer hands.

There are therefore a range of different, complementary and achievable options open to us. But fundamentally, it is not enough to try to reallocate wealth merely through taxation. These reforms should be accompanied and justified by promoting wealth at the bottom of the wealth distribution, through schemes such as reintroducing the Child Trust Fund – giving all citizens at the age of 18 a capital start in life. We also need to invest in early years education, offering most citizens a greater opportunity to generate wealth themselves starting from a more levelled playing field. The more effectively we can tax wealth, the bigger the opportunity we have to invest in everyone’s life chances, helping create the fairer society and more efficient economy that should appeal to a broad electorate.

Notes

1.These figures and others in this chapter are taken from Hills J., Bastagli F., Cowell F., Glennerster H., Karagiannaki and McKnight, A. Wealth in the UK: Distribution, Accumulation and Policy Oxford: Oxford University Press 2015 (paperback edition.).

2. ‘Wealth Inequality and the Accumulation of Debt’ in W.Salverda, B.Nolan, D.Checchi, I.Marx, A.Mcknight, I.G.Toth and H. van de Werfhorst Changing Inequalities in Rich Countries Oxford: Oxford University Press.

3. ‘Trends in the Distribution of Wealth in Britain’ in Hills et al 2015 op.cit.

4. H.Glennerster ‘Why Was a Wealth Tax for the UK abandoned? Lessons for the Policy Process and Tackling Wealth Inequality’ Journal of Social Policy Vol 41 P 2 pp 233–249, 2012.