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What are the real consequences of wealth tax?
One of my favorite things about working as an editor at Mundo is that I am constantly in touch with remarkable people from whom I learn a great deal: experts, lawyers, business people, and writers.
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Here you can find a piece mostly based on our partner´s article and with a personal touch from the editor.
The real consequences of wealth tax
One of the topics that are frequently discussed on the media is the Covid-19 pandemic huge economic crisis and how the governments are desperately trying to solve their financial emergencies by increasing tax on the wealthy. Sadly, the persecution by governments of the richest people is supported by public opinion. People usually think that the money of the wealthy has been ill-gotten, or that they are guilty just for being rich. Somehow, society believes that the wealthy are guilty of the increasing poverty and for growth of the extreme income inequality.
Extreme income inequality does exist and it is a problem that should be seriously addressed. It is our opinion at Mundo that there should not be such a wild inequality of income and wealth in the world. However, we do not believe that the solution lies in distributing the cake more effectively among all the world´s population. The problem will be solved if the cake grows bigger, and more wealth and resources are generated for everyone to enjoy. The key is to grow the pie, not to cut the pieces more evenly.
One interesting question to ask ourselves is why is the pie so small? Some of the reasons why this is so include government and corporate corruption, market manipulation, central banking, racism, favoritism, extreme state interference, and others. In plain words, it all comes down to this: pure human greed and baseness. Wealth is not the problem as some of these characteristics (racism, nepotism, manipulation, etc.) can be found both among the rich and the poor. The problem is human nature in itself, but we cannot fix that, can we?
Therefore, this article intends to address the issue of wealth tax, a tool using the excuse of distributing the cake more evenly, but that it doesn´t really work and even backfires most of the time. This topic is being discussed worldwide due to the current crisis and because most governments choose this strategy to finance their exhausted economies.
Are wealth taxes useful in helping the economy?
Wealth tax is different than income or sales taxes because it is levied on assets held at a point in time “regardless of whether they are sold, traded, earned or dividend”. This tax is levied on the value of the assets assuming they will be sold immediately. The wealth tax is reliant on the market, which is not the case for income tax or capital gains.
Thus, a wealth tax is basically impractical. I may hypothetically own 5 million dollars in Amazon shares, but I don´t have 5 million in cash However, the government assesses the value of my stocks, property or current wealth and taxes me accordingly. But these assets are mostly illiquid, therefore, I am forced to sell them in order to pay this tax. This is an utterly ridiculous system and also completely unfair. Moreover, this completely destroys the potentially productive capital.
Due to the deep crisis caused by the pandemic, many governments around the world are considering implementing a wealth tax. The main idea is that by doing so the country´s revenues would be significantly increased so that they can fight the coronavirus and reestablish their worn-out economies. This may sound like a good idea, but is it really?
When the wealth tax question arises, a sliding scale of annual tax rates is often discussed. This means that the wealthy pay a higher percentage of tax than the less wealthy. Although it may seem fair at first, if you think about it, this taxation system makes the same impact on everybody. What would be fair is that everybody pays the same percentage, i.e., if you have 10 million in assets and you pay a 10% rate tax, you pay 1 million, and if you have 1 million you pay 100,000 USD. In other words a flat-rate tax.
Moreover, if you analyze the situation rationally, the extreme taxation of the wealthy does not help anyone, because these are the people who have the means to set up complex offshore structures or simply leave the country taking their large funds with them. These funds usually support a country´s economy in the form of companies and employment, financial vehicles, etc. The ever-increasing restrictions on offshore zones and international structures have made the formation of tax-reducing structures much more difficult, this is a fact, but difficult for whom exactly? Now may be harder for a middle class individual or a small business to set up an asset protection offshore structure, but the extremely wealthy can easily afford and implement these strategies. They escape to those countries where they are treated best and generate an economic loss in the country they have left behind. Let us not even start with the fact that, in the case of many countries, it is highly questionable what the tax funds are used for. Thus, capital flight is a big risk and a side effect to the wealth tax which needs to be considered in the equation we are now analyzing.
When we talk about capital flight, we don´t just mean money or investments, but something that’s ‘maybe more precious: talent. The economic capital is not the only thing that leaves where it´s treated best but also productive individuals, talented people and their innovative ideas. The ugly truth is that the real goal of a businessperson is not to create job positions but to develop an idea and become rich making the people around him richer too. Obviously, in this process, jobs will also be created, and services will be provided, and there will be an injection of money into the general market. The richer the people are, the more they spend and hence the economy is strengthened.
Thus, it is important for governments to support business and make it as easy as possible for them to grow, to maintain a healthy fiscal system that allows for the support of the most vulnerable part of society. However, the main goal must be to encourage productivity, because that is the best way to help the people.
Let´s analyze why the over taxation of the wealthy is not a good strategy to help the part of society that struggles the most. When wealthy people generate money, it does not disappear into the air, but is constantly invested and injected into a country´s economy. The capital is either invested or saved in a bank, which allows the bank to lend money, to develop new businesses, develop property, spent in goods and services, etc. Even if a rich family would lock their money down in a basement, the central bank would be able to print additional money to the economy to counteract the cash removal and this would not cause an immediate inflation.
There is plenty of evidence that when governments have imposed a wealth tax, this strategy has backfired and negatively affected the country´s economy. Nowadays only three countries implement this tax.
In France, for example, during the '80s a wealth tax was imposed on those whose assets surpassed the 1.5 million. As a result, 42,000 millionaires left the country to places where they were treated better. In 2017 this tax was removed.
Sweden had a wealth tax of 1.5% for individuals or families owning more than 200,000 in wealth. The implementation of this tax caused a capital flight estimated in 1.5 trillion Swedish Krona.
Many countries have abandoned the idea of imposing a wealth tax for these reasons and also because it is very hard to implement. Before applying higher taxes on the wealthy (who eventually have the means to leave whenever and wherever they want) it is important to consider who is really going to suffer the negative effects of this tax.
Indirect, financial consequences of a wealth tax:
- Contrary to popular belief, the wealthy in general are not wasting their money on yachts and parties, but have their wealth in the form of illiquid assets. These assets are largely invested in the economy in the form of businesses, stock, bonds, etc.
- Implementing a wealth tax would increase costs in general because the investors subjected to this tax will try to compensate by increasing their returns. This will result in increased costs of products, services, etc.
- It won´t be profitable to invest in government bonds, hence the governments funds will be reduced.
- A wealth tax will produce a tendency to invest in illiquid assets instead of stocks and bonds, which will result in a decrease in the overall market.
- Many will be forced to sell their assets in order to pay this tax and the market will further decrease. Investors then will find a way to invest through other vehicles which may be less open for the public in general, thus shrinking the economy.
- Like we pointed out before, the wealthy have the means to afford more complex financial tools in order to reduce their tax burden such as trusts and international structures. They also can afford highly qualified professional lawyers, accountants and tax experts to legally avoid paying the tax.
Coming back to the pie metaphor, it seems that taking from the wealthy to give to the less wealthy is not the answer after all, but growing it and making it ever more nutritious so that everyone can feed on it, would be.
Another form of taxation that finds many objections is the inherited wealth tax. Besides the fact that the assets that are taxed in an inheritance process have been taxed many times over (through income, corporate, wealth tax, capital gain, real estate tax, etc.) it brings other problems as well. The argument is that the beneficiaries have never been taxed for these assets. Many inheritors are forced to sell or mortgage their assets in order to pay for this tax.
It is said that 70% of the families lose their wealth by the second generation and 90% lose it by the third one. Only 13% of families can maintain their wealth for three generations. This is because very few people are familiar with the asset protection structures available and that can include a second passport, a tax residency, a subsidiary company, foundation or a trust. Or a combination of all. Nobody teaches society how to get wealthy and even less how to maintain this wealth once generated. Most people are financially undereducated. At Mundo, we always stress the fact that a carefully designed asset protection strategy is vital for all families. This goes not only for high-net-worth individuals but also for the middle class.
Panama, for example, has affordable structures and residency programs available. We offer a unique asset protection plan that is based on the five-flag theory and consists of 5 different steps. We call it the forever free strategy and you can read about it in this article.
The burden of tax falls on the wealthy. In the US, 1 percent of the taxpayers paid a larger amount in income taxes (37.3) than the other 90% combined (30.5%). In September 2017, a report released by the Federal Reserve showed that in 2016 1% of the population owned 38.5% of the country´s wealth. We would love to see this huge gap narrowing down but not by government control and over taxation, which only makes everybody poorer, but by a free market unmanipulated plan, with low state interference.
The elephant in the room is that the extremely wealthy protect their monopolies through loopholes in the regulations in order to bend the law and crash their competitors, supported by a sector of corrupt government and justice systems.
The World Data Lab estimated that by 2019 under 600 million people will live in extreme poverty, and I wonder what these statistics would look like after the economic crisis generated by the major lockdowns in 2020. If we look at the unemployment figures this is frightening. Do we want to further reduce production with a wealth tax?
The extreme inequality is an issue that needs to be urgently addressed and the creation of jobs, education and economic growth are key factors to solve this problem. But releasing social plans to help the most vulnerable part of society is like putting a bandage on a man whose arm was just ripped off. He will probably bleed to death.
In the same way, giving out resources to people that are not productive is a death sentence for a country’s economy. Also, it makes them more reliant on the government’s aid.
It is our opinion at Mundo that there should be a free market with less regulation in order to reduce the prices of goods and services, thus, people will be able to afford more things (dinner at restaurants, entertainment, goods, travel, etc.), which will result in the economy growing. This strategy satisfies the needs of everyone, and everyone gets richer instead of poorer. We understand that this is easy to say but hard to implement, however, in our view this is the direction in which we should be moving if we want to reduce the economic inequity and make the world a fairer place.
In conclusion, while the extreme rich continue to manipulate the market with the help of a corrupt system and the poor keep relying on someone else´s magic hand to help them without producing something useful to society, the world economy in general is headed to total disaster.
Now is the time to plan for more stringent government regulation and to allocate assets accordingly.
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