Switzerland Illustrates Potential Drawbacks of Wealth Taxation
July 11, 2016
The surge in inequality over the past few decades has led some economists, notably Thomas Piketty, to advocate the taxation of wealth. However, the impact of wealth taxes on wealth accumulation has not been widely studied. Using data from households in Switzerland, a group of economists recently found that wealth taxes substantially reduce reported wealth holdings. Financial assets in particular were more responsive to taxation than non-financial assets, such as real estate. The results of this study imply that these taxes would generate little revenue with a considerable cost to the economy.
Many countries in the OECD impose estate or inheritance taxes, two kinds of wealth taxes, on their citizens. Estate and inheritance taxes are levied on the money and property of the deceased and paid by the beneficiaries. However, only a few of these countries tax personal wealth holdings on a yearly basis. Switzerland imposes the largest of these taxes, which generates 3.3% of its total revenues. The country’s wealth taxes are all raised at the canton and municipality level. Exemption levels are fairly low, exposing many upper-middle class households to the tax.
The variation of the wealth tax by canton, and the large number of households that pay the tax, make Switzerland an ideal candidate for this study. The authors find that a one percentage point increase in the wealth tax rate would reduce declared wealth holdings by a staggering 34.5%. While some of this decline could simply be attributed to a reduction in the reporting of wealth, rather than a real change in wealth accumulation, the authors argue that Switzerland’s 35% withholding tax limits this possibility. All financial assets are subject to this withholding tax, and these payments are returned to the taxpayer in full after taxes have been filed. The purpose of this tax is to ensure that all interest and dividends received by the taxpayer are included in taxable income. For filers whose wealth tax bills amount to less than 35% of their asset returns, this withholding tax provides an incentive to accurately report financial assets, otherwise they would not be eligible for a refund.
Some cantons structure their tax schedules differently, which alters the taxpayer response to wealth taxation. In the canton of Bern, taxpayers with wealth above a certain threshold must pay the tax on their entire wealth holdings. This creates a kink in the tax schedule, and provides an incentive for taxpayers to reduce wealth holdings to just below this threshold. This is in fact precisely what the authors found. For each percentage point increase in the wealth tax, 40% of wealth holders report assets below the threshold.
Surprisingly, the study did not find any significant impacts of wealth taxation on mobility. That is, there was no indication that taxpayers would relocate to another municipality in response to a change in the wealth tax rate. The authors hypothesized that higher rates of social welfare spending in high tax municipalities might motivate taxpayers to stay instead of relocating. However, they were unable to find any evidence that supported this conclusion.
Overall, this study provides compelling evidence that wealth taxes reduce wealth accumulation. For some proponents of wealth taxes, this is a feature, not a bug. However, capital accumulation is an essential ingredient for economic growth. Moreover, to the extent that wealth is earned through entrepreneurial risk-taking, rather than through cronyism, wealth inequality does not harm the economy. Policymakers should therefore be wary of adopting wealth taxation to combat inequality.