Tax The COVID-19 pandemic had strong economic and social impacts that exacerbated problems of inequality between rich and poor. While the wealthier classes were able to preserve their jobs and work remotely, many low-income workers lost their sources of income overnight or saw their incomes plummet. This increase in inequality, coupled with large fiscal deficits, has led several countries around the world and in Latin America and the Caribbean (LAC) to consider introducing or reforming wealth taxes, either permanently or temporarily.
The discussion about the role of tax systems
The discussion about the role of tax systems in income redistribution is a welcome discussion in LAC, since, as is known, our region is the most unequal in the world. According to an IDB study[1], the richest 10% of the population earns 22 times more than the poorest 10%, and the richest 1% of the population obtains 21% of the income of the entire economy. This inequality is even greater when looking at wealth rather than income. A study by Credit Suisse[2] finds that the richest 1% of the region owns 41% of the total wealth and that the richest 10% of the region concentrates 72% of it.
Despite this enormous inequality in the region, the current tax policy has not contributed significantly to reducing inequality. This is largely a consequence of systems that rely heavily on consumption taxes, high levels of evasion, high tax expenditures that favor the wealthiest, and low levels of personal income and wealth collection. In this way, the current discussion on the wealth represents an opportunity for the governments of our region to increase the redistributive impact of their tax systems.
Design and implementation of the wealth tax
Although wealth taxes are an instrument that can increase the redistributive impact of tax systems, in practice this impact can be very limited if they are not properly designed and managed.
In fact, the vast majority of countries that implemented wealth taxes observed low levels of collection, a consequence of high evasion or aggressive planning by taxpayers to avoid the tax. These low levels of collection added to certain concerns related to efficiency losses in the economy that we discuss later, leading several countries to eliminate this tax relief.
Thus, while 12 countries of the Organization for Economic Cooperation and Development (OECD) had a personal wealth tax in 1990, currently only 3 countries (Spain, Switzerland, and Norway) have this tax. In OECD countries with this, the average collection in 2018 represented only 1.8% of total government revenue (or 0.56% of GDP[3]), while in LAC countries it is the figure was 0.25% (or 0.06% of GDP).
Main difficulties in managing
Main difficulties in managing the wealth tax that facilitate its evasion
To understand the difficulties tax administrations face in managing a wealth tax or, looking at the other side of the coin, the ease with which taxpayers can evade or evade their payment, it is useful to think of an “ideal” design of the tax. tax.
That is to say, the base levied by the tax should include the total assets (gross assets) and deduct the debts or obligations that said individual has.
Family businesses, to encourage entrepreneurship
When analyzing this “ideal” design, two great challenges for the effective administration of this tax clearly emerge. The first challenge is knowing what assets people have. Additionally, tax administrations often have very little information on assets in trusts or abroad. Although this last challenge has been reduced in recent years thanks to international efforts for the exchange of information for purposes[4], there are still important challenges in this area.
Good intentions that facilitate circumvention
Given the aforementioned difficulties, and also as a consequence of pressure from interest groups, it is common for wealth taxes to exclude certain assets from the base, such as
The main residence, for social reasons, because they are illiquid assets, and because they are usually already subject to property
Pension assets, so as not to penalize family savings due to social concerns
Agricultural properties, since they are illiquid businesses and their payment can force the sale of the property.
Active abroad, because they are difficult to meet
Works of art and antiques, for being difficult to value and protect the country’s cultural heritage
These exclusions, while often well-intentioned, imply preferential treatment of certain assets. This distorts the investment decisions of individuals, by creating incentives to invest in tax-exempt assets. For example, individuals may borrow to purchase exempt assets, borrowing which they then discount against non-exempt assets.
Potential Negative Impacts on Savings
Wealth taxes can affect certain decisions of people, which reduces the efficiency in the allocation of resources in the economy. Two decisions that can be affected are decisions about how much to save and what assets to invest in[5].
When it comes to saving decisions, wealth, like other taxes on capital, can discourage saving by reducing the financial return on investments. Although this result is possible in theory, in practice, few studies on this subject do not find significant impacts of wealth taxes on the amounts saved by people[6]. The literature finds that this is due in part to the wide margins that taxpayers have to avoid the tax, which allows for reducing the effects of the tax on investment returns.
Although the wealth tax may not impact the number of people saving, the literature has found strong effects on the decisions about the assets in which people invest. As mentioned, the wealth tax generates incentives to invest in assets exempt from the, or in non-exempt assets that are difficult to detect or value by the tax administrations.
