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By Sathya Karunarathne

Successive governments have run budget deficits. Insufficient revenue collection and uncontrolled government spending have worsened the country’s fiscal situation.

Tax revenues, which averaged over 20% of GDP in 1990, fell to less than 10% of GDP in 2020. One-off changes in tax policy have significantly eroded the tax base. Weak tax administration also contributed to the sharp decline in tax collection.

While tax revenues have contracted, government spending has increased over time. Today, government revenue is not even sufficient to cover its expenditure on wages and salaries and transfers and subsidies to households which include pension payments and social assistance benefits such as Samurdhi.

In this context, various proposals are put forward to increase public revenues. One proposal is the reintroduction of the wealth tax.

A wealth tax should bridge the gap between rich and poor, achieving equality. This tax shifts the tax burden to affluent households, taxing an individual’s net wealth, which is the market value of total assets held. Wealth tax proponents argue that it is a progressive tax system and is a more powerful tool compared to income, inheritance or corporate taxes , because it addresses the issue of the concentration of wealth.

In addition, a tax should ideally satisfy the basic characteristics of taxation: it should not be a source of distortions; it must be fair and it must not be difficult to perceive.

The rationale for a wealth tax

One of the early proponents of wealth tax for developing countries was Nicholas Kaldor. Based on his recommendation, a wealth tax as well as an income tax, an expenditure tax and a gift tax were introduced in Sri Lanka in 1958.1 However, these new taxes generated little revenue. due to difficulties in determining the tax base and administration problems. Following the recommendation of the Tax Commission in 19902, the government abolished the wealth tax from the 1992/1993 tax year.

Wealth taxes have mainly been implemented in European countries. In 1990, twelve European countries had a wealth tax. Today there are only three: Norway, Spain and Switzerland. Several non-European countries have also imposed wealth taxes from time to time, including Argentina, Bangladesh, Colombia, India, Indonesia, Pakistan.

In recent times, there has been a resurgence of interest in wealth taxes. Presidential candidates in the United States have proposed various forms of wealth tax. In the UK and France there have been proposals to impose “super taxes” on the rich. The main rationale was to fight growing inequality in society.

Problems with a wealth tax

Despite a renewed interest in the wealth tax as a progressive tax based on equity, it scores poorly on the criteria of administrative efficiency and feasibility.4

Many factors have justified the repeal of wealth taxes in OECD countries. The reasons given are linked to the costs of efficiency, the risk of capital flight, particularly in light of the increased mobility of capital and the access of wealthy taxpayers to tax havens, the failure to achieve redistribution objectives in due to narrow tax bases, tax avoidance and evasion, administrative burdens and compliance costs versus limited revenues (high cost / return ratio) .5

To understand the efficiency costs of wealth taxes, one can consider taxing a person’s wealth accumulated through their savings. Despite the general consensus that taxing savings is an effective way to redistribute, a person’s savings decisions reveal little about their underlying resources and well-being. It only reveals their preference to consume tomorrow rather than today. Thus, a wealth tax imposes a tax on those who prefer to spend their money later rather than taxing the rich.6 Efficiency costs refer to the reduction in the welfare of individuals taxed more than $ 1 for generate $ 1 in income.7 Therefore, the efficiency cost of a wealth tax in terms of taxing savings is a reduction in future consumption that can be purchased with income, reducing the incentive to working for those who prefer to consume the product later and reducing the incentive for young people to save for their retirement. 8

Capital flight is the possibility of holding assets outside of one’s country of residence without declaring them. As wealth tax is imposed on residents, it increases the risk that the wealthy will reallocate their assets to avoid tax. Consequently, a high tax burden encourages taxpayers to change their tax residence to a lower tax jurisdiction or tax havens.9

Income-generating and non-income-generating assets are taxed under wealth tax. They can include land, real estate, bank accounts, investment funds, intellectual or industrial property rights, bonds, stocks and even jewelry, vehicles, works of art and antiques. 10 However, this tax base for wealth tax has often been reduced by exemptions. These exemptions were most often justified by social considerations such as the negative social implications of the taxation of pension assets. Other liquidity issues (e.g., farm assets), support for entrepreneurship and investment (e.g., business assets), prevention of valuation difficulties (e.g., works of art and jewelry) and the preservation of countries’ cultural heritage (eg works of art and antiques) were also cited as reasons for wealth tax relief. While some of these exemptions can be justified, they have led to a reduction in wealth tax revenue. They have also contributed to making wealth tax less fair since the richest as well as companies benefit from these exemptions that thwart the very objective of imposing a wealth tax which is to meet its redistributive objectives11.

The narrowness of the tax bases in the taxation of wealth often leads to opportunities for tax avoidance and evasion. For example, the wealth tax exemption in Spain in 1994 for owner-manager shares led wealthy companies to reorganize their operations to take advantage of the exemption, resulting in a significant erosion of the tax base. wealth tax.12

In addition, several other factors have also discouraged countries from maintaining a wealth tax. These include the difficulty in determining the tax base or the assets to be taxed, the underreporting and undervaluation of assets, the difficulty in measuring wealth tax13, the distinction between wealthy individuals. assets but cash poor, the constant need to assess assets and audit yields increasing administrative and enforcement costs.

Poor revenue collection and the other reasons mentioned have led to the abolition of wealth taxes in most countries (see Table 1 for more details). Tax revenues from personal wealth tax in 2016 ranged from just 0.2% of GDP in Spain to 1.0% of GDP in Switzerland. Sri Lanka’s experience with wealth taxation was no different, with tax producing low income, as reported by the 1990 Tax Commission.14

Conclusion

Taxing the wealth of the rich to generate income and eliminate economic inequality looks promising in terms of political debate. However, wealth taxes did not generate adequate revenue, failed to meet redistribution targets due to narrow tax bases, turned out to have high administrative and enforcement costs, tax evasion and evasion due to the underreporting and undervaluation of assets, increased the risk of capital flight and access to tax havens and may have contributed to the reduction of investment and employment.

Therefore, imposing a wealth tax may not be the ideal policy response to Sri Lanka’s low tax revenues, especially given the country’s previous experience with the low-producing tax. receipts.

Sathya Karunarathne is the Research Analyst at the Advocata Institute and can be contacted at [email protected] Learn more about Advocata’s work at www.advocata.org. The opinions expressed are those of the author. They do not necessarily reflect the views of the Advocata Institute or of any person affiliated with the Institute.

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