Context

• There is a good reason we do not tax wealth directly. Actually, there are many good reasons. But that’s not stopping some states from giving it a try. There are much more effective options for targeting wealthy people for tax revenue that are better for the economy. Some the US is already doing, such as state property taxes, federal capital gains taxes and estate taxes on inheritances.

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What is wealth tax?

• Wealth tax is a direct tax unlike the goods and services tax or value-added tax, can take several forms, such as property tax, inheritance or gift tax and capital gains tax.
• It aims to reduce the inequalities of wealth.
• It is based on the market value of assets owned by a taxpayer and charged on the net wealth of super rich individuals.

Why in news?

• The new bills this week by California and Washington propose taxing their richest residents 1% to 1.5% each year.
• Four other states including New York and Illinois propose taxing unrealized capital gains, or taxing wealth based on how much it grew in the last year whether or not you sold any assets.

Crafting good tax policy starts with a question: How much will it distort economic behaviour?

• Creates distortions: Many economists say that wealth taxes create the most distortions, followed by income and consumption taxes.
• Wealth taxes discourage saving and investment: A 1% or 2% wealth tax may sound small, but it’s very large compared with current tax rates. Since it’s levied each year, it’s better compared to current taxes on realized capital income. These plans drastically reduce the return on risky investment, and rewarding risk is important for economic growth.
• Unrealized capital gains, are much harder to measure: Income is relatively easy to measure. Your employer sends you money that is well documented and has an objective value. Overall wealth, especially unrealized capital gains, are much harder to measure.
• Mostly rich people hold Wealth in assets: Very rich people also tend to hold a lot of their wealth in assets that aren’t publicly traded, either in private equity, in their own businesses, fine art, gold bars or other possessions.
• Hard to implement effectively: Most jurisdictions have abandoned wealth taxes. They are very hard to implement at the federal level, let alone by states with fewer resources to collect and assess data on wealth holdings.
• Example of Switzerland: A possible model is Switzerland, where individual cantons have their own wealth tax, but the tax accounts for a trivial share of tax revenue.
• A wealth tax is a bad policy based on the economics and feasibility: Collecting it will require tremendous resources that states don’t have and it won’t produce the revenue they’re counting on.

Wealth Tax in India

• Abolished wealth tax: The government abolished wealth tax as announced in the budget 2015. In its place, the government decided to increase the surcharge levied on the ‘super rich’ class by 2% to 12%. (Super rich are persons with incomes of Rs.1 crore or higher and companies that earn Rs.10 crores or higher).
• Abolished to simplify tax structure and discourage tax evasion: The abolition was a move to do away with high costs of collection and also to simplify the existing tax structure thereby discouraging tax evasion.
• No wealth tax at present: India presently does not have any wealth tax i.e., a tax levied on one’s entire property in all forms. It did not impose a one-time ‘solidarity tax’ on wealth in post-covid budgets that could have generated resources for essential public investment.

Way ahead

• Promising that a few wealthy people can pick up the public tab is bad economics.
• States would be better off making their consumption taxes larger and more progressive.
• They can tax luxury goods like designer clothes, private jet travel or second homes heavily.
• Governments can better enforce our existing wealth taxes by eliminating loopholes in capital gains and estate levies.

Conclusion

• Wealth taxes will continue to be in the conversation as states and the federal government need more revenue and are reluctant to raise taxes on anyone who earns more than $400,000 a year. Many economists say that wealth taxes create the most distortions, followed by income and consumption taxes. Wealth taxes need to studied not only from the lens of fiscal challenges that the states face but also market economies and probable distortions.

Mains question

Q. What is wealth tax? Highlight the present status of Wealth tax in India. It is said that Wealth tax distorts economic behaviour. Discuss in the context of States in the US proposes taxing the rich.

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