Would a wealth tax really reduce inequality?

In the fight against growing inequality, the SPD wants to reintroduce the wealth tax - with a uniform tax rate of one per cent for the richest. NoWaBo and Markus Grabka discussed how effective this instrument is in our Short Cut series on the Bundestag elections.

 

The Corona Pandemic has recently reignited discussions about growing social inequality in Germany. The fact that inequality in Germany has not only been growing since the pandemic is proven by a study commissioned by the Forum and conducted by three German economists led by Bonn professor Moritz Schularick, who were the first to comprehensively record the long-term development of wealth inequality in Germany on the basis of tax data, surveys and lists of the rich.

The SPD proposes to bring back the wealth tax – with a uniform tax rate of one percent for high wealth. But how sensible is the wealth tax from an economic point of view? How would it affect the Gini index? And is a wealth tax an effective single instrument, or are complementary measures needed to have some effect on inequality? This is what we discussed on 24 August with Norbert Walter-Borjans, party leader of the SPD, and Markus M. Grabka from the DIW. The contribution is part of our New Economy Short Cut series for the Bundestag elections, in which we invite prominent candidates for election to the Bundestag to discuss their party’s promises with regard to the major economic issues of our time. Other panellists are Christian Dürr (FDP), Anja Hajduk (Bündnis 90/ Die Grünen) and Caren Lay (DIE LINKE). The programme at a glance.

The whole session as re-live here

The most important takeaways

There was consensus between Norbert Walter-Borjans (SPD) and Markus M. Grabka (DIW) on the general “stocktaking” of the problem. Both emphasised that wealth inequality in Germany is very high in international comparison, which has a negative impact on social cohesion and also potentially negative implications for economic growth. According to Markus Grabka, in order to close the gap between rich and poor, it is necessary to relieve the lower and middle income groups. The tax relief for the richest 10% in Germany has led to growing inequality, which is also shown by a recent study conducted by the DIW.

The question of how a wealth tax would have to be structured in order to counteract the increasing wealth inequality in Germany, on the other hand, turned out to be a complex topic, which led to a very lively discussion.

At the beginning of the conversation, NoWaBo placed the wealth tax in the context of the broader fiscal policy debate and in his party’s agenda. According to the SPD´s tax plans, a very broad majority population (even more than 80%) should be able to benefit from tax relief, whereas the very wealthy should be asked to contribute slightly more. He explained that the SPD proposal for a wealth tax was not about making the “rich poorer”, but only about taxing the increase in wealth. Considering the enormous need for public investment in Germany, it seems indispensable for the wealthy pay their fair share.  The party leader highlighted that the “trickle-down” approach of increasing demand by lowering taxes for the wealthy has failed in the past. On the contrary, according to NoWaBo, wealth tax could even provide an incentive for more consumption and thus have a positive effect on economic growth.

Markus M. Grabka (DIW) objected that a wealth tax could possibly endanger jobs, especially if it increased the tax burden on the private sector, which is currently heavily affected by the pandemic. From an economic point of view, it is fundamentally important “not only to split the wealth pie, but to grow it”. Not least, studies (such as Schularick et al. 2020) have shown that a wealth tax could even indirectly lead to more inequality. In his view, the wealth tax is “only one instrument in a larger toolbox”. According to Mr. Grabka, the inheritance and gift tax are crucial elements of a sound policy that seek to reduce income inequality. For instance, readjusting the exemption amounts for the inheritance tax could be an important first step in mitigating inequality.

In response to the central question of whether wealth tax of the kind proposed by the SPD could be sufficient to actually influence wealth distribution, Mr Grabka referred to a study commissioned by the Forum New Economy. According to initial calculations within the framework of this study, a wealth tax would have to be set at around 5% – 7% so that not only the additional income but also the substance would be taxed. NoWaBo stressed that a tax rate of 1% would already generate around 10 billion in tax revenues. Therefore, the tax drafted by his party was not merely symbolic.

 

What else was important?

NoWaBo brought into the discussion that the prevention of tax avoidance and tax evasion plays a fundamental role. Those who had “so far shied away from it” should also share in the social costs. Therefore, tax loopholes must be closed and the G20 decision on minimum taxation of companies must be consistently implemented.

Both NoWaBo and Mr Grabka addressed ways to facilitate asset accumulation and pension provision for low-income earners. The Riester pension must be made more attractive, possibly Scandinavian countries such as Sweden and the model of a sovereign wealth fund with opt-out option could serve as models here

 

The background: The political debate around the wealth tax

The Corona pandemic has exposed and even exacerbated existing inequalities, in Germany and elsewhere in the world. The titles of major international newspapers reporting how the market turmoil caused by the pandemic had greatly benefitted the super-wealthy widening thus the rich-poor gap, hid to many a call for political action. This is certainly a call that hasn´t been ignored by the parties in the run to the federal elections, by some more than others.

The SPD election program states “Those who have a great deal of wealth must make a greater contribution to the financing of our polity” . Apart from the redistributive effect, this measure is also intended to give the individual federal states more financial leeway for their future tasks. It is therefore planned to introduce a uniform tax rate of one percent for the very wealthy. In order to concentrate the tax burden on particularly wealthy sections of the population, there are also to be high tax allowances. According to the party programme, this measure will not endanger jobs. In addition, inheritance tax is to be reformed in such a way that it does not favour wealthy company heirs asymmetrically.

DIE LINKE, on the other hand, calls for a wealth tax of 5 % on assets (excluding debts) above one million euros. Exemptions of at least 5 million euros are to be provided for companies and assets necessary for business operations. In addition, foreign ownership of business assets is to be taxed in the same way as domestic ownership. This measure should make around 100 billion euros per year available for investment by the countries. And to deal with the Corona crisis, the party wants to levy a wealth tax on net assets over 2 million euros (for business assets there is an exemption of 5 million euros). This is to rise progressively from 10 to 30 percent and can be paid in instalments over 20 years. Estimated revenue: 310 billion euros over 20 years. By the Greens the position is somewhat less defined, however they stand for a wealth tax for assets above two million euros per person in the amount of 1 percent annually with constitutionally allowed tax breaks for business assets. CDU from its side rejects completely a wealth tax putting forward the argument that such measure would burden everybody, make housing more expensive and endanger jobs, thereby putting a break on growth and prosperity. The same position and arguments can also be found in the election program of the FDP.

What do economists say?

A DIW study from 2020 brought the issue of inequality in Germany again under the spotlight when it showed that wealth distribution in the country resulted even more unequal than previously reported – with the richest one percent of the population owning about 35 percent of the wealth, and the richest tenth holding around two thirds of the total wealth while the poorest 50 percent only disposes of 1,4 percent of wealth. In absolute terms – reports the study – the richest ten percent are those who have most seen their wealth increase. However, in relative terms, almost all wealth deciles could benefit similarly from wealth increases in the last decade, except the 15 percent who holds no assets at all.

In light of these numbers, the introduction of a wealth tax is among the first instruments that comes to mind if one wants to stop the widening of the wealth gap – yet, its effectiveness it´s not that trivial.

This is what Markus M. Grabka – one of the authors of the study – thinks about the introduction of a wealth tax: “However, this is associated with various problems and bureaucratic effort. Also, tax rates of, for example, one per cent wealth tax have in fact no significant external effect on the level of wealth inequality. It is therefore worthwhile to look at alternative policy instruments. Wealth formation policy in Germany is in urgent need of reform and the amounts of support should be raised significantly.”

Other articles, such as the one by Fuest et al. (2018), completely reject the idea of introducing a wealth tax, as it would have negative effects on economic growth, investment and employment, would be borne by a broad section of the population and would ultimately lead to a decline in overall tax revenues.

In a new study for the Forum on “Ungleichheit in Deutschland – Politikmashnahmen zur Trendumkehr“ (to be published soon), Bach et al. (2021) suggest that instead an effective promotion of home ownership could have significant effects on the reduction of wealth inequality in Germany in the long run. Similar effects, albeit lower, could be obtained through a more effective supplementary old-age provision and an effective savings promotion for the middle classes. A sovereign wealth fund investing in globally diversified portfolios could generate extra income benefitting the population as basic income or basic assets. Furthermore, wealth can be redistributed through an increase in inheritance tax or a wealth tax/levy on high wealth or more effective taxes on real estate assets. The revenue from these could be used to promote the accumulation of wealth of the middle classes or to finance a land inheritance. A structural tax reform entailing a reformed inheritance tax with less benefits and allowances, a wealth tax/levy for the super-rich, an increase in property tax, and an income tax on capital gains from real estate could generate additional revenue in the order of magnitude of up to 38 billion euros per year in the longer term, or 1.0 percent of GDP and it would likely have a slightly dampening effect on wealth inequality. The higher inheritance and wealth taxes for the wealthy and super-rich reduce wealth inequality per se. However, the effect is not very large in relation to the breadth of distribution, since only high wealth is affected. In the case of inheritance tax, it also only takes effect in the long term, when the assets have been transferred after one generation.

A simplified simulation in the study shows furthermore that over a period of 30 years – i.e. roughly the generation gap – a current wealth tax with an annual tax rate of 1 percent has the same effects as an inheritance tax levied every 30 years or a one-off wealth tax of 30 percent paid in equal instalments over 30 years. In addition, the simulation calculation shows the long-term effect of a broad-based wealth promotion scheme on the basis of a basic inheritance for the younger generation. Depending on the scenarios of the tax base, the total tax revenue ranges from 384 billion euros (with a personal allowance of 2 million euros and an allowance for corporate assets of 5 million euros) to 615 billion euros (with a personal allowance of 1 million euros and no allowance for corporate assets). However, the Gini coefficient of wealth distribution is only reduced by 1.0 to 1.6 percent by the wealth tax. This is because even such a high levy only accounts for up to 5 percent of the total private wealth of more than 12 trillion euros. Moreover, the Gini coefficient is related to the middle of the distribution and does not react strongly to changes at the upper margin, where the wealth tax is levied. Overall a stronger reduction of wealth inequality across the board can only succeed by strengthening earned income and wealth accumulation among low-income earners and the middle classes. 

Further information on the topic can also be found in the following Forum articles

A new study by Thilo Albers, Charlotte Bartels and Moritz Schularick shows for the first time the long-term development of wealth inequality in Germany, “The Distribution of Wealth in Germany from 1895 to 2018” – here.

A soon to be published study commissioned by the Forum on the main drivers of inequality in Germany, discussed in advance at our eighth New Paradigm Workshop – here.

A Forum study on income, consumption and wealth inequality in Germany by Bartels & Schröder – here.

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