Writing recently in Firstlinks, Andrew Macken enlightened us on the drivers and consequences of inequality and how investors can prepare their portfolios accordingly. He pointed out that inequality reduced dramatically after World War II due in part to higher taxes. The potential for new taxes specifically targeted at the ‘rich’ is explored in this article.
The gap between rich and poor is widening
The widening gap between the ‘haves’ and the ‘have nots’ is indisputable and an unfortunate outcome of our economic system. The COVID-19 pandemic has illuminated the problem with the combined wealth of Australian billionaires rising by more than 52% from December 2019 to December 2020. House prices have reached record levels and stock markets have been catapulted to new heights, bringing good fortune to those holding such assets.
By comparison, regular families have experienced stagnant wages, unemployment, continued low levels of home ownership and increasing debt and in many cases have tapped their superannuation early just to survive. Internationally, a recent Oxfam report claims the combined wealth of the world’s 10 richest individuals rose by US$540 billion during the pandemic and concludes that current policy settings have allowed:
"a super-rich elite to amass wealth in the middle of the worst recession since the Great Depression, while billions of people are struggling to make ends meet".
Such statistics have led many to question the capitalist system and demand the rich contribute more.
Unlikely warning voices
Calls for action have come from some unlikely places. As recently as this week, a London-based asset manager opined in the Financial Times that a wealth tax would support the pandemic recovery and reverse part of the long-term increase in wealth inequality. Two weeks ago at a recent Davos World Economic Forum, Russian President Vladimir Putin cautioned that the pandemic and rising inequality has created alarming parallels to the 1930s and warned that a failure to address these tensions helped trigger Word War II.
In December, hedge fund billionaire Ray Dalio warned that political and wealth gaps in the US could lead to conflict and even civil war.
Based on the mind-boggling statistics above, it is easy to mount an argument for taxing the rich more based on fairness grounds. However, notions of ‘fairness’, ‘rich’ or ‘wealthy’ are challenging because of their subjectivity and there is no widely accepted view on what is fair or who is rich or wealthy.
Recent house price data from Domain for the December quarter reveals that the median house price in Sydney reached a record high of more than $1.2 million. But anyone living in Sydney knows that if you own a house of median value, you are by no means ‘rich’ or ‘wealthy’ lending support to Warren Bird’s argument in Firstlinks that millionaires are not wealthy.
Furthermore, the latest official data reveals the average Australian household has a net worth of $1,022,200 with half of Australia’s households having a net worth of $558,900 or more, further clouding the distinction between ‘rich’ and ‘poor’.
Recent international developments
Globally, government responses in the form of direct income support and other fiscal measures have been extraordinary and necessary but the fiscal consequences could last a generation. To help address the burden, some countries have introduced controversial measures. For example, in early December, Argentina passed a new one-off tax on its 12,000 wealthiest citizens - those with assets worth more than 200 million pesos (US$2.5 million). The so-called ‘millionaires’ tax’ is a progressive rate of up to 3.5% on wealth in Argentina and up to 5.25% on wealth held outside the country and is expected to raise around 300 billion pesos to purchase medical supplies, provide relief to small and medium-sized businesses, and help poor neighbours.
It has led to similar calls in the UK for the imposition of a one-off wealth tax on the super-rich. The Wealth Tax Commission, a group of leading tax experts, academics and policymakers, issued a report in December stating that targeting the richest households would be the fairest and most efficient way to raise taxes in response to the pandemic. Their modelling claims that a levy of 1% on the value of household assets over a £1 million threshold could raise £260 billion over five years.
Theoretical options for new taxes on the ‘rich’
The effectiveness of wealth taxes rests heavily on the thresholds set, which assets and liabilities are in-scope and the rates that apply. Prior to the pandemic, wealth taxes were not particularly popular amongst OECD nations. According to the latest statistics (up to 2018), only five OECD countries (Colombia, France, Norway, Spain and Switzerland) levy a recurrent tax on individual net wealth. However, the revenue raised from these taxes is relatively small at an average of approximately 0.2% of GDP.
An OECD report in 2018 on the role and design of net wealth taxes concludes that:
“from both an efficiency and equity perspective, there are limited arguments for having a net wealth tax in addition to broad-based personal capital income taxes and well-designed inheritance and gift taxes”.
However, the report also argues that:
“capital income taxes alone will most likely not be enough to address wealth inequality and suggests the need to complement capital income taxes with a form of wealth taxation”.
Australia has a progressive income tax system and taxes capital gains, although the latter are taxed concessionally in many instances. Arguably, Australia relies too heavily on direct income taxation and should tax unearned income or idle wealth more heavily.
Inheritance taxes (otherwise known as ‘death duties’ or ‘bequests taxes’) existed in Australia until the late 1970s. Today, Australia is one of only a handful of OECD countries not to tax inheritances. While inheritance taxes are relatively efficient (they have little impact on incentives to work and save), they raise little revenue compared to income or consumption taxes.
In the UK, the standard inheritance tax rate is 40% and is charged on that part of the deceased’s estate above a £325,000 threshold. In recent years there have been calls for the introduction of inheritance taxes in Australia, New Zealand and Canada to address housing affordability, aging populations and growing inequality.
Realistic options for Australia
Last year, I outlined some general options the government could use to start repairing the fiscal hole caused by the pandemic including the unwinding of the legislated personal income tax cuts (in fact, these were brought forward!).
However, options such as the resurrection of a ‘Temporary Budget Repair Levy’ remain and could easily be modified to ensure a greater contribution from those deemed ‘wealthy’ or ‘rich’. Other options touted for some time include the reduction of the CGT discount (to 40% or 25%) and limits to negative gearing. These tax concessions are enjoyed primarily by the ‘haves’ as opposed to the ‘have nots’ so a reasonably arguable case for reducing them could be made on equity grounds.
The findings of the Retirement Income Review delivered in November raised intergenerational equity issues. For example, it found that most retirees leave the bulk of their retirement savings as a bequest instead of drawing down on it to fund their retirement. This raises the question of the purpose of the superannuation tax concessions which are meant to assist with the building of future retirement income and not purely for wealth accumulation. This could impact many investors if a higher tax rate is applied to superannuation bequests paid to non-dependants (currently 15%) to recoup the tax breaks not utilised in retirement.
The Review also suggests there has been insufficient attention given to assisting people to optimise their retirement income through the efficient use of their home equity and concludes that the pension system favours homeowners through the exemption of the principal residence from the age pension assets test. Accordingly, the age pension means test could be adjusted to include part of the value of the family home over a certain threshold, say $1 million, to address taxpayer subsidisation of property inheritances and to ease the pressure on the pension system.
What can investors do?
Investors should think more proactively and strategically about the tax positions of their investment portfolios, including liaising with financial advisers and tax specialists (e.g., timing of asset sales, the entity within which assets are held, general estate planning) based on their circumstances and the current rules. However, they should keep an eye out for any significant trends emerging in the tax landscape.
One thing is certain, the debt repair challenge thrust upon the government is too large to be addressed through normal means once the economy recovers. At some point, the politicians will start debating how to reduce the national debt but this time they may bow to societal pressures arising from rising inequality and implement measures aimed at simultaneously easing budget pressures while reducing the gap between rich and poor.
Dr Rodney Brown is a Lecturer at the School of Taxation and Business Law (incorporating Atax) and a member of the Centre for Law Markets & Regulation at UNSW Business School. This article is for general information only, as it does not consider the circumstances of any individual.