Over 2 years ago when we first discussed the fact that "muddle through" had failed, BCG noted that "there were only painful ways out of this mess." The most painful truth, they suggested, was that "the only way to resolve the massive debt load is through a global coordinated debt restructuring... which will have to be funded by the world's financial asset holders: the middle-and upper-class' who will have a ~30% one-time tax on all their assets to look forward to as the great mean reversion finally arrives and the world is set back on a viable path." However, given the delay (and worst progression), Ken Rogoff warns that temporary wealth taxes may well be a part of the answer for countries in fiscal trouble today, and the idea should be taken seriously; but they are no substitute for fundamental long-term reform to make tax systems simpler, fairer, and more efficient.
BCG's Original "Muddle Through has failed" discussion... which addresses the inevitable need for a wealth tax
And why that won't be enough...
On The Shortcomings Of A One-Time Wealth Tax,
Authored by Ken Rogoff, originally posted at Project Syndicate,
Should advanced countries implement wealth taxes as a means of stabilizing and reducing public debt over the medium term? The normally conservative International Monetary Fund has given the idea surprisingly emphatic support. The IMF calculates that a one-time 10% wealth levy, if introduced quickly and unexpectedly, could return many European countries to pre-crisis public debt/GDP ratios. It is an intriguing idea.
The moral case for a wealth tax is more compelling than usual today, with unemployment still at recession levels, and with deep economic inequality straining social norms. And, if it were really possible to ensure that the wealth levy would be temporary, such a tax would, in principle, be much less distortionary than imposing higher marginal tax rates on income. Unfortunately, while a wealth tax may be a sound way to help a country dig out of a deep fiscal pit, it is hardly a panacea.
For starters, the revenue gains from temporary wealth taxes can be very elusive. The economist Barry Eichengreen once explored the imposition of capital levies in the aftermath of World Wars I and II. He found that, owing to capital flight and political pressure for delay, the results were often disappointing.
Italy’s armada of Guardia di Finanza boats would hardly forestall a massive exodus of wealth if Italians see a sizable wealth tax coming. Over- and under-invoicing of trade, for example, is a time-tested way to spirit money out of a country. (For example, an exporter under-reports the price received for a foreign shipment, and keeps the extra cash hidden abroad.) And there would be a rush into jewelry and other hard-to-detect real assets.
The distortionary effects of a wealth levy would also be exacerbated by concerns that the “temporary” levy would not be a one-off tax. After all, most temporary taxes come for lunch and stay for dinner. Fears of future wealth taxes could discourage entrepreneurship and lower the saving rate.
In addition, the administrative difficulties of instituting a comprehensive wealth tax are formidable, raising questions about fairness. For example, it would be extremely difficult to place market values on the family-owned businesses that pervade Mediterranean countries.
Wealth taxes that target land and structures are arguably insulated from some of these concerns, and property taxes are relatively underused outside the Anglo-Saxon countries. In theory, taxing immobile assets is less distortionary, though taxes on structures obviously can discourage both maintenance and new construction.
So what else can eurozone governments do to raise revenue as their economies recover? Most economists favor finding ways to broaden the tax base – for example, by eliminating special deductions and privileges – in order to keep marginal tax rates low. Broadening the income-tax base is a central element of the highly regarded Simpson/Bowles proposals for tax reform in the United States.
In Europe, efficiency would be enhanced by a unified VAT rate, instead of creating distortions by charging different rates for different goods. In principle, low-income individuals and families could be compensated through lump-sum transfer programs.
Another idea is to try to raise more revenue from carbon permits or taxes. Raising funds by taxing negative externalities reduces distortions rather than creating them. Though such taxes are spectacularly unpopular – perhaps because individuals refuse to admit that the externalities they themselves create are significant – I regard them as an important direction for future policy (and I intend to suggest other ideas along these lines in future columns).
Unfortunately, advanced countries have implemented very little fundamental tax reform so far. Many governments are giving in to higher marginal tax rates rather than overhauling and simplifying the system.
In Europe, officials are also turning to stealth taxes, particularly financial repression, to resolve high public-debt overhangs. Through regulation and administrative directives, banks, insurance companies, and pension funds are being forced to hold much higher shares of government debt than they might voluntarily choose to do. But this approach is hardly progressive, as the final holders of pensions, insurance contracts, and bank deposits are typically the beleaguered middle class and the elderly.
There is also the unresolved question of how much the periphery countries really should be asked to pay on their debilitating debt burdens, whatever the tax instrument. Although the IMF seems particularly enthusiastic about using wealth taxes to resolve debt overhangs in Spain and Italy, some burden sharing with the north seems reasonable. As the economists Maurice Obstfeld and Galina Hale recently noted, German and French banks earned large profits intermediating flows between Asian savers and Europe’s periphery. Unfortunately, arguing over burden sharing creates more scope for delay, potentially undermining the efficacy of any wealth tax that might finally be instituted.
Still, the IMF is right – on grounds of both fairness and efficiency – to raise the idea of temporary wealth taxes in advanced countries to relieve fiscal distress. However, the revenues will almost certainly be lower, and the costs higher, than calculations used to promote them would imply. Temporary wealth taxes may well be a part of the answer for countries in fiscal trouble today, and the idea should be taken seriously. But they are no substitute for fundamental long-term reform to make tax systems simpler, fairer, and more efficient.