Choking Hazard: The Adverse Effects of “Eat the Rich” Policies
Research Paper analyzing four fiscal measures regularly recommended for raising taxes on “the rich” that would push economic actors to invest less, work less, move, and export their capital and their wealth
Proposals to increase taxes on the rich resurface often in the news. MEI researchers conclude in this study that, however the term “rich” is defined, this selective taxation does not pay, due to its longer-term indirect effects. By penalizing those who create wealth, this gives rise to a number of adverse effects that threaten the prosperity of all Canadians.
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| «Faire payer les riches» ne paie pas (Le Journal de Montréal, September 14, 2022)
Making the rich pay doesn’t pay off (The Hub, September 21, 2022) Penalizing those who create wealth will reduce proseprity: MEI study (The Suburban, September 21, 2022) Super-rich abandoning Norway at record rate as wealth tax rises slightly (The Guardian, April 10, 2023) |
This Research Paper was prepared by Valentin Petkantchin, Vice President, Research at the MEI, and Nathalie Elgrably-Lévy, Senior Economist at the MEI.
Highlights
The progressivity of the tax system is a widely accepted principle. Already in Ancient Greece, not only did taxation exist, but the idea of having the rich pay more was advanced. Today, despite some 2,500 years of history, the issue of the taxation of the rich remains topical. It may even be more topical than ever.
This Research Paper analyzes four fiscal measures regularly recommended for raising taxes on “the rich.” The first three target the “rich” as individual taxpayers, while the 4th targets companies:
- A 1% wealth tax, levied on fortunes over $10 million
- An increase in the capital gains inclusion rate from 50% to 75%
- An increase in the federal income tax rate from 33% to 35% for incomes over $216,000
- An increase in the federal corporate income tax rate from 15% to 18%
Whatever the definition of the term “rich,” such taxation targets the best-performing economic actors on the market, and therefore those who create wealth. Yet since all economic actors respond to incentives, and since taxation constitutes a powerful incentive, it is essential to study the unexpected and undesirable effects (the unintended consequences) of proposed measures, and to insert them into the debate. It is from this angle that this Paper proposes to analyze the four measures listed above. It will draw upon the teachings of economics, and Canadian and international experiences will also shed some empirical light on the matter.
A 1% wealth tax, levied on fortunes over $10 million
This tax is politically alluring since its base is very limited. However, it is difficult to implement as it encounters a multitude of operational obstacles and presents a number of adverse effects that harm society as a whole.
Defining what constitutes taxable wealth, calculating the value of the assets of which it is composed at the precise moment when the tax is calculated, and curbing the problems of tax avoidance and capital migration are all obstacles to the implementation and administration of a wealth tax. Indeed, most European countries that had introduced such a tax have abandoned it in recent decades, often for these very reasons. That is the case for Austria, Germany, Sweden, and France, which eliminated it because of the economic harm it caused.
Wealth taxes also have unintended consequences. Because they reduce the profitability of investments, they incentivize rich taxpayers to consume a larger portion of their wealth, and therefore to reduce their saving and their investment in productive activities, which undermines productivity and the progression of living standards. Germany estimated this, observing a potential reduction in economic growth, investment, and employment, as well as lower overall tax revenues.
An increase in the capital gains inclusion rate from 50% to 75%
This measure has several unwanted and harmful repercussions for the economy as a whole. For one thing, it would affect taxpayers of more modest means as well as those with the highest incomes. It would also increase the cost of venture capital, reduce the capacity of SMEs to attract qualified labour, slow the fluidity of capital in the economy, and ultimately compromise productivity growth. In contrast, eliminating this kind of tax is beneficial. In Switzerland, for example, the non-taxability of capital gains allowed for increased real incomes all while maintaining the overall level of tax revenues. Indeed, asked to decide in a referendum in 2021, the Swiss rejected—by a large majority of 65%—an initiative aiming to raise the inclusion rate up to 150%, much like what is proposed these days in Canada.
An increase in the federal income tax rate from 33% to 35% for incomes over $216,000
As income from labour represents 3/4 of the total taxable income of high earners, increasing the income tax rate directly targets those taxpayers who create wealth as employees. This increase would be particularly harmful in the Canadian context, for several reasons. Besides the fact that it would raise the combined federal-provincial rates, except Saskatchewan’s, to or above the psychological threshold of 50%, and several of them above 55%, it risks having a negligible, or even a negative, effect on total tax revenues in Canada, since it would incentivize individuals to modify their behaviour in the labour market. Certain taxpayers could even be tempted to emigrate to a country with a more attractive tax regime, which would affect the future performance of Canadian companies, and thus economic growth and the standard of living of the population.
Based on Canada’s experience in 2016, we can extrapolate that increasing the federal income tax rate from 33% to 35% would have a negative impact on total tax revenues when considering combined federal and provincial revenues.
The experience of the United Kingdom provides similar results following its raising of the top income tax rate from 40% to 50% in April 2010. Indeed, the British Treasury revised this rate downward as of 2013.
An increase in the federal corporate income tax rate from 15% to 18%
In theory, such a measure aims to increase taxes on the owners of companies, who are supposed to bear the burden of the higher corporate income tax. The reality, however, is much more nuanced.
For one thing, while it is companies that concretely pay the amounts due for this tax, they can lighten their burden by passing it on to other economic agents, notably shareholders and employees, but also consumers and retires (through their pension funds).
For another thing, by reducing the profitability of Canadian companies, a higher corporate income tax would undermine their international competitiveness. Indeed, a study of 85 countries showed that corporate income taxes have substantial unintended consequences on investment and entrepreneurship, and thus on economic growth.
As this Paper testifies, taxation is a delicate area where governments must act with a great deal of caution. Like nuclear energy that can illuminate cities if it is used properly or destroy them if it is not, taxation can fund public interventions but can also dig an economy’s grave.
Thus, any modification of the tax regime must be scrupulously analyzed in order to identify all potential unintended consequences, notably those that would push economic actors to invest less, work less, move, or export their capital and their wealth.
Finally, instead of seeking to increase the tax bur-den on the rich just because they are rich, the government of Canada should favour initiatives that will improve Canada’s international competitive positioning, notably with regard to the United States, and make it more attractive for foreign investment and wealth creation.
Introduction
Behind its provocative title, this Research Paper analyzes four fiscal measures often considered in order to collect more taxes from “the rich.” Whichever way this term is defined, such tax policy systematically targets entrepreneurs and economic actors who have done the best in the marketplace. By penalizing in particular those who create wealth, this selective taxation also gives rise to a number of adverse effects that threaten the prosperity of all Canadians.
Yet these adverse effects are often absent from the public debate.
By analyzing the relevant economic arguments, as well as Canadian and international experience, this study aims to describe these effects, for they deserve to make up an integral part of the debate. The point here is not to “defend the rich”—especially if their wealth was obtained through means other than trade in the service of consumers, innovation, and the creation of prosperity.
The four measures analyzed resurface regularly in the news and in economic debates. They are the following, with the first three targeting the “rich” as individual taxpayers, and the fourth targeting companies:
- A 1% wealth tax, levied on fortunes over $10 million
- An increase in the capital gains inclusion rate from 50% to 75%
- An increase in the federal income tax rate from 33% to 35% for incomes over $216,000
- An increase in the federal corporate income tax rate from 15% to 18%
What adverse effects would such fiscal measures have on the Canadian economy as a whole? What do national and international experience have to teach us about their consequences?
This Research Paper analyzes each of these four measures following a similar structure, namely:
- The presentation of the measure from a historical perspective
- An analysis of the economic arguments and the mechanisms by which adverse effects are disseminated, notably through distortions and incentives created in the economy by the new fiscal measures
- A study of the empirical arguments illustrating the effects of each new measure:
- Examples and potential lessons from the Canadian experience
- International examples and comparisons
- The proposal of recommendations based on the analysis of the tax in question, as the case may be, in order to promote the creation of wealth and prosperity in Canada
The Research Paper has one chapter devoted to each measure.