Wealth taxes can backfire

Accountants play a crucial role in ensuring compliance with tax regulations and can provide valuable insights to policymakers on designing effective and equitable wealth tax systems. And by understanding the implications of wealth taxation on businesses and individuals, accountants can contribute to current public discussions about creating a more just and balanced economic environment that promotes equality and social wellbeing.

The consequences of the Covid-19 pandemic, the Ukraine invasion and economic recession have exerted immense pressure on governmental treasuries across Europe, raising the prospect of tax hikes and reductions in benefits to balance the books. With inequality indicators on the rise in developed economies, those on modest incomes concerned about the impact of a heavier tax burden are calling for wealthier households to contribute their ‘fair share’ to the common purse.

They are not the only ones to feel the rich should pay more tax for the benefit of all. A group of 150 economists sent a letter to the 50 world leaders attending the June 2023 summit in Paris for a new global financing pact, arguing that the world’s wealthiest people are responsible for an outsize proportion of global greenhouse gas emissions. They suggested a 2% tax on extreme wealth would yield at least US$2.5 trillion a year, which could be used to tackle climate-related damage in poorer countries.

Currently, only three European OECD countries have net wealth taxes: Norway, Spain and Switzerland. Belgium, France and Italy also levy a wealth tax but only on certain assets.

Blowback

However, imposing individual taxes on the affluent can have unforeseen consequences. A recent study that Donald N’Gatta and Gaizka Ormazabal and I conducted, based on data from 4,381 publicly listed companies across 26 European countries between 2000 and 2017, identifies a link between the individual needs of major shareholders and the implications on corporate decisions.

Wealth taxes are annual taxes imposed on the overall net worth of individuals or families. According to the Organisation for Economic Cooperation and Development (OECD), net wealth encompasses the total value of assets (such as real estate, bank accounts, bonds, shares, investment funds, life insurance policies and luxury goods) minus any outstanding debts (eg mortgages or loans).

In the context of the companies analysed in our study, business owners’ wealth predominantly relies on the value of their shares in their businesses. As a result, substantial rises in share prices directly impact the amount they owe in wealth taxes.

Take the example given in our study of a fourth-generation Norwegian family-owned business in the maritime industry. In 2011, the owner held 49.86% of the shares and 60% of the voting rights, with the company’s market capitalisation amounting to NOK6.3bn (€0.8bn).

That year, Norway had a wealth tax rate of 1.1%, so the owner had a tax burden of approximately NOK34.8m (€4.3m) on their stock holdings.

In 2012, when the stock price increased by 15.38%, that tax bill jumped to NOK39.9m (€7.7m), far exceeding the owner’s salary at the company, which stood at NOK2.3m (€314,000) in 2012.

However, it is important to consider that increases in wealth linked to share values may not directly translate to increased cash holdings for individuals.

Ripostes

Individuals subject to wealth tax have various options. These include adjusting their lifestyle by changing their fiscal residence to minimise future tax liabilities (as in the case of Jim Ratcliffe, CEO of petrochemicals giant Ineos, relocating to Monaco from the UK), seeking financial loans or selling assets, including shares.

However, these alternatives come with their own associated costs, such as potential damage to reputation, negative publicity, interest payments on loans, and potential loss of control over the company (something shareholders generally strive to avoid once they have obtained control).

Alternatively, controlling shareholders can request additional dividends from the company. On average, our study found that these shareholders opted to allocate around 3.5% in additional dividends during these years.

It is important to consider the hidden costs associated with these increased dividends. Our research reveals that the announcement of significant dividend payouts leads to a stock price growth that is around 50 basis points lower than expected. This suggests a negative impact on stock returns, but also on subsequent investments by these companies.

Misaligned interests

While tax-driven dividend increases may assist controlling shareholders in meeting their tax obligations and provide short-term satisfaction to minority shareholders, they may not align with the long-term best interests of the company. The funds allocated to dividends could have been more effectively used to finance profitable projects, highlighting a significant governance failure within these companies. In other words, boards with a controlling shareholder may not have the capacity to provide effective oversight.

Our research findings also raise concerns about the social implications when shareholders prioritise their own interests over those of other stakeholders within the company.

Controlling shareholders may choose to prioritise dividend payments, even if it negatively affects the company’s stock price and future growth, rather than sell personal assets and potentially lose control.

Furthermore, there are implications of asymmetrical taxation among different categories of shareholders on the competitiveness of companies. We found that dividend increases are more significant for companies whose shareholders do not use investment vehicles (such as holding shares directly in their own name rather than through other entities) or other institutional shareholders.

Wealth taxes serve as an important means of funding a welfare state and addressing social inequality. However, our research indicates that a more comprehensive approach is required to optimise their impact. Excessive taxation can give rise to undesirable incentives that may hinder economic growth and discourage wealth creation.