By Sathya Karunarathne
Successive governments have run fiscal deficits. Inadequate revenue collection and unrestrained government expenditure have worsened the country’s fiscal position.
Tax revenue which averaged over 20% of GDP in 1990 has declined to under 10% of GDP inAd hoc tax policy changes have significantly eroded the tax base. Weak tax administration has also contributed to the sharp decline in tax collection.
While tax revenue has contracted, government expenditure has ballooned over time. Today, government revenue is not sufficient even to meet its expenditure on salaries and wages and transfers and subsidies to households which include pension payments and social welfare payments such as Samurdhi.
In this context, there are various proposals put forward to raise government revenue. One proposal is the reintroduction of the wealth tax.
A wealth tax is expected to bridge the gap between the rich and the poor, achieving equality.
This tax shifts the tax burden to affluent households, taxing an individual’s net wealth, which is the market value of total owned assets. Proponents of wealth taxation argue that this is a progressive system of taxation and is a more powerful tool in comparison to income, estate or corporate taxes as it addresses the issue of wealth concentration.
Moreover, a tax should ideally satisfy basic characteristics of taxation: it should not be distortionary; it should be fair, and it should not be difficult to collect.
The rationale for a wealth tax
One of the earliest proponents of the wealth tax for developing countries was Nicholas Kaldor. Based on his recommendation, a wealth tax together with an income tax, expenditure tax and a gift tax were introduced in Sri Lanka in 1958.
However, these new taxes yielded little revenue due to difficulties in determining the tax base and problems in administration. Following the
recommendation of the Tax Commission in 1990, 2 the government abolished the wealth tax from the year of assessment 1992/1993.
Both income-generating and non-income generating assets are taxed under wealth taxation. They can include land, real estate, bank accounts, investment funds, intellectual or industrial property rights, bonds, shares, and even jewellery, vehicles, art and antiques.
However, this tax base for wealth taxes has often been narrowed through exemptions. These exemptions have been justified most commonly on the grounds of social concerns such as the negative social implications of taxing pension assets. Further liquidity issues (eg – farm assets), supporting entrepreneurship and investment (eg- business assets), avoiding valuation
difficulties ( eg- artwork and jewellery) and preserving countries cultural heritage (eg – artwork and antiques) have also been cited as reasons for wealth tax reliefs. While some of these exemptions can be justified, they have led to the reduction of revenue raised from wealth taxes.
They have also contributed to wealth taxes being less equitable as the wealthiest such as businesses benefit from these exemptions defeating the very purpose of imposing a wealth tax which is to meet its redistributive goals. Narrow tax bases in wealth taxation often leads to tax avoidance and evasion opportunities. For example, Spain’s 1994 wealth tax exemption for the shares of owner managers resulted in wealthy businesses reorganizing their activities to reap benefits of the exemption resulting in a
significant erosion of the wealth tax base.
Further, several other factors have also discouraged countries to sustain a wealth tax. They are namely, the difficulty in determining the tax base or what assets to be taxed, underreporting and undervaluation of assets, difficulty in measuring wealth taxes distinguishing between
individuals who are asset rich but cash poor, the constant need to value assets and audit returns increasing administrative and enforcement costs .
Low revenue collection as well as the other reasons discussed have led to the abolishing of wealth taxes in most countries
Tax revenue from individual net wealth taxes in 2016 ranged from only 0.2% of GDP in Spain to 1.0% of GDP in Switzerland. Sri Lanka’s experience with wealth taxation was no different with the tax yielding low revenue as
reported by the 1990 Tax Commission.
Country Status of the tax Rationale
India Abolished in 2015 There was substantial evidence that the cost of
administering the wealth tax was substantially higher than the revenue generated from the tax.
France Abolished in 2018 Administration costs were far higher than the returns from tax. Instead of a wealth tax imposed a flat tax rate on capital
gains. Issues surrounding how to determine the net worth of an
individual was a significant contributor to capital outflows
from the country.
Sweden Abolished in 2007 Sweden implemented a wealth tax for most of the 20th century, though its revenue never accounted for more than
0.4% of the gross domestic product in the postwar era. One
reason is that the levy treated different assets differently. This distorted investment as the wealthy took on debt to buy tax-free assets. In 2007 the government repealed its 1.5% tax on personal wealth valued at over $200,000.
Germany Abolished in 1997 Recovering taxes was more than the benefit derived. A 2018 study found that Germany’s long-run GDP would be
5% lower with a wealth tax and employment would shrink by
2%. This is identified to be because investors would be disincentivized to invest. The study concludes that the wealth tax’s “burden is carried by virtually everyone, as indicated by the decline in GDP, investment, and employment”.
Austria Abolished in 1994 The administrative burden of calculating the exact levy resulted in significant negative externalities.
Pakistan Abolished in 2003 This led to a significant outflow of domestic capital and the use of illegal channels such as the “haffala “system to
launder money. Abolished due to the negative externalities.
Taxing the wealth of the rich to generate income and to eliminate economic inequality sounds promising in terms of political debate. However, wealth taxes have failed to generate adequate revenue, failed to meet redistributive goals as a result of narrow tax bases, proven to have high
administrative and enforcement costs, resulted in tax evasion and avoidance due to underreporting and undervaluation of assets, increased the risk of capital flight and access to tax havens and may have contributed to the reduction of investment and employment.
Therefore, imposing a wealth tax may not be the ideal policy response to Sri Lanka’s low taxrevenue, especially given the country’s previous experience with the tax yielding low revenue.
Sathya Karunarathne is the Research Analyst at the Advocata Institute and can be contacted at email@example.com. Learn more about Advocata’s work at www.advocata.org. The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.