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European Experience With Wealth Taxes Provides Warnings for U.S.

Posted on Jan. 31, 2020

Talk of implementing a wealth tax has attracted both praise and concern, and while this may be a new proposal for the United States, Europeans have decades of experience with the tax.

Although wealth taxes have not always proven successful in Europe, “if you wanted to introduce a wealth tax that bites, the U.S. would be the ideal place to do so,” Marius Brülhart, a professor of economics at the University of Lausanne, told Tax Notes.

With the Iowa caucuses set for February 3, tax proposals by Democratic presidential candidates Sens. Elizabeth Warren, D-Mass., and Bernie Sanders, I-Vt., are at the forefront of political discussions, especially the controversial wealth tax.

Many European countries have implemented a version of the wealth tax, and shortly thereafter abolished it. Practitioners in these countries have provided insight into why the taxes were unsuccessful and lessons that the United States can learn from their implementation. Regardless of the outcome of the Democratic primaries, it will not be the end of politicians' calls for a wealth tax.

“The number of OECD countries levying individual net wealth taxes dropped from 12 in 1990 to 4 in 2017,” according to a 2018 OECD report. Only three OECD nations still implement a net wealth tax: Norway, Spain, and Switzerland.

According to that report on wealth taxes in the OECD, “decisions to repeal net wealth taxes have often been justified by efficiency and administrative concerns and by the observation that net wealth taxes have frequently failed to meet their redistributive goals.”

Switzerland is a major exception to the increasingly popular trend in Europe toward repealing the tax —  especially considering that Switzerland has “by far the largest wealth tax in the OECD relative to the size of government,” according to a 2016 research paper coauthored by Brülhart.

It is difficult to apply an analysis of European countries’ experiences with wealth taxes to the United States to determine whether Warren's and Sanders’s proposals would produce the outcomes promised by their campaigns. Europe has many neighboring member states that facilitate cross-border travel to avoid tax liability, and in some countries the tax is levied by cantons. Further, the taxes proposed for the United States are conceptually different in design compared with those implemented in other nations.

Because of the differing circumstances between Europe and the United States, studies from European nations and lessons from practitioners have limited applicability. “Every country and every tax system are different,” Brülhart said.

Finally, a Wealth Tax That ‘Bites’?

In the United States, the issue of cross-border travel is typically not a concern because the tax would be implemented at the federal level. Even so, the United States is one of the few countries that imposes a tax on expatriates if they make above the exclusion amount, currently $102,000. Expatriates with a net worth greater than $2 million are also required to pay an exit fee based on their assets. That amount would increase as a strong antiavoidance measure under proposals from Warren and Sanders.

Both candidates have proposed a 40 percent exit tax, with Sanders’s rising to 60 percent if the person’s net worth is more than $1 billion. Warren's 40 percent exit tax would apply to those with net worths above $50 million. 

Discussions of increasing the exit tax under section 877A have sparked concerns, and those seeking the U.S. presidency "must understand that an accidental American or an expatriate American is not automatically a fraudster,” said Fabien Lehagre, president of the Paris-based Accidental Americans Association.

Under Warren’s “Ultra-Millionaire Tax,” taxpayers with assets worth more than $50 million would pay a 2 percent annual tax on those assets, and a 6 percent rate would apply to assets in excess of $1 billion. Warren’s proposal would affect the wealthiest 75,000 — or 0.1 percent — of households in the United States.

Warren justifies her wealth tax proposal with revenue estimates, saying it “will bring in $3.75 trillion in revenue over a 10-year period.”

Sanders proposes a progressive wealth tax structure, with a rate of 1 percent for taxpayers whose net worth is above $32 million, increasing to a maximum rate of 8 percent on wealth over $10 billion. Sanders plans to raise approximately $4.35 trillion over a 10-year period.

Gabriel Zucman and Emmanuel Saez, both French economists and professors of economics at the University of California, Berkeley, advised Warren and Sanders on their wealth tax proposals. Zucman told Tax Notes that they “provided revenue estimates and advised on rates and the best enforcement strategies.”

Swiss Wealth Tax Still Going Strong

In Switzerland, wealth tax is one of the most significant revenue streams, accounting for 9 percent of cantonal governments’ revenue, according to Brülhart's study.

Wealth taxes are paid annually on a self-reported basis, and Swiss tax authorities do not have access to citizens' bank information. Brülhart said that if a Swiss taxpayer forgets to declare a Swiss bank account, its assets will remain undiscovered — unless a whistleblower informs the tax authorities or they initiate an investigation .

Thus, Swiss wealth taxes are reliant on the compliance of individuals reporting their assets. “Tax enforcement in Switzerland is comparatively lax,” Brülhart said. However, it helps that the wealth tax rates in the cantons do not exceed 1 percent, he said, whereas Warren and Sanders are proposing rates of up to 6 percent and 8 percent, respectively.

Switzerland differs from the United States in that its wealth tax schedules have very low exemption thresholds and wealth taxes are raised by cantons, not the federal government, Brülhart said.

In its report, the OECD mentions that “Switzerland collects considerably higher revenues from its wealth taxes than other countries, which may be explained by tax design features such as comparatively low exemption thresholds and broader tax bases as well as by the high share of wealthy individuals in the country.”

Paolo Bottini, a lawyer and partner at Bär & Karrer Ltd. in Switzerland, said the Swiss wealth tax “originates from the medieval age.” The cantons introduced a variation of a wealth tax early on, even before an income tax, according to Bottini.

“Due to the historical roots of the Swiss wealth tax, it is very difficult to conceive today the abolition of this tax, although various cantons lowered the wealth tax rate considerably,” Bottini told Tax Notes.

Viewing sustainability from the U.S. perspective, Eric Pichet, a French economist and professor at the KEDGE Business School in France, said the wealth taxes proposed by Warren and Sanders could be sustainable, citing the Swiss wealth tax’s longevity.

The OECD report highlights what several practitioners have said regarding the difference between these two countries: In Switzerland, there aren't many taxes that hit wealthy taxpayers hard, other than the relatively low wealth tax; in the United States, however, wealthy taxpayers face estate or inheritance taxes, capital gains tax, and higher income taxes.

“Desirability and acceptability of a wealth tax depends on what other taxes exist,” Brülhart said.

The OECD report notes that “in Switzerland, there is no capital gains tax; in Norway, the inheritance tax was repealed; and in the Dutch system, the tax on assumed income from savings and investments replaces the taxation of the actual income flows from these assets.”

In addition to a wealth tax, Warren and Sanders have proposed significant changes to the capital gains tax. In comparison with the United States, “political acceptability in Switzerland is higher, and the wealth tax is not challenged in a serious way,” Brülhart said. Therefore, the wealth tax in Switzerland has not been fundamentally questioned by citizens, and opponents’ views on the wealth tax “do not get much traction.”

Brülhart's study looked at the effects of changes in municipal taxation on the likelihood of moving in or out of the municipality. His research on intranational mobility suggested that one reason wealth taxes are “leakier” in Switzerland than in other countries is because its cantons are smaller.

Another frequently mentioned issue with the candidates' proposals is the complexity of valuating taxable assets, especially privately held businesses. Implementing a wealth tax in the United States could result in increased administrative burdens not only for tax authorities, but also for business owners.

“The wealth tax impacts personal assets even when these assets do not produce any income. This is particularly problematic when the shareholder of a private company has to fund the wealth tax without receiving dividends from the company due to the necessity of financing investments,” Bottini noted.

Brülhart emphasized that the issue of administrative burdens in valuating assets is not brought up often in Switzerland. “Cantons learned the rules, and there does not seem to be a source of great friction,” he said.

France’s Wealth Tax ‘Flop’

“Tax competition was probably sufficient to kill European wealth taxes on its own,” Zucman and Saez said in their October 25, 2019, article in The Washington Post.

In 2016 wealth tax revenue in France was 0.2 percent of GDP, which represents a very small share of revenue, according to the OECD report.

There were three main problems with France’s wealth tax, according to Pichet. First, there was a “very low threshold of €800,000 before 2011, and €1.3 million after,” he said.

Also, assets were taxed at too high a rate, Pichet said. The rate was “1.5 percent above €10 million, with the possibility to have to pay more taxes on assets than available income,” he said. Warren and Sanders are proposing far higher rates.

Finally, Pichet said, the French tax was very complex — a criticism that is also leveled at the U.S. proposals. “There were very large deductions, so the tax fell on millionaires but exempted many billionaires who owned their own company,” he said.

Pichet emphasized that the European wealth taxes and the U.S. proposals involve completely different issues, geographically speaking. French citizens who relocate within Europe must pay income tax in the country they relocate to, but they also must pay tax on their real estate in France, he said.

In the United States, taxation is based on citizenship, so to avoid a paying the tax, taxpayers must leave the country and renounce citizenship while being subjected to hefty exit taxes. “Both are more difficult than in the EU,” Pichet said.

Another reason for France scrapping its wealth tax could be that “in addition to net wealth taxes, the government levies taxes on capital transfers and taxes on capital gains,” according to the OECD report.

Pichet doesn't think that complexity will be an issue if either candidate's wealth tax proposal moves forward, however. He said the problem with the U.S. proposals is “clearly a constitutional issue.”

Saving More, Investing Less?

Another potential consequence of the United States’ proposals is decreased investments in markets and businesses, which could cause a slowdown in economic growth. The big question is, will individuals subject to the wealth tax increase their savings and decrease investments?

Brülhart emphasized that this is something the United States must pay attention to. There are fewer incentives to accumulate wealth, which “is also a real concern for economists,” he said. However, the wealth tax did not have a tremendous impact on economic investment potential in Switzerland.

“Beyond effects on the overall level of savings, net wealth taxes are also likely to affect the composition of savings," the OECD report says. "Adverse effects on savings and investment may also come from the distortions in the choice between different types of savings vehicles that wealth taxes generate through exemptions and reliefs.”

The United States must be cautious when looking at the savings response statistics in evaluating the high-rate wealth tax proposals of Warren and Sanders, Brülhart said. Using the data based on the experiences of countries where lower rates were applied will not yield accurate data, he said, noting that Switzerland has never implemented a wealth tax rate of over 1 percent across all cantons.

“We do not have direct evidence on the effect that wealth taxes would have in the U.S.,” Brülhart said. Therefore, “we need to rely on some amount of guesswork to predict the effect a wealth tax would have in the U.S.”

The National Taxpayers Union Foundation released a report January 15 outlining the underreported consequences of a wealth tax, which specifically includes the impact of the tax on entrepreneurs.

The report says a large wealth tax could “stifle innovation at a time when entrepreneurship should be encouraged” by indirectly forcing business owners to liquidate ownership of their personal companies to pay their tax bills.

In its report, the foundation posed a hypothetical in which a founder is the sole owner of his business, valued at $100 million. "This founder would owe $1.2 million in wealth taxes under Sanders’s plan, and $1 million under Warren’s. This founder would have to sell between either 1.2 or 1 percent of his company in the first year alone just to raise liquidity to pay a wealth tax bill,” the report says.

Brülhart noted that a big difference between Switzerland and the United States is that Switzerland has no third-party reporting of financial wealth.

Fortunately for the United States, the Foreign Account Tax Compliance Act requires foreign banks to share information with the U.S. Treasury Department if an American citizen opens a bank account abroad. EU financial institutions will face hefty penalties if they do not comply with the U.S. disclosure requirements.

Warren’s proposal includes a “systematic third-party reporting that builds on existing tax information exchange agreements adopted after the Foreign Account Tax Compliance Act.” Sanders’s proposal also includes "improvements" to international tax enforcement, including changes to the controversial act.

While this may prove successful to combat tax avoidance for investments in offshore accounts, “any strengthening of FATCA will have negative consequences for accidental Americans and American expatriates,” Lehagre said.

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