What could a 'wealth tax' look like?

Variants of the phrase ‘Extreme times call for extreme solutions’ reputedly date back to the era of Hippocrates. The economic situation the nation finds itself in as a result of measures taken by the Government to fight COVID-19 has raised the prospect that tax solutions which would usually be considered extreme may be required to plug financial holes.

The possibility of a ‘wealth tax’ has not been seriously examined for almost 50 years but, in spring 2020, the London School of Economics established a Wealth Tax Commission (WTC) with that purpose in mind.

The WTC published its final report on the prospect of a wealth tax on 9 December 2020, with the paper subject to a significant level of scrutiny ever since.

In this article, we’ll take a look at what the WTC recommended, as well as clarifying a few items which have been reported as recommendations, but weren’t; we’ll touch on the issues with implementing a wealth tax; and we’ll consider the prospects that a wealth tax sees the light of day.

Key recommendations

The Commission’s starting point was that any wealth tax needed to meet four key principles, with each principle formed from research with the general public regarding the priorities around any such tax. The principles were to:

• raise substantial revenue – given the size of the hole in the public finances;
• be fair – with this defined as raising more tax from those with a greater ability to pay;
• be administratively efficient – so the cost of collecting should not be too high; and
• be difficult to avoid and not encourage avoidance.

Before looking at the report’s recommendations, it is worth confirming a few points which have been described as recommendations but were in fact not. For example, the WTC did not recommend a specific wealth threshold at which a tax should apply, or the rate of tax which should be used.

The revenue which could be raised using several options was modelled with most attention focused on – but not to the extent of a recommendation of – the option of the wealth tax applying on net assets worth more than £500,000. The tax would be assessed on individuals rather than households, with the rate of tax being 5% – albeit with a standard payment period of five years, so allowing a tax rate of 1% to be paid in each of those five years.

Arguably the key, and most controversial, recommendation of the WTC was that the value of an individual’s main residence (net of any mortgage), their private pensions, and the value of business assets should be considered when working out whether the threshold for liability was crossed.

Based on that model, it was estimated that £260 billion in tax would be raised. To achieve the same level of revenue from increases to other taxes over five years, it was estimated that Basic Rate Income Tax would need to increase by 9p, or all income taxes by 6p.

A threshold at £500,000 was estimated to impact 8 million individuals, or 17% of the UK’s adult population.

If the threshold was only payable on assets over £2 million rather than £500,000, the tax take was estimated to fall to £80 billion.

Whilst rates and specific dates of implementation were not recommended, a number of broader points were.

First, that a wealth tax needs to be credibly one-off. A key reason for not recommending an annual tax is that it would drive economically-inefficient avoidance behaviours from those who might have to pay it. It therefore seems obvious that, if the one-off nature of a wealth tax is not credible, this would still drive those broader, negative economic impacts.

Minimising avoidance was also a significant factor in the WTC’s separate recommendation that the wealth tax should not be pre-announced.

The recommendation that the tax should be based on the value of all assets (including business wealth, private pensions and main residences net of mortgage) was to meet the principle of fairness. Why should two individuals with wealth of £1 million, one primarily linked to listed equities and the other linked to their business or residence, be treated significantly differently?

An issue created by the inclusion of pensions and properties derives from their lack of liquidity – namely the ability to pay the tax. Those who haven’t yet accessed, or can’t access, their pensions are given scope to delay payment until they do so, or until they reach state pension age. Payment is ultimately expected to be taken from tax-free cash. The report also recommends the introduction of a statutory deferral scheme for those with liquidity issues – perhaps those who are property rich, but cash poor.

The valuation of assets is to be based on open market value at the date of assessment. The report indicates that pensions would be simple to value, which is probably true in the case of defined contribution schemes. However, I suspect the proposal to use the CETV to value defined benefit schemes will create a fair amount of debate given how much higher this is likely to be than the valuation for lifetime allowance purposes.

One important point to note around pensions is that no value is to be given to State Pension rights. This is linked to their status as a state benefit, rather than a personal asset. Interestingly, applying the same ‘state benefits’ principle in reverse means that debts associated with student loans are not deducted from the wealth assessment.

Issues around residences of individuals are recommended to be dealt with by pro-rating the tax liability based on place of residence over the previous seven years. So those who have emigrated from, or moved to, the UK in the last seven years would still potentially be liable, but with the tax reduced to reflect their period outside the UK.

A final recommendation worth noting is that low-value items, with the report suggesting a threshold of £3,000, should be excluded from any wealth assessment. Primarily this is because the cost of valuing the item would outweigh any tax liability which arises.

Before turning to the prospects for a wealth tax, let’s look at a quick example of the potential impact on an individual.

Frank has a house worth £500,000, but with an outstanding mortgage of £150,000. In addition, Frank has a pension worth £200,000 and ISAs worth £50,000.

After deducting the value of Frank’s mortgage from his property, Frank’s net wealth is calculated as £600,000, meaning he has a liability of £5,000 on the excess of £100,000 over the £500,000 threshold.

He could choose to pay £1,000 a year over the next five years or, because all of the excess can be attributed to the value of his pension, he could defer payment until he accesses his pension or reaches state pension age.

Will we see a wealth tax?

It’s important to remember that this isn’t a paper prepared at the request of the Government, although both the Treasury and HMRC are thanked for their assistance in its preparation. The WTC felt the evidence base around the idea of a wealth tax was deficient given the idea hasn’t been seriously considered for so long, so set out to fill that gap. The fact the report backed the introduction of a one-off wealth tax will also naturally attract some attention from the Government, as well as the wider financial commentariat.

The report itself opens with comments from Rishi Sunak given in response to a Parliamentary question in July 2020, of “No, I do not believe that now is the time, or ever would be the time, for a wealth tax”. That would seem to pour cold water on the prospects of a wealth tax but, as already stated, these are extraordinary times. The deficit is expected to reach 19% of GDP in coming months: the highest figure ever in peacetime; twice the level at the peak of the 2008 financial crash; and twice the level when the Chancellor gave his thoughts on a wealth tax.

The Government made a manifesto pledge not to raise Income Tax, National Insurance contributions or VAT. Will the Government risk breaking that pledge, or will it have to consider extraordinary new avenues?

Pensions tax relief is another option – perhaps removing higher and additional rate tax relief and potentially replacing it with a flat rate? At face value, this appears a simple change but, as more than one Chancellor and their supporting team at the Treasury has come to realise, it really is a horrendously complex change to make. Significant numbers of ‘victims’ would be seen in defined benefit and workplace schemes on far lower salaries than might at first be thought.

Research has consistently shown support amongst the general public for a wealth/fortune tax. In the WTC’s report, it was clearly shown to be a more popular option than an increase in Income Tax, CGT, IHT or Council Tax.

An obvious question is whether this support is limited to the point where people become personally affected by a wealth tax. If set at the £500,000 level covered in the report, many people will be liable who might not have considered that to be a risk when expressing support for the idea.

If a tax were introduced, there would also naturally be scepticism about its one-off nature. Whenever the topic of one-off taxes is mentioned, the fact that Income Tax was originally intended to be a one-off tax to cover the cost of the Napoleonic Wars, but is now a core ongoing part of the tax system, is brought up. This is a slightly simplistic analysis of the position, given there have since been short periods during which income taxes were abolished. And, of course, a key reason why income taxes have remained popular is the increased efficiency of taxing income in the current labour market rather than taxing capital.

Reviews of several other taxes, more closely linked to the Government, are underway or have recently been completed. The House of Commons Treasury committee has launched a ‘Tax after Coronavirus’ inquiry. The Office for Tax Simplification is in the process of completing a review of CGT and in July 2019 completed a review into IHT.

The next Budget is due on 3 March 2021. The WTC’s report will lead to further speculation over a wealth tax but, given we’re far from out of the COVID woods just yet, it feels as though in early March the focus will still most likely be on protecting the economy and health of the nation, rather than introducing new taxes.

This articles was previously published by FT Advsier