We’ve all heard of taxing the ultra-rich as the key to solving fiscal deficits around the world. Whether it be Bill Gates claiming that he should pay “significantly higher” taxes, or Warren Buffet advising that the government should “get serious about shared sacrifice”, taxing the ultra-rich at significantly higher rates has been debated throughout the last decade. But is it really the panacea for deficits and inequality? Or is it an alternative method of political populism? 

On one hand, it is understandable why these figures campaign for greater taxes on the rich. An elevated wealth tax seemingly solves inequality, a benefit especially from a Rawlsian perspective (inequalities should only be allowed if it helps the least advantaged), as the government can equally redistribute public revenue towards the lower income population through social welfare programs to improve their quality of life. This is especially effective as the disproportionate concentration of wealth leads to a vicious cycle of inequality, prompting an amplified social divide.  

Beyond solving inequality, a tax upon the top 1% could be considered further appropriate due to wealth being compounded with supposed “rent-seeking behavior”. The capital of the rich individual can be used to lobby or campaign for greater political influence, aiding a high net worth individual to pass favorable laws/regulations to expand their wealth without creating any tangible value to the economy. For example, Sheldon Adelson, the owner of Las Vegas casinos(see figure 1), heavily campaigned against online gambling, a competitor to his business. Thus, he removed competitiveness in the market with his capital, rather than outcome rivals with his wealth, resulting in unproductive “rent seeking behavior”. 

Figure 1(the Las Vegas Sands)-www.sands.com 

 Furthermore, it is known that concentrated wealth brings about greater inequality. As it enables individuals to own a larger share of appreciating assets, which historically grow around 3% faster than real GDP per capita (Capital in the Twenty-First Century, 2014), thereby widening the inequality gap between those who live paycheck to paycheck (49% of the UK population lives paycheck to paycheck) and those who can afford assets. 

Beyond preventing greater inequality, wealth taxes reduce the risk of debt spiral, as the revenue of the government increases and thus, less bonds have to be created to cover governmental funding. In turn, prices rise from scarcity and yields (the effective interest rate the government pays to borrow money) thus decreasing the cost of capital for the government. Hence, governments can increase funding for public services, maximizing average social wellbeing in metrics such as the Human Development Index—which considers factors such as health, education and standard of living. 

Additionally, taxation may come in the form of wealth tax, money paid to the government based on the total value of assets you own. The tax ensures that wealth gaps are addressed, as the population most able to pay cannot avoid taxes, as it targets wealth from unrealized capital gain and low to no income. The increased tracking of assets increases transparency, reducing the likelihood of asset price manipulation to reduce taxes. For instance, taxpayers may try to avoid inheritance or land tax through undervaluing or devaluing properties. Furthermore, taxation may encourage a virtuous cycle, as individuals/families may decrease the proportion of their cash holdings and increase investments, causing the growth of firms and the economy as a whole as they have greater capital access.    

A more obvious criticism of not taxing the ultra-rich is that the rich experience exponentially lower marginal utility from $1 of consumption. While utility may be less quantifiable than economic benefits of taxing the rich, it goes without saying that Jeff Bezos’s hourly capital gain of over $1 million from making $26 million/day (Moneyzine.com) does little good to him but would set most up for life. Thus, whether taking a utilitarian or Rawlsian approach, it seemingly makes sense to progressively tax wealth. 

While progressive taxation is justified on utilitarian grounds, unchecked wealth concentration also poses political risks, as extreme inequality can undermine the foundations of democracy. Economists such as Emmanuel Saez suggest that an extreme inequity in the distribution of wealth leads to the formation of oligarchs and dynastic domination. The most notable example of the lack of redistribution that allowed for the formation of oligarchs with powerful economic/ political influence is perhaps in Russia. The inability to address tax loopholes combined with a lack of wealth tax accelerated the accumulation of wealth and power to the certain members of society in the 90s. This enabled them to hold influence over the media and election campaigns resulting in the irreversible formation of the oligarchs within the economy. The lack of a strong tax code against the rich was largely to blame, as it allowed them to acquire previous state enterprises that were the most profitable in the economy without sharing their wealth. 

On the other hand, many, including the richest person in the world, Elon Musk, disagree with taxing the ultra-wealthy. He states that the taxes are because “they run out of other people’s money” (2021). This statement can be true to some extent, one argument for taxation is that wealthy individuals allocate capital inefficiently due to preference for less productive assets such as art, however, is the government necessarily going to put the capital to better use? The US goes through $6.8tn/ year, with cases where capital is wasted occurring every year. ($25bn/year on bureaucratic matters for the department of defense—The Washington Post) Consequently, it leads to the question, would capital be better redistributed from the wealthy spending their wealth? 

Furthermore, large taxes could simply result in a greater movement of wealth or people outside of the state that introduced these taxes. France from 1988 to 2007, experienced the movement of €200bn outside the nation after the Impôt de solidarité sur la fortune was introduced (Pichet et al). Similarly, the UK has experienced “Wexit”, the wealthy exiting the UK to dodge taxes, where it expects the outflow of 16,500 millionaires from the UK or 11.6% of total millionaire relocation in the world. This could be largely attributed to the increase in inheritance tax as well as the abolishment of a non-domiciled tax regime. 

In addition to driving capital flight, higher taxes may also reduce transparency. Higher tax burdens incentivize wealthy individuals to establish shell companies or trusts, reducing the governmental revenue, while also increasing the cost for the government that attempts to avoid this from occurring. Furthermore, the increased use of tax planning through legal loopholes may diminish tax motivation for the rest of the population. This could exacerbate the tax gaps for institutions such as the IRS, which had a tax gap of $696bn in 2022 alone. 

Beyond the risks of capital flight and reduced transparency, it is also important to consider how taxation affects entrepreneurship, which is a key driver of growth in any country.; 11% of US private sector employment comes from venture-capitalist/angel invested companies. Studies utilizing empirical data, with a difference-in-difference approach by OECD proves that nations abolishing wealth taxes increased entrepreneurial activities by 0.5%. While not a significant percentage, taxing ultra-high-income individuals may, in truth, diminish investments into high-risk, high-return investments and entrepreneurship, as high reward may only result in a greater proportion of profits taxed, resulting in the loss of potential value—or what economist call deadweight loss. 

Beyond the risks of capital flight and reduced transparency, it is also important to consider how taxation affects entrepreneurship, which is a key driver of growth in any country. 11% of US private sector employment comes from venture-capitalist/angel invested companies. Studies utilizing empirical data, with a difference-in-difference approach by OECD proves that nations abolishing wealth taxes increased entrepreneurial activities by 0.5%. While not a significant percentage, taxing ultra-high-income individuals may diminish investments into high-risk, high-return investments and entrepreneurship, as high reward may only result in a greater proportion of profits taxed, resulting in the loss of potential value—or what economists call deadweight loss. 

So, what is the optimum solution for any government around the world? It’s clear that taxing the wealthy has clear benefits, until the wealthy individual changes their behavior through immigration or tax minimization. From a theoretical viewpoint, it may be easy to calculate the optimum marginal tax rate that optimizes governmental tax revenue from the ultra-rich, but the truth is, that is not the case at all. Each wealthy individual would have a different utility function or a different “tipping point” where they would transfer their wealth to a foreign state. Hence, a more robust approach to taxing the wealthy could stem from international cooperation. The cooperative design could include universal minimum tax rates that decrease the opportunity cost of not transferring wealth abroad and greater information sharing between countries to prevent offshore tax evasion. Thus, this solution could help address today’s lack of redistribution.