Explaining a wealth tax to clients

The wealth tax has landed in the North American policy mainstream.

With polls showing no party likely to win a majority of seats in the Oct. 21 federal election, and Massachusetts Senator Elizabeth Warren rising to near-frontrunner status in the race to become the U.S. Democratic presidential candidate, the possibility of a wealth tax in Canada or the U.S. has increased in recent weeks.

Last week, New Democratic Party (NDP) leader Jagmeet Singh listed the party’s “super wealth tax” among six priorities he would fight for in supporting a minority government. His plan would see rich families taxed 1% annually on wealth exceeding $20 million. The Green Party is proposing the same tax.

An NDP spokesperson said the tax would apply to households, rather than individuals, in order to prevent wealth being spread among family members to avoid the tax.

“All assets and liabilities will be included in the tax base, including real estate, luxury items [and] investments (including closely held stock), with the exception of lottery winnings,” the spokesperson said in an email.

Warren would impose a 2% annual tax on household net worth between US$50 million and US$1 billion, above which it would rise to 3%.

Warren’s net worth calculation includes residences, closely held businesses, retirement assets, assets in trusts or held by minor children, and personal property valued above US$50,000.

The policy rationale in both countries is to curb growing inequality, with the super-rich not paying their share of taxes. Some have pointed to the influence of French economist Thomas Piketty, who found the rate of return on capital exceeds productivity and wage growth, contributing to more income and wealth for the affluent.

A report from the Canadian Centre for Policy Alternatives last year found that fewer than 100 families, each with net worth over $1 billion, have accumulated more wealth since 1999 than the bottom 12 million Canadians. Warren’s platform says the richest 130,000 American families hold almost as much wealth as the bottom 117 million families.

And both proposals promise massive revenue for government programs.

The NDP’s costing, verified by the parliamentary budget office (PBO), says the tax will bring in $5.6 billion in 2020-21, increasing to $6.8 billion by 2023-24. Administrative costs (included in the revenue figures) would total $114 million in 2020-21, rising to $138 million in 2023-24.

Warren’s tax has a 10-year revenue estimate of $2.75 trillion, and includes a “significant increase” in the Internal Revenue Service’s (IRS) enforcement budget.

However, the PBO says the NDP’s revenue estimate has “high uncertainty” due to expected avoidance by wealthy families. It noted that “the magnitude of this response is highly uncertain and dependent on the level of enforcement and the asset valuation techniques prescribed by the legislation.”

When asked earlier this month how the Canada Revenue Agency (CRA) would be able to determine whether a person’s wealth exceeds $20 million, Singh pointed to publicly available information and said the tax would “require self-reporting.”

“We would use all the tools available that our CRA has to ensure that those who have wealth of over $20 million pay 1% on their wealth over $20 million,” he said.

The NDP spokesperson said in the email that the tax would be paired with boosted audit resources for the CRA, as well as other new enforcement rules.

Peter Weissman, partner at Cadesky Tax in Toronto, doesn’t think a wealth tax could be implemented in Canada. He pointed to problems associated with defining and quantifying wealth, and the costs and challenges of enforcing such a tax.

“We have enough problems enforcing the Income Tax Act the way it is,” he said. “It would be a whole new area for the CRA, in my opinion.”

Without knowing the rules, Weissman wasn’t prepared to discuss potential tax strategies for clients, but he compared the likely reaction to how business owners responded to the Liberals’ tax changes to private corporations in 2017, which led to the government walking back several measures. “There would at least be the same kind of outcry,” he said.

He also warned that some wealthy Canadians may opt to leave the country. Because Canadians are taxed on their accrued capital gains — not on their wealth — when they become non-residents, Weissman said it may be cheaper to pay this departure tax than to remain and pay an annual wealth tax.

Warren’s proposal anticipates this response. To prevent capital flight, she would levy a 40% “exit tax” on net worth above $50 million for Americans who renounce their citizenship.

The NDP spokesperson said the party’s proposal would include “penalties for taking assets out of the country to avoid the tax.”

Wealth taxes abroad

A 2018 report tracked the decline of wealth taxes among countries belonging to the Organization for Economic Co-operation and Development (OECD) — from 12 in 1990 to four in 2017. Governments repealed the taxes due to administrative concerns, and because the taxes failed to redistribute wealth and generate revenue, the report said.

The OECD said there is a case for addressing wealth inequality through taxation, as it far exceeds income inequality. However, it said taxing wealth through capital income taxes, and inheritance and gift taxes, may make more sense.

For countries implementing a wealth tax, the report recommended:

• having a high threshold to only target the very wealthy, thus avoiding an excessive burden and capital flight;
• keeping the value of taxpayers’ total net wealth constant for a few years to avoid yearly assessments;
• limiting debt deductibility;
• developing third-party reporting; and
• avoiding international double wealth taxation.

A report earlier this year from the C.D. Howe Institute also argued that a wealth tax’s objectives can be better achieved through taxes on capital income, which are more easily measured, and on wealth transfers.

The NDP has also pledged to increase taxation on capital gains to 75%. The Greens would increase the inclusion rate to 100%.

While the U.S. has an estate tax (the exemption was raised beginning in 2018 to estates worth US$11.2 million), Canada has no inheritance tax aside from provincial probate and the deemed disposition on death.

Implications for business owners

Weissman said a lot of wealth is wrapped up in family-run businesses, further complicating matters.

“There isn’t a price tag that someone comes along and puts on those companies,” he said, until there’s a transaction.

“[Valuation] is largely based on assumptions. It’s a very expensive exercise and the value itself is inherently inaccurate.”

Warren’s platform, which includes closely held businesses in the net worth calculation, says the IRS would be authorized to use “cutting-edge retrospective and prospective formulaic valuation methods” to assess the value of such assets.

Taxing wealth in practice

Weissman doesn’t see a wealth tax in Canada, regardless of the election outcome, given the difficulty in drafting and administering the changes.

“I don’t think it’s something that could realistically happen,” he said.

A more likely — and, in his view, positive — outcome would be the next government undertaking a comprehensive review of the tax system, and considering a wealth tax and other options in the process. The Conservatives promised to undertake such a review if elected.

As for south of the border, Congress could still constrain an Elizabeth Warren presidency. Speaking in Toronto earlier this month, Charles Myers, founder and chairman of Signum Global Advisors in New York, said a Warren presidency, while likely, would be forced by a Republican Senate to govern from the centre.

The NDP also proposed a luxury tax, which is also in the Liberal platform. Both parties proposed taxing at the point of sale purchases of personal automobiles, boats and aircraft valued at $100,000 or more: the Liberals at 10%, the NDP at 12%. The Liberal plan would bring in an estimated $585 million in 2020-21; the NDP’s tax would generate $668 million.

A luxury tax would be much easier to administer than the wealth tax, Weissman said, and probably more palatable to taxpayers.

The PBO again said revenue estimates were highly uncertain. Sales of luxury goods are sensitive to economic conditions and buyers may switch to cheaper items.