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Taxing wealth

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Recent proposals for levying a ‘mansion tax’, an annual tax on properties worth more than £2 million, sit uneasily with the recommendations of the two major reviews of the tax system undertaken during the past 40 years. Both the Report of the Meade Committee on The Structure and Reform of Direct Taxation (1978) and the Mirrlees Review Tax By Design (2011) recommended that the transfer, not the ownership, of capital (houses, shares, savings etc.) be the object of any wealth tax.

The Meade Report was established in 1975 by the recently-founded Institute for Fiscal Studies (IFS) to examine a tax system in which inflation and years of ad hoc practice had resulted in a particularly distorted and inefficient structure. The Mirrlees Review was another IFS initiative deliberately following in the footsteps of the Meade Report. Both committees were led by Nobel laureates in economics, Professor James Meade and Professor Sir James Mirrlees, and both were agreed that wealth, especially unearned wealth (whether an inheritance or a gift from a living person), was a suitable target for taxation.

As the Meade Report noted:

capital produces an income which, unlike earning capacity does not decline with age and is not gained at the expense of leisure

and that

wealth, quite apart from any income which it produces, confers independence, security and influence.

The concern was that if the possession of wealth was taxed, then incentives to earn wealth would be dampened:

Whereas an annual wealth tax will fall on wealth which results from a man's own effort, enterprise and saving just as much as on inherited wealth, taxes on capital transfers may be chosen so as to fall on the inheritance of wealth without falling on the accumulation of wealth.

In concentrating on the taxation of the transfer of wealth, the Meade Report proposed that such a tax be levied on the donee (recipient) rather than the donor, that it be progressive and be related to the length of time for which the wealth would be enjoyed. A progressive rate of tax would be levied as the lifetime accumulation of transferred wealth grew. In taxing the recipient for the length of time for which the wealth was to be enjoyed, the age of 85 was taken as the estimated length of life.  If the recipient transferred some or all of that wealth prior to their 85th birthday, the tax paid for the unused years would be refunded. This time-related tax not only captured  an important benefit of wealth but  also moved away from allowing the incidence of death to determine the incidence of inheritance taxation. With Inheritance Tax levied on each occasion of death, the holders of large estates had an incentive to skip generations by passing wealth from, say, grandparents to grandchildren.

Together, these proposals formed a combined Progressive Annual Wealth and Accessions Tax (PAWAT). In essence the Mirrlees Review reiterated the case made by the Meade Report. Unlike the ‘mansion tax’, it was the transfer, size and duration of wealth that was to be taxed, not its mere possession.

At the time of the establishment of the Meade Committee, the Labour Government, honouring its February 1974 election manifesto commitment, published a Green Paper on a Wealth Tax in August 1974 and a Select Committee on a Wealth Tax reported in August 1975. However, the inability of the select committee to agree on a majority report (it published five drafts) led the Chancellor of the Exchequer, Denis Healey, to announce in December 1975 that he was postponing the introduction of a wealth tax.

In 1978, prior to the publication of the report, Professor Meade arranged to speak to a group of MPs led by Geoffrey Howe. That meeting went very badly with Meade subsequently expressing surprise to Howe ‘at the unmitigated hostility shown by the majority of your group’. While aspects of the Meade Report, such as tax relief on savings made for future needs (e.g. pensions, limited share purchases) were to be adopted by the incoming Thatcher government, the Conservative Party was very opposed to any proposals for the taxation of capital. Within Whitehall, the Inland Revenue appeared resistant to all change, castigating the Meade Report as:

…disappointing: its original proposals are not practicable, and its practicable proposals are not original.

In turn, the Treasury criticised the Inland Revenue observing that while it was:

…easy to do a hatchet job on a theoretical analysis of this kind, the tax system was urgently in need of reform.

At least the Inland Revenue acknowledged the existence of the Meade Report. As John Kay, a Meade Committee member, remarked of the 1979 General Election in which tax was a major issue, the Meade Report ‘was barely mentioned’. A similar fate seems likely to befall the Mirrlees Review..

At the moment the main wealth transfer tax is Inheritance Tax (IHT), which is levied on the estate of the deceased. In many cases the main asset is the family home. This often causes consternation not least when the income of its former occupant bears little relationship to the value of the asset. ‘Why tax what someone has worked hard to earn?’ is a common complaint. Yet the relationship between work effort and earnings is complex. Many people work hard and earnings are not simply a function of effort, but as much of market power and luck.

That aside, prior to death the owner-occupier enjoys considerable tax advantages in living in his/her own home. In 1963, the taxation of the imputed income from living in your own house was ended, in part as a political move to encourage home ownership. Imputed income arises from the fact that were you and your neighbour to live in each other’s house, you would charge each other rent on which tax was payable. If you return to live in your own houses, you must by definition be receiving an imputed rent on which you are not paying tax. Owner occupiers are also exempted from Capital Gains Tax on their principal residence.

IHT raises less than 0.5% of all tax revenue and arouses a level of indignation disproportionate to its revenue-raising ability. Were it to be scrapped and moves made towards introducing a PAWAT, it might be politic to remind owner-occupiers of the tax-relief which they enjoy on the income and capital gain received from their home. None of these tax advantages are available to those renting in the private sector and such disparities exacerbate the housing shortage by discouraging owners from downsizing.

If inequality of wealth really is the political concern, then there are more efficient and fairer ways of addressing the issue than by levying a mansion tax. History reminds us of the complexity of ideas developed in the past; it also reminds us of the unwillingness of politicians to adopt them or, with a few notable exceptions, to listen to eminent economists who have written substantial reports on the subject.

For a longer discussion of the Meade Report, please see:!/fileManager/mchick-working-paper.pdf

Please note: Views expressed are those of the author.


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