ECO4028S
Essay 1 – Taxation
25/08/2021
David Golding (GLDDAV021)
Introduction:
South Africa is a country with rampant inequality, with a Gini Income coefficient of 0.63 for
income (World Bank, 2020) and an estimated 0.9 for wealth (Orthofer, 2016). This is a major
obstacle in the way of achieving the aim of an equitable distribution of assets in the country.
Generally speaking, the solution to inequality is to have a progressive personal income tax
system. South Africa already has one of the most progressive income tax systems in the world
(Business Tech, 2021), despite this wealth distribution has remained effectively unchanged
since Apartheid (Sguazzin, 2021).
In light of this, a wealth tax that does not require transfer of an asset (as South Africa’s current
wealth taxes do) should be considered. There is no tax on latent wealth. What must also be
considered is that ultra-wealthy citizens predominantly do not get their income from labour,
but rather through assets such as shares or property which is taxed considerably lower than
personal income tax.
This essay will evaluate a potential wealth tax using the five principles of good tax design and
conclude that any tax that can be collected from the ultra-wealthy in South Africa will
ultimately be worthwhile in solving the inequality problem present in the country.
Equity
There are two types of equity to consider when imposing a tax – vertical and horizontal equity.
The Davis Tax Committee (2018) differentiates between the two as follows: vertical equity is
the concept that a taxpayer with greater means pays more tax than someone with lesser means,
horizontal equity suggests that tax burdens should be based on economic capacity.
Given that any form of wealth tax would only target the extremely wealthy, and likely be very
progressive in nature, it stands to reason that the objective of vertical equity would likely be
achieved. There are, however, two caveats that need to be made to this assertion. First, there is
only going to be true vertical equity when monies collected from the extremely wealthy are
actually distributed to the poorest citizens of South Africa. There are ample ways in which this
could be achieved. The second caveat is regarding who truly bears the burden of the tax. It is
likely that the highest net worth individuals will also be the most able to avoid paying tax. A
large portion of the potential tax revenue could end up not being collected if the extremely
wealthy are able to (potentially with the help of tax attorneys or other professionals) shirk on
some or all of their tax duty. The result of this would be that the tax benefits impoverished
citizens at the expense of the wealthy primarily, while the ultra-wealthy avoid paying their
share. Given the dire nature of South Africa’s inequality, this is a risk that the government will
have to take. Any additional revenue that can be collected to distribute that exceeds the
administration cost of the tax should be seen as a benefit from an equity perspective.
The Davis Committee holds that should there be exemptions to a wealth tax, there will be
horizontal inequalities (van den Heever, 2019). At face value, this seems a simple decision, all
asset classes should be subject to the tax. This prevents taxpayers from transferring their wealth
into assets which are tax free (Saez and Zucman, 2019). Delving deeper into the issue presents
an interesting trade-off though as not all assets, and indeed not all wealth, is created equal.
Taxing seniors or pensions would raise an ethical dilemma. What needs to be considered
though is that the vast majority of pensioners will not be taxed – this tax applies only to the
extremely wealthy. Other similar concerns are related to illiquid assets that may need to be sold
to fulfil the tax burden and may have uncertain values. There may be remedies to these issues,
however these will come at the expense of the simplicity of the system.
Efficiency
Traditionally, taxes are associated with a deadweight loss. There are two reasons for a
deadweight loss to occur, administration costs and government inefficiency in the markets. The
idea being that government, through imposing a tax, takes a market out of its natural
equilibrium and moves it to an inferior equilibrium – resulting in a deadweight loss. To be
noted though is that deadweight losses have a positive relationship with the elasticity of
demand. It stands to reason that, above a certain point, wealth elasticity of demand becomes
very low. Ultra-wealthy people will likely have far more in terms of reserves and income than
they would like to spend to be satiated. As a result, decreasing the wealth of people who are
already incredibly wealthy does not seem likely to substantially impact the economic decision
making of the taxpayer. As such, it is unlikely to have a major impact on economic variables
such as GDP (Davis, 2018).
Saez and Zucman (2019) raise the argument a change in behaviour from taxpayers who will be
subject to a wealth tax may actually see an increase in consumption expenditure. The rationale
behind this argument is that, to avoid paying a tax based on wealth, exceptionally wealthy
individuals may attempt to lower their wealth levels. The most common way to do this is to
consume more goods and services. This is an example of the substitution effect at play,
consuming now becomes cheaper and thus more appealing than saving funds for later
consumption. Should this be the case, the increase in consumption should actually see an
increase in GDP, ceteris paribus. The decrease in savings levels that this may bring about are
not of concern given South Africa has net FDI inflows at 1.456% of GDP (World Bank, 2020).
Capital Stock levels are thus unlikely to fall to the extent that they will offset any potential
benefit arising from increased consumption.
An additional concern is the amount of people paying the tax. Theoretically, a progressive tax
restricts the tax base. In so doing, this restricts the revenue collected. In South Africa, 3560
people own around 15% of all household wealth (at an average net wealth of R486.2 million)
and the top 1% owning 55% (Chatterjee, Czajka and Gethin, 2021). This implies that the tax
base does not need to be broad for the tax to be efficient.
The final efficiency-related concern of a lack of innovation can also easily be rebutted. The
basis for this rebuttal is that there is a lack of incentive for people as wealthy as even the top
1% of South Africans (average net worth of R17.8 million) to innovate given that their
extraordinary wealth is enough to ensure comfortable living (Chatterjee, Czajka and Gethin,
2021). A potential wealth tax will have no negative impact on the bottom 99% of South
African, it may actually substantially fuel innovation in this country as smaller businesses will
be allowed to flourish if the ultra-wealthy do actually increase their spending.
Simplicity
For a tax to be effective, it should be simple to understand for anyone who will be paying the
tax. Obeying this principle will likely sacrifice the equity of the tax though. As such, a tradeoff is created.
The simplest to understand method of imposing a wealth tax would simply be that anyone who
has a net worth that can be determined to be above a certain level pays some percentage of said
net worth to the government in the form of a tax annually. This has the added benefit of being
collected at a pre-determined time and see people pay an amount they are aware of in advance.
A shortfall of this sort of a model is that it is not progressive in nature and is therefore not
equitable. Further to this, it may force individuals to sell their assets at low prices in order to
fulfil their tax burden (Davis, 2018). The alternative is to treat the system similar to how capital
gains are treated under South African tax law. The idea would be to have the amount owed in
the form of tax accrue to SARS, but only become payable once the asset is sold. This would
render concerns over the complex system of valuing fixed or niche assets null and void. There
could also be provisions that make the tax progressive in nature. This would be a slightly more
complex system with liquid assets being taxed immediately and illiquid assets only being taxed
once they are sold. It would also impact the predictability of income flowing to the government.
Despite these downsides, a system of this nature balances simplicity and equity fairly well as
items do not need to be continuously valuated.
Transparency and Certainty
Transparency in taxation policy consists of two main sub-criteria, these being: solid rationale
behind the introduction of the tax and understandable legislation. On the rationale side, a wealth
tax has an incredibly well-reasoned rationale. South Africa has enormous wealth inequality,
much of it due to past injustices caused by the white minority government. It should not prove
hard to justify redistributing some wealth, especially given that very few people will actually
bear the burden of this tax. Having understandable legislation is likely to be a higher bar for a
wealth tax to meet though. To ensure equity and to attempt to close loopholes, legislation will
likely need to be complex to some degree. Despite this, the tax will only affect a very small
percentage of the South African population. Further, it stands to reason that anyone wealthy
enough to be subject to a wealth tax has the required funds to hire an attorney or tax practitioner
to explain the legislation and its impact to them. This is thus a minor concern, given the
potential benefits that would likely arise from such a tax.
Tax buoyancy
Tax buoyancy is a measure of how able government is to raise revenue across different phases
of the business cycle. It does this by comparing changes in tax revenue to changes in economic
growth (Tanchev and Todorov, 2019). As a wealth tax has not been implemented in South
Africa, there is no concrete answer on how buoyant such a tax might be. As a result, this paper
will speculate what is likely to happen.
Tax buoyancy in South Africa is at around 0.82. This implies that a 1% increase in GDP results
in tax revenue increasing by 0.82% (Naape and Mahonye, 2020). This is not particularly
buoyant as the increase in GDP exceeds the increase in tax revenue.
Tax buoyancy for a wealth tax would likely look very different to the buoyancy levels shown
by current forms of taxation though. Wealthy people are generally going to have their wealth
in the form of assets such as shares and/or property (Tarver, 2021).
Both the JSE all-share index and the South African Housing price index are procyclical
(Trading Economics, 2021). This suggests that the wealth levels of the ultra-wealthy in South
Africa are likely to have a strong positive relationship to GDP. As a result, a wealth tax is likely
to see revenue growth increase more than GDP growth. The flip side of this though is that there
will be considerably less revenue to collect in economic downswings.
Practical Considerations
In terms of the execution of a wealth tax, there are two concerns: difficulty in collecting data
on wealth, and the possibility of tax avoidance/evasion. The first of these concerns is currently
being addressed by SARS following the recommendations of the Davis Committee. Data is
being collected on the wealth levels of taxpayers. Difficulties in valuations are also present,
however, imposing a system similar to a capital gains tax whereby accrued tax revenue is
collected only when the asset is sold mitigates the need to consistently track the value of illiquid
assets. Tax avoidance remains a major concern. Leaks such as the Panama Papers and the end
of numbered bank accounts in Switzerland should lessen this threat though (Shields, 2018).
Additionally, South African inequality is so serious that any revenue from a wealth tax that
exceeds the administration costs will be beneficial to the country.
Conclusion:
A wealth tax is a controversial topic. It is, however, the right move for South Africa to take.
Unlike other forms of tax, a wealth tax does not mandate a trade-off between efficiency and
equity – it can actually improve both as well as presenting tax buoyancy. The problem arises
from the fact that, to maintain horizontal equity, a wealth tax will likely not be incredibly
simple. Protecting owners of illiquid assets additionally tales away from the certainty of such
a tax. Perhaps the biggest problem is that those subject to the tax will attempt to avoid it –
especially if they do not see it as a just measure. Despite the potential for avoidance, any monies
that can be collected for redistribution should be seen as a positive. The potential upside from
a wealth tax is massive. Only a very small number of people in the country would need to be
subject to the tax, and only have to pay miniscule portions of their substantial wealth, for this
policy to be effective. The inequality situation in South Africa is dire and any potential
remedies should be considered.
Words: 2178
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