Wealth Tax

Why South Africa has no wealth tax

In a recent study about wealth inequality in South Africa, the authors claimed there was “no sign of decreasing wealth inequality since apartheid: if anything, we find that inequality has remained broadly stable and has even slightly increased within top wealth groups.” This is worrying, because it suggests South Africa’s post-apartheid economy is not redistributing wealth.

The paper, titled Estimating the Distribution of Household Wealth in South Africa, was authored by Aroop Chatterjee from the Southern Centre for Inequality Studies, and Amory Gethin and Léo Czajka from the World Inequality Lab.

So, how bad is it?

Well, the report found that the top 10% of South Africa’s adult population owns 85.6% of all wealth. The wealthiest 3 500 people (0.01% of the adult population) own more than the poorest 32 million people (90% of the adult population).

Wealth inequality in South Africa has not decreased since apartheid and has even slightly increased within top wealth groups.

But this is not surprising. South Africa is known as one of the world’s most unequal countries. Despite consistently promising to address wealth inequality, the South African government has not passed policies that would lead to redistribution.

In 2013, the Davis Tax Committee (DTC) was established to review South Africa’s tax system. Five years later, the DTC concluded its work issuing multiple reports on diverse topics such as financing of the National Health Insurance and Carbon Tax. Certainly, there are multiple policies which could address wealth inequality.

Its key report, however, was on the Feasibility of a Wealth Tax in South Africa. This has become a topic of much discussion. Let’s unpack why South Africa does not have a broad wealth tax and what should be done.

The DTC report begins by noting South Africa already has some taxes on wealth “in the forms of Transfer Duty, Estate Duty and Donations Tax” but these “raise very small amounts of tax revenue.” In fact, taxes on wealth constitute 1.4% of South Africa’s tax revenue. Expanding wealth taxes will be a difficult mission, the report finds.

Challenges with creating a wealth tax

The report concluded there are many complications involved in administering a wealth tax. In order to tax wealth, assets (such as residential buildings and financial stocks) must be valuated. The process of valuating wealth can create costs. The report states the principle that equal wealth should be taxed equally. This means there should be a coherent valuation of wealth. But this can be challenging. How can the wealth of assets like art be valuated? How can wealth be valuated when records of purchase are unavailable? After all, how do we determine how much something is worth? All this may be possible, but costly. The report warns that it could actually impede on intended revenue.

The report also argues that wealthier people can consult tax experts to exploit loopholes in tax policy. This shifts the burden of a wealth tax to people who cannot afford such advice, which is certainly unintended. More than this, many wealthy people may move to contain their assets abroad and given low co-operation between foreign tax authorities, wealthier people may simply evade wealth tax.

Most importantly, the report claims there is not enough information on the wealth South Africans own. More information would need to be compiled before even designing an efficient wealth tax.

These are not easy challenges to address and many other countries have wrestled with these problems, without being able to solve them. In fact, many countries which previously administered wealth taxes have ceased. The report notes a decrease among OECD countries collecting wealth tax from twelve in 1990 to four in 2018.

There is not yet enough information on wealth in South Africa to create a wealth tax.

“In most cases, the rising costs of classifying and measuring net assets, structuring the tax collection system, and, above all, accounting for global assets have been the cause of concern.”

Feasibility of a Wealth Tax in South Africa

There are also a few other economic concerns

South Africa has been increasing the revenue it earns from its Capital Gains Tax (CGT) which is tax on the profit gained from the sale of an asset. A wealth tax may act as a disincentive to procuring assets and thus reduce tax revenue from the CGT.

Furthermore, since the target of a wealth tax is a small portion of the population, the tax rate must be large to attain immense revenue. This can act as incentive for capital flight, which is simply the removal of assets from a region. One of the largest motivators of capital flight is to avoid the loss of wealth. The report shows that a wealth tax in France has caused up to one third of French billionaires to “either live in – or at least hold substantial residential or financial assets in – Switzerland and Belgium.” So, the wealthy avoid the wealth tax and reduce its potential revenue — while still contributing to wealth inequality in other countries.

The challenge of retirement funds

Much wealth in South Africa rests in retirement funds. It is estimated at R2.2 trillion. These funds are exempt from CGT, Estate Duty and dividends tax. Effectively, wealthy people can generate wealth tax-free through retirement funds. But taxing these funds is challenging because many poor people also have retirement savings. The DTC reveals that of the 6.79 million South African with retirement savings, “5 million are below the UIF ceiling of R178 000 p.a., of whom approximately 3 million are even below the current income tax threshold of R75 000 p.a.”

DTC claims that retirement funds are a large component of the wealth of lower income earners in South Africa. So taxing retirement funds would impact these lower earners and taxing only the wealthier people who have retirement savings is argued to be costly.

But this is not the case everywhere. DTC notes that:

The importance of pension assets for South African households is unsurprising when one considers that the domestic pension system is almost entirely capitalized and privately administered. By contrast, most developed countries have pay-as-you-go social security schemes which obviate the need for households to participate in privately-run retirement schemes.

Effectively, South Africa, would need to administer its own public pension system to reduce the reliance of the private sector. Then, it will be easier to tax private pension plans. This would not only apply to wealth tax, but also the reintroduction of CGT and dividends tax.

What about immovable property?

It is easier to find out who owns and is liable to pay tax on immovable property. It’s also not possible to move off-shore. It also motivates landowners to use property rather than leave it vacant — since they are liable on tax just for owning it. This form of wealth is uniquely easy to tax and does not necessarily impede economic activity.

But there are some challenges. First, municipalities in South Africa already struggle to maintain their valuation rolls and there are inconsistent approaches to determining property values. Second, unlike luxury assets (like jewelry and art), many middle-income families own property and this would subject them to wealth tax, which will likely be paid from their income. There are also retired property owners who no longer earn income. Third, there are people who have received property through land restitution and there is the issue of tribal land too. It is likely unintended that these people be taxed.

The challenge can be solved by exempting particular property-owners. The DTC, however, suggests this would “undermine the economic efficiency of the tax.” But that’s okay because there are still many wealthy property owners who would be liable to this tax. Consider, in the DTC’s own words, the “extraordinary wealth in luxurious real estate (largely in the Western Cape Province).”

Furthermore, the first issue can be solved by developing the capacity of local government to effectively value property. Even without a wealth tax, municipalities do need to improve their valuation systems because valuation does affect existing taxes already.

The DTC then makes another claim against a wealth tax on immovable property. They claim the current Transfer Duty, which taxes the sale of property, encourages people to not buy and sell property. They point that this can cause “stagnation within the residential property market thus reducing related capital and revenue income tax collections.”

But if true, then the best way to combat this stagnation is a wealth tax. If the property is sold, it is taxed. If it is not sold, it is still taxed. Voila. The harm of stagnation reducing tax revenue is addressed.

Another benefit of a wealth tax on immovable property is that the state does not need to wait for the property to be sold to collect tax. It can do so on a monthly or annual basis.

DTC’s final recommendation

The DTC recommended three things to address before implementing a wealth tax.

  1. Determine what wealth to tax
  2. Develop comprehensive data on wealth ownership
  3. Evaluate if the generated revenue would exceed its costs

The first is a political conversation. General society and policy-makers need to decide what to tax. But this should also be informed by the second and third. We may want to tax all wealth, but if the costs of doing so are too great, our intentions won’t be met in any case.

A strong starting point is immovable property. The generated revenue here should exceed costs and it should be possible to develop data on property ownership. The recent household wealth paper shows that 28% of South Africa’s wealth lay in owner-occupied housing.

Next should be a push for a government pension plan to reduce the reliance of private plans — so that these plans can be taxed. The same paper showed that pensions assets also hold 28% of South Africa’s wealth.

Together, just over half of all wealth is held by these two asset types. If there was ever an answer on what to tax, these should be included. Instead of trying to pass a broad wealth tax in the short term, we can focus our efforts on at least taxing immovable property and developing a public pension plan (to then tax private plans).

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