Amidst the ongoing discussion around managing the enormous deficits faced by the United States, which frequently surpass the trillion-dollar mark, one proposed strategy for augmenting government revenue has targeted the nation’s wealthiest individuals. The suggestion is not to levy a tax on their annual earnings but rather on their accumulated wealth. This idea was put forward by U.S. Senator Elizabeth Warren of Massachusetts, who proposed a wealth tax that would impose a 2% tax on net worth exceeding $50 million and a 3% tax on net worth over $1 billion. Despite its introduction, this proposal has not been brought to a vote, and it has attracted criticism because it could potentially decrease the gross domestic product by diminishing the incentive for people to save.

However, a recent study conducted by the Texas McCombs School challenges the assumption that wealth taxes necessarily deter savings. Assistant Professor of Finance Marius Ring examined the tangible impacts of a wealth tax through a case study of Norway, among the few nations that currently enforce such a tax. Contrary to expectations, Professor Ring’s findings indicate that imposing a wealth tax may encourage individuals to save more. He stated, “Wealth taxation does not appear to diminish the amount that people save. Taxing someone’s savings does not necessarily mean they will opt to save less.”

In Norway, where a wealth tax of 1% is levied on assets over $160,000—affecting 15% of the taxpaying population—Professor Ring analyzed geographical variances in tax assessment from 2005 to 2015, correlating this data with third-party information on household savings, housing characteristics, and transaction prices. His research uncovered that for every additional Norwegian Krone paid in wealth taxes, households increased their net savings by 3.76 NOK annually. Interestingly, these savings predominantly resulted from increased work efforts rather than reduced consumption. This is explained by what economists term the income effect, where higher earnings lead to increased consumption.

Professor Ring elaborates, “This relates to how people find it unpleasant to reduce their consumption. If someone has their heart set on purchasing a specific type of RV at retirement, they may find it less painful to work more, thereby increasing their savings, rather than cutting back on their current consumption.” Moreover, the study noted that individuals affected by higher wealth taxes did not necessarily work longer hours; instead, they prolonged their involvement in the workforce, delaying retirement.

Furthermore, Professor Ring’s findings indicated that higher wealth taxes did not alter how people allocated their investment portfolios, with those subjected to more enormous tax liabilities continuing to invest similar proportions of their financial wealth in the stock market. Ring’s research focused primarily on the moderately wealthy—specifically, those within the 85th to 90th percentile of wealth distribution. Nevertheless, he speculated that the ultra-rich might respond similarly to a wealth tax, possibly saving even more, especially if their priority leans more towards accumulating wealth than spending it, such as in efforts to expand business empires.

While Professor Ring clarified that his study was not intended to provide policy recommendations for or against a wealth tax, it does challenge one of the primary arguments against such a tax by demonstrating that it does not invariably discourage saving. The broader implications of his research suggest considerations for designing an optimal tax system, with economists generally advocating for taxes that cause minimal distortions or alterations in people’s behaviours. According to Ring, a wealth tax could meet this criterion, though he also points out that other taxes on savings, like those on dividends or capital gains, might also achieve this goal. Ultimately, while Ring’s findings do not explicitly endorse a wealth tax over other types of wealth-based taxes, they do contribute to a nuanced understanding of the potential effects of such a tax on savings behaviours.

More information: Marius Ring et al, Wealth Taxation and Household Saving: Evidence from Assessment Discontinuities in Norway, The Review of Economic Studies. DOI: 10.1093/restud/rdae100

Journal information: The Review of Economic Studies Provided by University of Texas at Austin