Tax the Rich - Canada has the tools it needs to make a wealth tax work

May 16 2023

To fight 21st-century inequality, Canada needs 21st-century taxes that force billionaires and corporations to pay their fair share

Ward McAllister, a wealthy New Yorker, recently threatened that if the U.S. Congress were to move ahead with its plans to levy a high income tax, the plan would backfire because it would simply drive “rich men to go abroad.”

OK, it wasn’t that recent. It was 1894, and the tax McAllister was scandalized by was the terrifying rate of two per cent.

If McAllister’s great-grandchildren are still rich, they’re probably singing the same tune today. Yet while the rich have always claimed that high taxes don’t work because they will simply be avoided, the truth is very different. It’s perfectly feasible to implement high—even very high—taxes, it just requires sensible design and the political will to actually enforce them. 

In contemporary Canada and the United States, successfully tackling inequality requires three ingredients: an income tax, a corporate tax and a new wealth tax—all rigorously enforced and carefully designed with increasing rates reaching very high levels for the super rich.

The crucial role of a wealth tax

Not only are current income taxes in Canada far too low, but we’re entirely missing one crucial piece of the puzzle: the wealth tax. The problem is that the income tax, long the primary tool for dealing with inequality, is increasingly inadequate for dealing with the phenomenon of wealth-hoarding billionaires. 

The richest person in Canada today is David Thomson, who is estimated to possess family wealth of $77 billion in a country where 235,000 people experience homelessness every year. 

Imagine for a moment that society was to try to tackle this grotesque disparity by implementing a 100-per-cent income tax on Thomson’s annual income. His mountain of wealth would still diminish very slowly. Say he spends $100 million a year on various mansions, banquets, yachts and other frivolities of the super rich—at this rate, it would still take 770 years to reduce his total wealth to levels of normal people. That’s why the income tax is ineffective at dealing with inequality of this magnitude. To deal with our 21st-century situation effectively, we need a wealth tax.

Wealth taxes are not new. They have existed in a dozen countries in Europe over the last several decades, working decently in some cases and terribly in others. In practice, they typically face three recurring obstacles.

One is accurately valuing the resources of the rich, since certain assets such as artwork or private businesses might not have an obvious price. 

The second problem is with exemptions. These are deadly to the wealth tax because they lead to widespread gaming of the system. For instance, in Sweden, exemptions on business equity made it easy for rich individuals to simply shift their wealth into ownership of firms and thereby avoid the wealth tax. 

The third problem is tax avoidance. Estimates of this vary widely, but the most pessimistic estimate is that it can be a very big problem indeed: a one-per-cent increase in the wealth tax lowers the amount of wealth that rich individuals declare by roughly 40 per cent after five years.

Luckily, the last few years have seen an explosion of studies examining what makes wealth taxes succeed or fail.

The valuation problem is smaller than it first appears because at least 80 per cent of the wealth of the top 0.1 per cent of the wealthiest families is in the form of assets that are regularly traded. These include publicly traded stocks, bonds and real estate, and so have a clear market price. Does anyone really believe that men like Thomson and Elon Musk can hide the bulk of their wealth when information about the value of the shares of Thomson Reuters and Tesla is readily available? 

For private businesses, simple formulas can be used to approximate their value. For instance, Switzerland uses rules based on the book value of a business’s assets plus multiples of the firm’s profits. Mistakes happen, of course, but tax authorities can correct them by using retroactive adjustments when assets are finally sold. Taxpayers can then be refunded or debited if it turns out their assets were worth slightly less or more than originally estimated. 

Avoidance can also be substantially mitigated by having a single tax system for the whole country—as opposed to relying on a decentralized regional system—since in Switzerland and Spain the rich often avoid wealth taxes by simply moving to a nearby city with a different tax rate. 

Making extensive use of third-party reporting, whereby financial information is passed directly to the tax authorities by employers and banks, is also vital. After all, it’s not as if the amount of wealth possessed by the rich is literally unknown. It’s just hidden. 

The wealthy know exactly how much their investments are worth, down to the penny, since it’s meticulously recorded in their banking documents. All that’s needed is legislation requiring such information to be automatically shared from the banks and money managers to tax authorities, as is already standard practice with many people today. 

For instance, as a professor, my university simply shares my income information directly with Canada Revenue Agency (CRA) and automatically deducts my taxes from the source, adjusting for any mistakes at the end of the year. There’s no reason why techniques that work very well for the rest of us shouldn’t also be applied to the rich.

According to state-of-the-art research, instituting a centralized tax system and third-party reporting would likely reduce total avoidance in Switzerland from a disastrous 43 per cent to a sustainable 6.9 per cent.

All in all, the evidence is clear: an effective wealth tax is completely feasible as long as it is designed cautiously and carefully. Just as the income tax was a fundamental requirement for building the welfare state in the 20th century, the wealth tax is a fundamental requirement for building a decent society in the 21st century. 

The historical precedence for high taxes

What about the other core ingredients of high income and corporate taxes—will such taxes simply be avoided by the rich, rendering them ineffective and unworkable? 

The evidence shows that the answer is an overwhelming no. The historical record is clear: many countries have successfully implemented very high taxes over the years and some still do.

As hard as it is to believe today, high taxes were actually invented in the U.S., which was the first country in the world to introduce top marginal tax rates above 70 per cent in 1919. In Canada, the top tax rate was 72.5 per cent in the early 1920s and reached a staggering 95 per cent during World War II. Perhaps even more impressively from today’s perspective is the fact that in 1952—long after WWII was over—the top rate was 91 per cent. All told, from 1939 to 1971, the top tax rate was 75 per cent or higher (with one exception in 1942).

Even more radically, in the 1960s and ‘70s in the United Kingdom, Sweden and Denmark, the official tax rates for the richest were often over 90 per cent of their income. Importantly, it’s not only the “statutory” legal rate that was high. The “effective tax rate”—meaning the amount of money that rich people actually paid—was very high, too. This means that enforcement was working and avoidance was modest; the rich really were paying their taxes.  

Today, a number of countries continue to successfully implement relatively high taxes. For instance, Sweden, Slovenia, Belgium, Portugal and Finland all have “top effective marginal rates” of more than 70 per cent (when social security contributions, payroll taxes, consumption taxes and income taxes are combined).

Steps to tax the super rich effectively

The bottom line is that we now have decades of concrete experience as well as empirical evidence of what’s necessary to force the rich to pay their taxes. The solutions are well-known, commonsensical, and for the most part, relatively easy to implement:

• Close loopholes;
• Implement third-party reporting because when this exists in a substantial way, tax evasion rates are less than 5 per cent;
• Hire far more auditors, particularly to audit the super rich; these audits pay for themselves, as it has been estimated that every extra hour spent auditing a millionaire generates an extra $1,000 in revenue;
• Make penalties for tax evasion more severe, so that the super-rich actually face the prospect of jail time (nothing deters an executive from tax fraud like the prospect of being dragged out of their board rooms in handcuffs in front of their colleagues);
• Make accountants and lawyers criminally liable for aiding rich people in using tax havens or evading their taxes;
• Charge rich citizens who emigrate a steep exit tax. Since the bulk of their wealth is ultimately created by the collective efforts of community members, caregivers, workers, public infrastructure and the shared institutions of the country, rich individuals shouldn’t be allowed to flee with it.

All of these reforms are straightforward and perfectly feasible for a country like Canada to implement right away and unilaterally. 

An international tax system would perform even better

Of course, the tax system would work better with more international cooperation. In particular, we need cooperative efforts to close tax havens. Though still a major problem, there has actually been good progress on this front in recent years. The Organisation for Economic Co-operation and Development’s new system of automatic exchange of information means that it’s no longer possible (as it was a few years ago) for a rich Canadian to open a secret bank account in Switzerland or The Bahamas to hide their money. Now, those places automatically share their information with the CRA. Cheating is still possible, but it’s much more complicated now—requiring more sophistication and criminal intent. 

We also need a better global tax architecture to tax corporations fairly in order to stop them from hiding billions of dollars in profits every year in tax havens. The basic solution is for each large company to be legally required to report how much real economic activity they do in every specific country where they operate. This would let each country freely set their own tax rates on that income. 

For example, suppose Amazon makes $10 billion in profits in a year, with 10 per cent of its sales, payroll, and assets deriving from Canada. The CRA would then tax $1 billion of Amazon’s profits at whatever rate the Canadian public chooses (ideally much higher than the current abysmal rate of 15 per cent). With this system in place, Amazon (and other multinationals) would no longer be able to avoid paying taxes in Canada by claiming, as they currently do, that the only places they make profits just happen to be tiny islands in the Caribbean which coincidentally charge no tax. 

It’s true that more global cooperation would be greatly useful for cracking down on tax evasion. 

But in the meantime, it’s still perfectly possible for Canada to go it alone and start truly taxing the rich. We have all the tools we need. The rich will cry crocodile tears and attempt to avoid the taxes, as they always do, but whether they’re successful or not is up to us.