South African wealth tax can have disastrous consequences

South Africa’s ruling African National Congress (ANC) has revived plans to introduce a new tax on the wealthy to fund its basic income grant.

Mmamoloko Kubayi, the ANC’s head of economic transformation, said the proposal calls for an appropriately structured wealth tax to promote equity and raise revenue.

The target should ideally be the top 5% of high net worth individuals and estates with significant assets, Kubayi said.

The revenue from a wealth tax would be used to fund the R350 social relief of distress grant, which was introduced at the beginning of the Covid-19 lockdown.

Organisations like Business Unity SA and Business Leadership SA have proposed a 200 basis point increase in value-added tax (VAT) to 17% as an alternative.

Despite pushback from the private sector, Kubayi insisted that a wealth tax is the only acceptable option as an increase in income tax or VAT would weigh on already overburdened taxpayers.

However, she wants the grants to be conditional and linked to some form of work or skills development program.

South African wealth tax warning

A wealth tax has populist appeal, but it has many problems, including being difficult to execute, damaging the economy, and raising little revenue.

Bureau for Economic Research economist Hugo Pienaar said there are only 133,000 super-wealthy South Africans with a taxable income of over R1.5 million.

Trying to raise R45 billion for basic income grants from 133,000 wealthy taxpayers will require an exorbitantly high tax.

Such a high tax will encourage many wealthy individuals to leave South Africa and move their businesses to tax-friendly countries.

The country already has a problem with losing high net worth individuals (HNWIs).

Data from New World Wealth and Henley & Partners shows that approximately 4,500 HNWIs have left South Africa over the past decade.

“In particular, many South African billionaires have left the country over the past 10 to 20 years,” New World Wealth said.

“Notably, there are 15 South African-born billionaires globally, but only five of them still live in South Africa.”

A wealth tax will accelerate the move of rich individuals to countries like the United Kingdom, Australia, and the United States.

Wealthy people are often job creators through businesses and investments, and losing them can be disastrous for economic growth and unemployment.

As such, Pienaar said he does not think a wealth tax is a sustainable funding option for social grants.

Lessons from France’s wealth tax

Many European countries implemented a wealth tax in the early nineties, but most abandoned them because they were ineffective and expensive to administer.

One of the biggest problems was that it raised very little revenue because wealthy people had the means to move to other countries and take their money with them.

The impact of a wealth tax is seen in France, which imposed this system in 1998 to fund anti-poverty initiatives.

The tax was triggered when an individual’s net wealth exceeded 1.3 million Euros and was between 0.5% and 1.5% levied on all net wealth above 800,000 Euros.

An individual’s unrealised capital gains from property and financial securities could be taxed if the individual’s net wealth exceeded 1.3 million Euros, even if salary income was low.

A study by French economist Eric Pichet showed the impact of this tax was significant.

Since the tax rate was imposed, there was a sharp increase in immigration by wealthy French taxpayers. Between 2000 and 2016, more than 60 000 millionaires left France.

France lost tax revenue from these wealthy taxpayers, and the country also lost the capital these people moved to their new homes.

Wealthy French business owners moved their businesses abroad, removing jobs from the French economy and lowering GDP growth.

In 2006, it was estimated that 6 billion euros of annual revenue were lost each year as a result.

Another significant shortcoming of the wealth tax was that it targeted unrealised capital gains.

If an individual was within the tax threshold in terms of fixed assets such as property and land, taxes were to be paid on the capital gains and some portion of the principle.

If a person did not have enough liquidity to cover these taxes, they would be forced to sell some of their assets to cover the taxes.

It is a problem for a person who owns a significant share in a big company – which can be worth millions – but doesn’t receive income (liquid assets) from the shares.

There was, therefore, a big incentive for taxpayers to undervalue their assets or not disclose assets to authorities to stay below the tax threshold.

At least 700 million Euros tax revenue were lost in 2004 to this practice.

The wealth tax resulted in the richest portion of the French population leaving their country, with significant knock-on effects.

The wealth tax cost France an estimated 7 billion Euros anually – twice the revenue received from the new tax. The cost significantly exceeded the benefits.

France abolished its wealth tax in 2018.