How a Wealth Tax Can Save Most Canadians $2,000 a Year

By Shahar Rotberg

In 2012, the wealthiest top 20% of Canadian households (also known as the 1st quintile) held about 67% of all net wealth in Canada (see graph below this paragraph). In contrast, the 4th and 5th quintiles combined, which account for 40% of Canadian households, held only 2% of all net wealth. This disparity in wealth, which is not far behind that observed in the U.S., has been alarming to policy makers who have been trying to find ways to reduce it. In this post, I suggest a policy scheme that can effectively reduce some of these disparities and help the bottom and middle quintiles.

It seems to me that a major obstacle to reducing wealth inequality in Canada is that policy makers tend to implement higher income taxes to raise revenues believing it will reduce wealth inequality, but they significantly miss the mark. This policy seems to be anchored in the belief that high income earners are wealthy, and thus should carry most of the tax burden. However, wealth is a stock (a pool of money that has been accumulated over time, or inherited in many cases) while income is a flow (earned each year and is wage dependent). Thus, many high income earners are not necessarily wealthy. In fact, the correlation between income and net wealth is only 0.57. This means that not only do higher income taxes decrease people’s incentive to work, but they are also not very effective at reducing wealthy inequality. So, what can we do?

Rather than raising income taxes, we can use a wealth tax. Wealth taxes are used in many countries, such as Norway, Germany, France, Netherlands, etc. The advantage of a wealth tax is that it does not significantly distort the decision to work. And although it does distort the decision to save, it also creates incentives for households to put their wealth to work in order to prevent it from disappearing at a higher rate. So all in all, the productivity of capital may actually increase as a result. Sounds like this tax may be more promising than income taxes, wouldn’t you say?

And so, I suggest to implement a 1% wealth tax on net wealth above 1 million dollars. So, who will be paying this tax? According to the data (shown in the graph below), the wealthiest 20% of households own on average $2,460,081, while the next 20% of the wealthiest households own on average $783,649. This means that the majority of Canadian households own less than 1 million dollars, and thus the proposed wealth tax will not hurt roughly 80% of Canadian households. At this point, some of you might be worried that if your house is worth more than 1 million dollars, you will have to pay this wealth tax. But you must remember to subtract the value of your mortgage from the value of your house. After accounting for your mortgage, it is unlikely that you will fall into the 1 million dollar net wealth category (remember that I am only discussing taxation of net wealth, and not gross wealth).

Given these numbers, if Parliament introduced a 1% wealth tax on households with net wealth above 1 million dollars, the total revenue from this tax would equal to roughly 12% of the current total income tax revenues (I excluded households who are above the age of 65, as to not hurt those who are in retirement). Then, using an income tax calculator, one can show that by reducing income taxes by 12%, the median household in Canada, whose income is roughly $70,000 a year, can save roughly $2,100 in income taxes per year (the average income tax for the median household would drop from 24.74% to 21.69%). In other words, households who own less than 1 million dollars will not pay any wealth taxes, but will benefit from lower income taxes, while households who own more than 1 million dollars will pay a tax of 1% on each dollar of net wealth in excess of 1 million dollars. In the graph below I show that gains are significant (around $800 per year) even for those earning $35,000 a year, and are quite high (around $6100 per year) for those earning $150,000 per year. Thus, for most households these tax savings should equal to about 1-2 months of rent, which is a significant economic relief.

To sum up, there seem to be more efficient methods to reduce wealth inequality than using income taxes. I suggest using a moderate wealth tax of 1% that will fall only on the wealthiest, non-retired, households in Canada. This wealth tax would mean significant income tax savings for struggling households and, I believe, can effectively reduce wealth inequality.

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