What is the best way to redistribute wealth?

You might have guessed by now that I enjoy talking about taxes.

My interest is justified because taxes are an important tool for redistribution, and help reduce the levels of inequality. Back in 2020 (before the coronavirus was labelled a global pandemic), the United Nations sounded the alarm on the world’s growing inequality levels. According to the World Special Report 2020, economic inequality is growing within many countries as fewer people get richer, while more people fall into poverty. This was an important period to show that addressing inequality matters. People living in poorer neighbourhoods had a greater risk of contracting the disease because they were more likely to be employed in jobs that could not be done remotely. So some people end up being in a better position than others.

That brings us back to taxes. Economists agree that the reduction of economic inequality is one of the main tasks of the government in an economy, particularly to address inequality of opportunity. If people are left to their own devices, we will get it wrong. Think about it, people who are born rich (or more well-off) might donate some of their money to charity. However, without an incentive or coordinating mechanism, their donations are less likely to meet the needs of those who are less well-off in society. This keeps us in a society where some people have access to more resources than others, which is not always based on merit or the amount of effort put in. The unfairness of it all is why taxes are hailed as a powerful way to redistribute wealth.

So taxes must exist and in the past, I have explained extensively why they must be designed carefully. The gist is that our tax positions ultimately reveal who we value in society because it shows how committed we are to the redistribution of wealth. So let’s talk about who should be valued in society and how taxes can help.

Determining value

I once had an interesting conversation with a friend who is a medical doctor with the NHS (the UK’s tax-funded public health service). He lamented the low wages he earns in exchange for the work he puts in, compared to a footballer in the English Premier League. For context, a UK doctor’s take-home pay will average around £50,000 a year, compared to an Arsenal player’s annual salary of at least £2 million. Considering that doctors save lives and make us healthier so we can be more productive, it begs the question of why they are paid considerably less than football players (who provide value by entertaining).

The discussion around value is relevant here because first, how we assign value determines who has access to more (and less) resources in society—as we saw with the doctor and footballer. Our current process for assigning value does not often reflect the true underlying value that is produced. And so, without direct intervention, we can end up in situations when people are rewarded much less than they ought to be for the work they do, which produces inequality. It also matters because value also impacts how we design key policies to correct the resulting inequalities.

Let’s unpack that second part a bit more.

Who to tax

Recently, US President Joe Biden announced a “billionaire minimum income tax”, which will hit Americans with assets of $100 million or more. The policy is the President’s attempt to ensure the wealthiest pay a fairer share of their income to the Internal Revenue Service (America’s federal tax-collecting agency). The word “fairer” is emphasised here because that after all, is the basis of redistribution—to ensure people are not excluded simply because their circumstances restrict their access to certain resources.

This approach reveals preferences about who should be valued when designing tax policy. It shows that the super-wealthy should not be allowed to keep paying lower rates than the average taxpayer. It also leans towards the Maximin Principle in Economics, which argues that the just design of social systems (such as tax policy) should maximise the position of those who are worst off in society. 

I believe this should be the tax position for a country like Nigeria. It should be about ensuring that sufficient opportunities are available to the less well-off in society, and also that opportunities are not disproportionately available to other members just because of their initial wealth or other advantages.

Remember that 40% of the population lives in poverty. This means that a sizable chunk of the population does not have enough for survival and to insure themselves against life’s adversities such as accidents or illness. In fact, statistics from the National Bureau of Statistics (NBS) show that more than 37% of Nigerian households were exposed to increased prices of major products in recent years. Worse still, 46% admit to not having a specific coping strategy when faced with shocks and negative events. Some even respond to shocks by reducing food consumption just so they can manage. At the same time, the country’s elite—the top 10% of the population—account for over 30% of national consumption. That’s more than the entire middle 40% of the population.

However, Nigeria’s wealthy are still underpaying their taxes.

I won’t put this all down to a lack of effort from the Nigerian government. Back in 2018, the government launched a tax amnesty programme called Voluntary Assets and Income Declaration Scheme (VAIDS). The plan was to raise as much as $1 billion by encouraging high net worth individuals (HNIs) and companies yet to declare their assets and taxes to come forward without prosecution. It was a modest target, given that other countries that ran similar schemes like Indonesia, were able to generate up to $10 billion after 800,000 tax evaders revealed themselves to the government. Anyway, VAIDS only met 8% of its target and you could say that since then efforts to tax the rich have cooled. Nowadays, you are more likely to see news headlines about the Federal Inland Revenue Service (FIRS) designing new taxes to extract from the informal economy.

Taxing wealthy individuals is not the easiest thing to do because wealth is extremely tricky to measure. Limited income data for HNIs makes it difficult to properly account for how much people have and who they are in the first place. To solve for this though, we can turn to a proxy for wealth—asset ownership. The World Bank proposes that raising property tax revenue to 0.2% of GDP would raise an additional ₦300 billion in revenue. Taxing property also helps with redistribution because it transfers wealth from older, wealthier, property owners to younger people. At the same time, there are lower risks of capital flight—unlike income, it is harder to move wealth out of the country in search of lower tax havens. 

Remember that a tax system focused on redistribution will tend to increase opportunities for those with fewer resources, while ensuring that those with more resources aren’t just enjoying more advantages without pulling their weight. This is why some governments like to levy inheritance taxes as well. This is a type of wealth transfer tax that ensures that the heirs of wealthy individuals don’t just inherit wealth that entrenches or even widens inequality of opportunity across the population. Arguably, this might even be easier to pull off than property taxes because wealthy people have to make their assets as transparent and measurable as possible when passing the wealth on.  

The other side

Like with all economic issues, there isn’t always a consensus on tax policy.

To quickly recap what we have covered so far, raising taxes on the wealthiest can help to reduce inequality, fund programmes that benefit lower-income households, and mitigate the amount of dynastic wealth in the country.

Those who disagree with this approach tend to fall into two camps. The first camp will argue that we shouldn’t tax the rich because it doesn’t work since they are very good at avoiding tax (something that VAIDS tried to fix). Those in the second camp believe that even if we successfully tax the rich, everyone would lose out because of the negative consequences that arise such as less investment and slower economic growth. 

Let’s look at the second camp’s argument in more detail.

According to this view, raising taxes on wealth discourages savings and investment because it leaves people with lower disposable income. 

Imagine an individual deciding how much to save. When the government takes a portion of what is earned on savings, every naira of planned future consumption requires more naira of present savings. So, taxing the return to savings effectively raises the price of saving in terms of forgone current consumption. It is then fair to assume that this price increase will reduce the individual’s planned level of savings.

The importance of savings to any economy is well-documented. A diminished flow of savings and investment ends up causing slower growth in the economy’s stock of capital goods, such as property, plant and equipment. These are crucial for businesses to produce more and expand. As the capital stock grows more slowly, so too do output, employment, productivity, and wages. 

The second camp might also argue that taxing the rich disincentivises wealth creation in the economy. You might be thinking: why should I strive to be a billionaire if Zainab Ahmed is just going to come and take a huge chunk of it away? You might then conclude that it’s better to work less or even move to another country to avoid a tax system that allows somebody else to benefit from the wealth you have managed to build. It works differently, but it still has the same effect as what we saw with reduced savings (fewer wealthy people means fewer investments available for capital accumulation).

On the surface, this particular growth argument against wealth taxes seems clear and compelling. From the way I’ve set it out above, it might come across as common sense.

But a very different picture emerges when you observe the trends between taxes and growth. The data on the growth argument against wealth taxes is mixed at best. Some interesting policy recommendations that have even come out of studies suggest that it is better to place a one-off wealth tax, rather than an annual tax, which will continue to penalise people who save (and is bad for the economy).

What is worth drawing out at this point though, is that the fixation on economic growth as a justification for not taxing the rich is limiting for one crucial reason—the way we measure growth is flawed. That brings us back to the value discussion. Gross Domestic Product (GDP), the common metric for measuring economic growth, only considers the monetary value of all final goods produced in the economy. That leaves out so many key aspects of what happens in an economy, such as the external costs that arise from production or the benefits that consumers get from innovation and improvements in quality. But just because these are excluded from the GDP we calculate doesn’t mean they don’t matter. We also know that it is very possible to grow economically because rich people are getting richer. Key inequality indicators show that income is increasingly concentrated at the top of the income ladder across countries. So without rigorous evaluation, we can think we are achieving progress and growth on a broader level when we are not. So we can’t just base our decision to abstain from taxing wealthy people on how it impacts economic growth.

There’s also the fact that when governments ignore inequality, it not only harms people living in poverty and other disadvantaged groups, but it affects the well-being of society as well. Rising inequality levels are associated with discontent, deepen political divides, and even lead to violent conflict. As Nigeria has grown more unequal, the security situation has deteriorated. Data shows that there have already been 1,100 violent attacks in the first three months of 2022 alone, which is more than all the attacks that occurred between 2000 and 2006. High insecurity levels disrupt business operations and even make it difficult for people to travel safely across the country.

Growing inequality is often assumed to be an inevitable cost of any development process. This is why governments need to take their redistributive role seriously and ensure that the tax systems they put in place do not reinforce or entrench inequalities that are already in place. Some policymakers might be hesitant about taxing the rich because of the potential negative effects on GDP (growth). However, from what we have seen, this is not sufficient to dissuade us from taxing the rich. GDP is an imperfect measure of societal welfare and one that tends to downplay inequality, which we should care about. 

Of course, the extent to which taxes can save the day is limited. The main thing that policymakers need to understand is that collecting the tax revenue is just as important as how they decide to spend it.