Taxing the Rich: Erope's Cry for Help to Finance Green Transition

"For a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle," proclaimed Churchill as the crowd cheered for the man recognized as the UK's greatest prime minister. 

Even after more than 100 years, the Europeans still could learn a thing or two from Churchill's powerful oration in front of the town hall in Malmesbury. For the last few decades, Europe has been considered as the pioneer of the transition to sustainable practices through numerous studies on renewable energy as a direct output of the Paris Agreement. However, due to its rising costs and waves of resource nationalism within economic giants like the US and China, the European Union is starting to be left behind in this economic race to address climate change. While 18% of European citizens on average are expecting Europe to become a world leader in electric vehicle production in the next ten years, 46% think it will be China instead, according to a recent European Investment Bank survey. As a result, desperate calls for a wealth tax to finance the green transition are gradually gaining traction in Europe, with a variety of initiatives from various political movements putting the subject back on both the political and economic agenda. Can taxing the rich close the green investment gap? Will such fiscal tool be a wasted effort like Churchill's famous words? It turns out that by examining the neoclassical growth model as well as past taxation systems following the wealth distribution in Europe, we might be able to determine the potential outcome of such policy.

Potential gamechanger?

In a September French legislative report, Jean-Paul Mattei of President Emmanuel Macron's ruling majority, the MoDem group, talked favorably of such a levy to finance the ecological transition. Early this summer, Social Democrat MEP Aurore Lalucq successfully requested for a "European citizens' initiative" from the European Commission. If a million signatures are collected in at least seven nations within a year, it might lead to the creation of a European directive imposing an "ecological and social wealth tax" on the 1% richest households.

A research study commissioned by the European Parliament's Green Group examined the potential consequences of such policy. It discovered that a European tax on the 0.5% wealthiest households would generate an outstanding 213 billion per year. This is all the more astonishing given the virtual disappearance of wealth taxes within EU member states. Only Spain will have one in 2023, with a threshold of 700,000 and rates varying by autonomous community. 

A disappearance in the engines of Europe

One of French President Emmanuel Macron's first actions as country leader was to repeal the impt de solidarit sur la fortune (ISF), a "solidarity tax" on wealth imposed by Franois Mitterand's government in 1981. Based on the ISF regulations, individuals with a net worth of more than 1.3m (1.14m) were taxed a rate ranging from 0.5% to 1.50% (on assets worth more than 10m). While it may have aided social unity in France, it resulted in an exodus of France's wealthiest. As seen in figure 1 from New World Health, more than 12,000 millionaires fled France in 2016. Between 2000 and 2016, the country lost more than 60,000 millionaires, according to the report. When these people fled, France lost not just the wealth tax revenue, but also all other revenue sources, such as income tax and VAT.

Figure 1, Source: New World Health, 201

Macron then replaced it with the IFI, a tax on property wealth, to patch the budgetary deficit. Despite the additional tax, the adjustment cut income significantly: the ISF brought in 4 billion to the public coffers in 2017, but only 2.35 billion in 2022. The impact of the adjustment on lowering the tax exile rate or boosting the country's competitiveness has yet to be determined.

Looking into North-Central Europe, a wealth tax remains part of Germany's Basic Law (which serves as the country's constitution), although currently suspended. In 1995, the court ordered Kohl's government to modify the property values used to calculate the wealth tax as property was taxed less heavily than financial assets. As the Kohl administration decided not to do so, the tax was automatically suspended -- but not abolished -- on January 1, 1997.

Due to the same reasons why Macron abolished the ISF, a wealth tax at the national level for European engines like Germany and France are highly unlikely to make a return. Economy minister Bruno Le Maire stated that a comeback for the ISF would lead to an exile of the wealthiest in a context of tax competition between states, a flight of capital and thus job losses -- repeating 2016. Therefore, a return at national level is highly improbable for wealth taxes to fund the green transition. To understand its implications, we first should understand the condition of green investments in Europe. 

Europe's green investment gap

The IPCC published its special report on limiting global warming to 1.5 Celsius in October 2018, concluding that meeting this goal would need global CO2 emissions reaching net zero by 2050. Despite the large volume of predicted investment requirements, these estimates are likely to understate the real requirements of the EU's 1.5 C climate policy route. 

First of all, the EU's climate strategy is centered on attaining net zero emissions by 2050. This misses the fact that the IPCC's special report on reducing global warming to 1.5 C  defined a 2050 net zero objective as a worldwide average. Given huge variations in countries' economic, technical, and social capabilities, the world's richest regions must decarbonize quicker than the rest of the globe, including Europe. The second reason why the EU's present investment forecasts are too low is because they provide no room for error. The Fit for 55 initiative strives for a precise landing and net zero emissions by 2050. This approach disregards the inherent uncertainty in both the highly complex foundations and potentially non-linear trends of global warming, and the interdependencies that define present economic systems. 

Fundamentally, to contribute credibly to the global 1.5 C objective, the European Union must increase its efforts and ambitions. A serious effort entails putting in place the necessary green infrastructure faster and on a larger scale than is currently anticipated. To a considerable extent, funding these infrastructure projects would require public money, and policymakers should consider how to cover the ensuing investment gap, at least partially. Thus the Europeans came up with the wealth tax policy to offset these investment gaps. 

'Unconventional' but now encouraged

Hence, why is it difficult to find studies regarding the use of wealth taxes as a tool to increase funding for this global situation? This can be explained by the long-standing consequence of the neoclassical growth model, which argues that the optimal capital tax rate, which includes wealth and capital income taxes, should be zero. These conclusions are based on models that assume an equal distribution of wealth based on labor income and an endlessly elastic supply of capital in relation to the tax rate (Atkinson et al, 1976). However, the rise in conditional and unconditional wealth inequality over the last few decades has prompted a slew of publications proposing positive optimal tax rates even in a neoclassical context after these assumptions are relaxed. This is also supported by OECD's calls to urge its member countries to employ capital taxes to increase income without jeopardizing fragile economies in the aftermath of the 2009 financial crisis or even the pandemic. Furthermore, a recommendation reiterated by the IMF in 2021 advocated for the use of wealth taxes to raise public income and address historical or currently emerging disparities. 

A European Solution? Current Verdict

As a national level is highly unlikely, by moving to the European level, the supporters of a wealth tax can bypass the criticism that individual nations' firms are being weakened in European economic competition. This factor is undoubtedly what has prompted France's Ministry of Economics to keep the idea of a European wealth tax on the table. If the European Citizens' Initiative receives the required amount of signatures, advocates of the wealth tax will be able to mobilize European public opinion. Public opinion appears to favor such a move in many nations, including Germany. Apparently, their opinion is also backed by recent studies.

According to a recent study, household wealth in the EU22 is disproportionately concentrated among the wealthiest households: the richest 1% own 32% of total net worth, while the poorest half of all households own only roughly 4.5% (Kapeller et al, 2023). This suggests that the wealthiest households have a greater power than previously thought to close the EU's green investment gap. A wealth tax that exempts all save the richest 1% or 3% of households can be justified not just by their ability to pay, but also by the reality that wealthy households have bigger carbon footprints.

Furthermore, many believe that wealth taxes are still fair since they can diminish the current concentration of wealth. As a result, they may be an important instrument for preserving public support for the challenging transition to a society with low resource intensity and carbon neutrality. Altogether, the infrastructure needed to establish and enforce a European wealth tax, most notably complete beneficial ownership registers, would be a powerful instrument for combating tax evasion, and illegal financial flows in general. With those criteria upheld, findings indicate that a progressive European wealth tax with high exemption ceilings of 1 to 2 million adopted at the European level could be an effective instrument for closing the EU's green investment gap.

Feasible?

While a wealth tax has a long way before making a significant comeback in Europe, there is movement in Brussels. Such a tax would also establish the groundwork for a common tax system that would strengthen the EU as a whole, at a time when the continent's far-right Eurosceptic parties are attempting to weaken it ahead of the 2024 elections. However, without an integrity-based and transparent institution governing it, this would lead to the same old story. The rich will still win, as depicted by the recent European tax office data where the top 0.1% highest earners pay a decreasing tax rate as their income rises. Leaning back to Churchill's famous saying, "There is no such thing as a good tax." 

References

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