When you tax people’s wealth, they save more

With Uncle Sam running chronic trillion-dollar deficits, one proposal to increase revenue has been to raise it from the wealthiest Americans: through a tax, not on their yearly income, but on their accumulated wealth.

U.S. Sen. Elizabeth Warren, D-Mass., introduced one version of a wealth tax, which would tax net worth over $50 million at 2% and net worth over $1 billion at 3%. But it’s never come to a vote, and critics charge it would reduce gross domestic product, partly by reducing people’s incentives to save money.

But new research from Texas McCombs questions whether wealth taxes reduce savings. Marius Ring, an assistant professor of finance, investigates the real-world effects of a wealth tax in Norway — one of the few countries that currently implements one.

Surprisingly, the tax appears to motivate people to save more, he finds.

“Wealth taxation does not seem to reduce how much people save,” Ring says. “Taxing someone’s savings doesn’t necessarily imply that they will want to save less.”

Norway levies a tax of 1% on wealth over $160,000, affecting 15% of taxpayers. Ring looked at geographic differences in how the tax was assessed from 2005 to 2015. He correlated that information with third-party data such as household savings, housing characteristics, and transaction prices. He found:

• For every 1 additional Norwegian Krone (NOK) paid out in wealth taxes, households increased their net savings by 3.76 NOK each year.
• These savings were mostly the result of working more, rather than consuming less.

People work more, Ring says, because they don’t want to cut back on their plans for future consumption. It’s an effect economists call the income effect, because it involves greater income leading to greater consumption.  

“It relates to how downward adjustment of consumption is unpleasant,” he says. “If I have my eyes set on a certain type of RV to buy at retirement, then I’ll have to save more. It might be less painful to work more than to consume less in order to increase my savings.”

People don’t necessarily work longer hours, he adds. Instead, they stay in the workforce longer and retire later.

Besides boosting savings, higher wealth taxes did not affect people’s portfolio allocations. People with larger tax bites set aside the same fractions of their financial wealth to invest in the stock market.

Ring notes that he looked principally at the moderately wealthy: people in the 85th to 90th percentile of wealth distribution. But he doubts the ultra-rich would respond differently to a wealth tax. In fact, he argues, if they care more about adding wealth than spending it — for example, building a larger business empire — they might save even more.

He emphasizes that he’s not making policy recommendations for or against a wealth tax. He’s simply assessing one of the arguments against it by showing that it doesn’t always discourage saving.

The broader implications of his findings, he says, lie in the design of an ideal tax system. Economists generally favor taxes that have less distortions: lesser effects on people’s behavior.

Ring’s findings suggest that a wealth tax may be such a tax, but so might other kinds of taxes on savings, such as taxes on dividends or capital gains.

“My findings suggest that a wealth tax could fit this bill,” he says. “But they don’t necessarily favor a wealth tax over other types of taxes on households’ wealth.”

“Wealth Taxation and Household Saving: Evidence from Assessment Discontinuities in Norway” is published in The Review of Economic Studies.