MODULE : APPLIED TAX LAW AND PRACTICE (MPAC516)

GROUP 5

QUESTION

DISCUSS THE ADVANTAGES AND DISADVANTAGES ASSOCIATED WITH LEVYING

CAPITAL GAINS TAX COMPARED TO IMPLEMENTING UNIVERSAL WEALTH TAX

Capital Gains Tax

Capital Gains Tax (CGT) is a tax levied on the capital gain arising from the disposal of a
specified asset. A Specified asset can either be immovable property that is land and buildings or
any marketable security such as debentures, shares, unit trusts, bonds and stock. CGT is
administered in terms of the Capital Gains Tax Chapter 23.01. A capital gain refers to the profit
you make from selling a specified asset or capital asset. The capital gains tax preference can
drastically alter the taxpayer’s liability at the end of the year because of the potential to lower
rates that apply to capital gains. However, this tax preference only applies to certain income and
certain entity types. CGT is charged at the rate of 5% of the selling price of the specified assets
which were acquired before 22 February 2019 and disposed after that date and at the rate of 20%
on assets acquired after 22 February 2019.

Wealth Tax

Wealth tax is a tax levied on the market value of assets owned by a taxpayer. A wealth tax
doesn’t have to be indiscriminate when it comes to asset types; it applies to all property such as
real estate, cash, investments, business ownership and other assets, less any debts you owe. Two
major types of taxes are levied on wealth: those applied sporadically or periodically on a person's
wealth (net wealth taxes), and those applied on a transfer of wealth (transfer taxes) according to
Thuronyi (1996). Net wealth taxes are typically assessed on the net value of the taxpayer's
taxable assets that is, value of assets minus any related liability, either sporadically (often known
as "capital levies") or on an annual or other periodic basis.

Transfer taxes, which are typically assessed on the net value of the taxable assets transferred, fall
into two basic categories: those levied on the transferor or her or his estate (more typical in
common law countries), and those levied on the recipient. According to Victor Thuronyi (1996),
the tax base for taxes on wealth can include either the worldwide net assets owned by,
transferred to or received (depending on the type of tax) or given away by a taxpayer who has a
sufficient connection with the , or those assets situated in a jurisdiction regardless of the
taxpayer's connection with it. However, a government may decide to exempt some asset types to
foster certain behaviors. For instance, it might decide business assets didn’t count to encourage
entrepreneurship. Ultimately, a wealth tax’s structure depends on how a country designs the law
and the rate differs in most countries. (D Rodeck and B Curry : Wealth tax 2021).

Capital Gains Tax and Wealth Tax

Both Capital Gains and Wealth Tax are considered as Direct Taxes. A direct tax is one, which is
paid by a person on whom it is legally imposed and the burden of which cannot be shifted to any
other person. The person from whom it is collected cannot shift its burden to anybody else. The
tax-payer is the tax-bearer. The impact that is the initial burden and its incidence, the ultimate
burden of direct tax is on the same person who is responsible for payment of jurisdiction Income
tax, wealth tax, property tax, estate duties, capital gain tax, company tax which are all direct
taxes.

Direct Taxes are elastic. If the State suddenly stands in need of more funds in an emergency,
direct taxes can well serve the purpose. The yield from Direct Taxes can be easily increased by
raising their rate. The disadvantage of direct taxation is mainly due to administrative difficulties
and inefficiencies. The extent of direct taxation should depend on the economic state of the
country. A rich country has greater scope for direct taxation than a poor country. However direct
taxation is an important aspect of the modern financial system.

Even though Capital Gains Tax and Universal Wealth Tax are both classified as Direct Taxes,
there are advantages and disadvantages of levying Capital Gains Tax compared to implementing
Universal Wealth Tax.

Advantages of levying Capital Gains Tax compared to implementing Universal Wealth Tax

1. Easy Administration
Proponents of wealth tax may imagine a system that is simple, broad‐based, easy to
administer, and lucrative for the government. But wealth taxes are complex and costly to
collect, compared to levying Capital Gains Tax.
 One problem of implementing the universal wealth tax is asset valuation. A wealth tax
may require taxpayers to report valuations, not just of financial securities and homes, but
also of such items as household furnishings, artwork, jewelry, vehicles, boats, life
insurance policies, pensions, family businesses, and farm assets. Many of these assets
have no ready market valuation.

Accounting for wealth held in trusts would also be difficult, and for people with non-
traded ownership in family businesses, book and market valuations can differ
substantially. Furthermore, valuations of assets change over time, so a large industry of
accountants would be needed to prepare regular valuations for tax returns. However, in
Capital Gains Tax, the value of an asset is specific since there is an arms’ length
transaction to establish price.

Victor Thuronyi (1996) acknowledged that, taxes on net wealth have frequently been
deemed too impractical, particularly in developing countries. Problems of uncovering the
ownership of wealth and assigning it to particular taxpayers, and of accurately
determining net values, can combine to make the tax especially difficult to enforce. On
the basis of substantial experience, Richard Goode concludes that net wealth tax,
although attractive in principle, must be judged impractical in most developing countries.

2. Reduces the Potential for Tax Evasion and Avoidance

Saez and Zucman acknowledge that tax avoidance and evasion were an issue in many
European countries that attempted a wealth tax. In the United States, wealthy individuals
try to avoid wealth tax liability by sheltering their assets in foreign bank accounts and
investments.
The flow of capital across international borders has soared since the 1980s. Corporations
and individuals are increasingly moving their investments to countries with better growth
opportunities and lower taxes. However, Capital Gains Tax is very clear and specific. In
Capital Gains there is a potential of reduction for tax evasion and avoidance since the
cost is specific and identified.
3. Discourages Double Taxation
According to the Tax Policy Center, many wealthy taxpayers already pay corporate
income taxes, individual income taxes, and estate taxes. A wealth tax would tax that
income again if a business owner decided to hang on to their wealth rather than spending
it which would result in double taxation.
Net wealth taxpayers whose worldwide net wealth is subject to tax may be subject to
double taxation. For example, under treaties, immovable property is normally taxable in
the country in which the property is situated. An important difficulty in relying on treaties
is that there are relatively few that cover net wealth taxes. It is probably not a top priority
for developing and transition countries to devote resources to negotiating treaties in this
area. Thuronyi (1996) concluded that it makes more practical sense for them to structure
their net wealth taxes so as to impose the net wealth tax on nonresidents in a manner that
is creditable in a nonresident's home country if that country levies a net wealth tax on
worldwide assets. However, there is no double taxation in levying Capital Gains Tax
since it is only levied on capital gain arising from the disposal of a specified asset.

4. Discourages relocation of wealthy citizens

In a Wealth Tax environment, there is a risk that wealthy individuals would relocate to
another country to avoid the tax. In France, more than 42,000 millionaires left before the
country eliminated its wealth tax in 2018. However, in the case of Capital Gains Tax, it is
difficult for a property to be registered in the new owner’s name before they get a Capital
Gain Certificate.

5. Potentially Lower Rates

The long-term capital gains tax rates are lower than the ordinary income tax rate. As of
2012, the maximum capital gains rate is 20 percent while the maximum ordinary income
tax rate is 25 percent. To qualify for this lower rate, you have to have owned the property
 for at least one year. For example, if you sell land that you've owned for two years, your
profit is taxed at just 20 percent rather than 25 percent.

6. Deferred Taxation
Capital Gains Tax applies only when you actually realize the gain or loss, rather than
when the value of your capital assets increases or decreases. For example, if the value of
your land increases by $5,000 during the year, but you don't sell it, you don't have to pay
the income taxes because you haven't actually realized any of the gain or loss. This is
advantageous because you don't have to worry about paying taxes unless you actually sell
the property. The downside to not having to pay taxes until you sell is that, when you do
sell a property, all of the income is taxed in the same year.

Disadvantages of levying Capital Gains Tax compared to implementing Universal Wealth

Tax

1. Discourages Hiring
Saez and Zucman argue that a wealth tax could disincentive companies and their
shareholders from holding on to wealth and encourage hiring, which could positively
affect low and middle income families. However, with Capital Gains Tax, the Owners to
own their properties as long as they want it to appreciate thereby negatively affecting
low and middle income families.

2. Does not apply to Inventory

The capital gains rate does not apply to property that would be classified as inventory,
even if you have held it for more than one year, because inventory is not considered a
capital asset, for example assume you have a business that buys and sells investment
properties. If you have a property that you've held for more than one year when you sell
it, your gains count as ordinary income, not capital gains income because the land is
inventory to your business. Alternatively, assume you own the land under your store as a
 sole proprietor and you sell it when you move your store to a larger location. As long as
you've held the land for more than one year, it qualifies because you're not a dealer in
land.

3. Does not apply to Corporate Income

If you have incorporated your business, the capital gains preference doesn't apply to gains
for the corporation because all corporate gains are taxed at the same rate. For example, if
you've incorporated your business and the corporation sells land it has owned for 10
years and has a gain of $2 million, your corporation still pays taxes on that gain at the
corporate tax rate, not the long-term lower capital gains tax rates.

4. Middle-Class Tax Relief

In Wealth Tax there is relief on middle class. Over the last few decades, middle-class
incomes, after taxes and benefits, have grown half as fast as those of the rich, according
to researches. Some wealth tax proposals don’t just increase taxes on the wealthy but
reduce the middle class’s tax burden. For example, Richard V. Reeves and Isabel V.
Sawhill, senior fellows of economic studies at the Brookings Institution’s Center on
Children and Families, recommend eliminating income taxes for most middle-class
households by raising the standard deduction to $100,000. Such a change would relieve
much of the tax burden placed on middle-class families. However, Capital Gains Tax is
applied uniformly according to one’s gain hence there is no relief at all.

5. Encourages wealth inequality

Universal Wealth tax encourages the very rich to spend more of what they have and what
they make compared to Capital Gains Tax. Some of that spending, such as contributions
to charity, may benefit society and discourage wealth inequality and some extra spending,
by giving money to political candidates, would increase rather than reduce the political
influence of the mega-rich, running exactly counter to the goal of some wealth tax
advocates. The Peter G. Peterson Foundation found that a wealth tax would help fund
programs that would ensure the benefits of economic growth would be more evenly
distributed, benefiting lower-income Americans and helping to reduce wealth inequality.
 Revenues raised from a wealth tax can also be spent directly on programs to aid the poor
(Thuronyi 1996). However, Capital Gains levying does not redistribute income and solve
the issue of wealth inequality.

Conclusion

In recent decades, countries all across the world have reduced capital gains taxes, and most
countries that had annual wealth taxes have abolished them. Recent attempts by the United States
of America to raise taxes on wealth and capital income go against the global economy's lessons
learnt about efficient taxation. The Europeans learned that levying punitive taxes on the wealthy
stifled economic development. It was discovered that wealth taxes increased tax evasion and
capital flight. Wealth taxes in Europe raised little money and were plagued with loopholes.
Wealth is a collection of savings that can be used to make investments. The richest Americans'
fortunes are primarily made up of socially good corporate assets that generate jobs and revenue,
rather than private consumption assets. Raising wealth taxes would backfire on ordinary workers
by hampering productivity and wage growth.

It's difficult to come up with a fair and effective system of taxing capital, but experts agree that
wealth taxes are inefficient. Wealth taxes are deemed virtue taxes that penalize the wealthy for
being prudent and reinvesting their earnings. Rather than introducing a wealth tax or boosting
capital income tax rates, officials should reconsider the governments’ entire approach to capital
taxation. Consumption-based taxation, which taxes wealth in a simpler method that does not
hinder savings, investment, or growth, is a preferable alternative.
Reference List

1. Rodeck, D. Curry, B.; 2021.; What is a Wealth tax;

https://www.forbes.com/advisor/investing/what-is-a-wealth-tax
2. Saez, E. Zucman,G.; 2019: The Triumph of Injustice: How the Rich Dodge Taxes and
How to Make Them Pay: Financial Markets and Portfolio Management, Springer; Swiss
Society for Financial Market Research, vol. 34(3), pages 349-352.
3. Thuronyi, V. (1996). Tax law design and drafting. Washington, D.C: International
Monetary Fund