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On the banks of the picture-perfect Swiss mountain lake of Zugersee, the sedate town of Zug sports several well-tended aviaries. It is inhabited by scarlet ibises, golden pheasants, snowy owls and other non-native birds. They are a good symbol of another exotic species that have found a home in Zug: some of the world’s richest and most notorious financiers — such as the late Marc Rich, the commodity trader and fugitive from US justice — have long been attracted by the canton’s offer of a comfortable living, discretion and a light tax regime.

Much like tropical birds have got used to the Swiss winter weather, the resident rich have successfully acclimatised to one feature of Zug’s tax system that on the face of it looks hostile. Zug’s taxman may charge a very low rate of income tax, but it — like its fellow Swiss cantons — also confiscates a fixed portion of its residents’ net wealth every year. 

I have long thought it is counterintuitive that Switzerland, best known abroad for welcoming the world’s wealth and its owners, is one of few countries charging a regular tax on residents’ net wealth in all forms. So last week, I went there to investigate more closely. 

It is admittedly a very small portion that is confiscated: with a top marginal rate of 0.3 per cent, each additional SFr1m ($997,000) the richest Zug residents put in the bank incurs an annual tax bill of SFr3,000. But the tax starts at a low threshold and it has to be paid year in, year out. The revenue is significant. Heinz Tännler, Zug’s business-embracing finance minister, told me the wealth tax accounted for about one-fifth of Zug’s tax revenue from personal taxation. And it is higher in other cantons; in Geneva, a 1 per cent top marginal rate means every additional million owned will set its wealthiest residents back SFr10,000 per year.

Switzerland is such a useful case study of the wealth tax because it achieves in practice something that in the abstract would seem impossible. Simple theoretical arguments about taxation and incentives suggest that a tax on net wealth should have at least four negative effects. The first is that it discourages the accumulation of wealth. The second is that it scares away the wealthy. The third is that, as a result, it encourages tax jurisdictions to undercut one another to attract wealthy taxpayers, which results in a race to the bottom. Try to have a wealth tax, in other words, and you will soon be forced to bring it down to almost zero. And the fourth is that a net wealth tax puts obstacles in the way of entrepreneurs and other taxpayers who may have high net worth but little income or cash flow — and who may find themselves forced to liquidate assets to pay the tax. 

The fact that Switzerland, which on the face of it suffers from none of these problems, can sustain a net wealth tax suggests all four worries are exaggerated. That is the conclusion I take back from Switzerland when comparing it with other countries. 

Take wealth accumulation first. The incentive for accumulating wealth obviously depends on the threshold at which the wealth tax starts to bite. Senator Elizabeth Warren’s proposed US wealth tax would only start at $50m — that is, only once a lot of wealth has already been accumulated. One could, however, expect a serious disincentive for saving if the tax started at low thresholds — as it does in Switzerland. In the canton of Zug the wealth tax is payable on net wealth above just SFr102,000 for single taxpayers. But in practice, there is no sign of damage on this score: Switzerland consistently records one of the highest savings rates of all rich countries.

In fact, if Zug is anything to go by, the second worry is misplaced too, at least for countries that have other attractions. The wealth tax is obviously not stopping some of the world’s richest people from choosing Switzerland as their home. This could of course be different with net wealth tax rates much higher than Zug’s, such as the 2 to 3 per cent rate proposed by Warren. But she has a convincing solution to this potential problem: the tax would be linked to US citizenship (and presumably US permanent residence, which remains highly coveted around the world) and a 40 per cent “exit tax” on net wealth would be due on relinquishing it.

Against these impressions, however, one academic study finds a fairly large sensitivity in reported wealth to changes in the wealth tax in Switzerland. The researchers’ key estimate is that a 1 percentage point increase in the tax rate reduces reported wealth by 23 per cent — very large, but note that even with such a drastic response, you could push rates up to at least 3 per cent and continue to increase tax revenues.

There are, however, reasons to think the real sensitivity is smaller. Even this study finds that the effect is not due to people moving between cantons; only to changes within cantons over time. If it is not that the wealthy are chased away, the question is how fast wealth stocks can be changed in response to tax reforms. The 23 per cent response to a 1-percentage-point tax hike was calculated from much smaller actual variations. You cannot easily consume 23 per cent of a large fortune, as doing so would usually just involve buying alternative valuable (hence taxable) assets. Meanwhile, studies in Sweden and Denmark (which both had net wealth taxes until recently) show a much smaller response — less than a 1 per cent reduction in reported wealth — to a 1 percentage point higher tax rate. Third, the Swedish study shows that this is almost entirely down to avoidance — under-reporting wealth — rather than changes in savings behaviour. This, in other words, is an effect that a state determined to enforce honest reporting can minimise.

All this, however, leaves intact the puzzle of why there is no race to the bottom between Swiss cantons, as well as the challenge of dealing with illiquid wealth. In the next Free Lunch I report what I learnt from my trip about these questions.

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Talk about the mirage of making America great again. US president Donald Trump has railed against the North American Free Trade Agreement and marginally renegotiated it, but who would benefit or lose from dismantling Nafta?

Economists Raphael Auer, Barthélémy Bonadio and Andrei Levchenko look at the location-specific impact of shifting Nafta-covered trade to baseline most favoured nation terms, given differences in local industry structure. 

They conclude: “Though dismantling or renegotiating Nafta was a prominent pillar of the Trump presidential campaign, Trump-voting districts would experience systematically greater wage decreases if Nafta disappeared.” The reason is an almost perfect correlation between import and export exposure to Nafta countries: “Places that suffer the most from Nafta import competition are also overwhelmingly those that export to Nafta.”

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