The most wealthy need to pay more tax: here’s what the UK can learn from the rest of the world

 
UK 2040 Options recently analysed the current state of wealth and income inequality in the UK. The experts they engaged with were clear that taxation is a key factor that is ripe for reform.

In the twelve years I spent working in financial markets, wealth management and tax consulting all over the world, I gained valuable insight into how businesses and rich individuals respond to the incentives that tax systems around the world offer them. More recently, as a teacher, a charity CEO and the Director of the Social Mobility Commission, I’ve seen firsthand the impact that high levels of inequality have on society.

This blog draws on these experiences and explores some realistic options for policymakers to reduce inequality, which have been tried and tested in other countries.

It’s not inevitable: a reflection on the international context

The IFS sets out how poor tax design in the UK is a major challenge. Certainly, if we were able to redesign the tax system from scratch, it could reduce inequality and damaging distortions, while improving productivity and economic growth. But in reality, we know that political constraints mean that reform is often slow and incremental, and it can take time for new ideas to gain acceptance.

Whenever a new tax is proposed, or the reform of an existing one is recommended, those who are adversely affected lobby hard to maintain the status quo. Practical proposals, sensible reforms or attempts at simplification (such as the “Pasty Tax”) are often dismissed as impossible to implement, unfair when considered in isolation, or likely to result in damage to the economy. The result is tax inertia. Instead of optimising policy to minimise distortions, improve incentives and raise productivity, policymakers make fewer changes, instead using devices such as fiscal drag to increase revenue.

The resulting set of income and wealth taxes in each country throws up some surprising differences. What some consider to be radical policies in the UK are uncontroversial elsewhere. For example, unlike the UK, Australia (where I am currently based) has no inheritance tax and the state pension is means-tested.

How ultra-high-net-worth individuals avoid tax

As a director at a global wealth management firm, that included a Swiss private bank, I oversaw complex investments for wealthy clients, spending much of my time in cities such as Dubai, Geneva, London, Monaco and Paris. I often met ultra high-net-worth clients, with at least $25-50 million in net assets. I listened as advisers explained how they could avoid tax.

Most sought to minimise their tax liabilities where it was clearly legal and involved limited disruption to their lifestyle. If it was legally or reputationally risky, or hard – such as requiring a move abroad – they were more likely to decide to stay and pay the sticker price taxes. Some were happy paying local taxes on income and capital “in full” since the country had enabled them to generate that wealth. A few, particularly those with fewer ties to the country, sought to pay as little as possible, even when that involved taking risks or moving to a tax haven.

One British man I met in Monaco had sold his UK business and was there for five years to avoid paying millions of pounds of UK taxes on his gain. He could still visit the UK but only for a limited number of days each year. When I first went to his apartment, he would stand on his balcony overlooking the harbour, and tell me how lucky he was. The third time we met he told me how much he missed his family and couldn’t wait until he could move back to spend more time with his grandchildren. I’m sure that if the rule had been ten years not five, or he was allowed back in the UK for even fewer days, he would never have left England and paid his taxes there. The set of choices we gave him incentivised him to avoid paying tax here.

To the extent international law permits, we can start by changing that.

But we must go much further than simply tightening up rules on the number of days that small numbers of wealthy UK citizens who become non-resident can spend in the UK without triggering tax implications. Understanding how other countries have introduced similar taxes can help us overcome the inevitable resistance that the threat of a new tax brings.

Seven practical ideas for policymakers to reduce inequality

1) Increase the Stamp Duty Land Tax surcharge for non-UK-residents purchasing UK residential property from 2% to 15%

International ownership of housing can increase inequality. It can reduce the supply of housing available for locals, increase rents and house prices and make it harder for young British people to own their own home. Hamptons estimated that in 2023, 24% of homes sold in Greater London went to international buyers, rising to 45% of those in prime Central London.

Other developed countries have taken much bigger steps than the UK to deter foreign ownership, or at least to raise greater taxes from it. At one extreme, Canada has banned foreign purchasers altogether, until at least 2027. The situation is similar in New Zealand, with some exceptions for temporary ownership of newly built housing. To buy in Switzerland, foreigners need a permit, only 1,500 of which are issued each year through cantons. Singapore recently doubled the additional stamp duty paid by foreigners buying residential property to as much as 60%. In Australia, foreign buyers will soon be hit by extra fees and taxes totalling 14%-17%.

In comparison, the UK charges foreign buyers a mere 2% supplement, with few restrictions on owning property in the UK. Increasing the rate to 15% could deter overseas buyers, freeing up property for local buyers, while bringing in revenue from the most determined. Halving the rate for new-build flats could prevent the risk of this policy reducing the housing supply.

2) Increase the higher rates of Stamp Duty Land Tax for those purchasing additional existing homes from 3% to 6%

It is not just overseas buyers that compete for property with first-time buyers. Local residents also acquire second homes and investment properties. Singapore citizens and permanent residents buying their second or subsequent properties pay a 20%-35% supplement. In comparison, the UK charges those buying additional properties only 3% more. Doubling this to 6% for existing properties would bring in much-needed revenue. Exempting new-build flats could prevent the risk that this could reduce supply.

3) Create a new Annual Property Tax on market-based hypothetical rental income, charged to owners of all homes, except UK resident owner-occupiers

One way to ensure properties are more likely to be rented is to tax vacant properties as though they are let. Many countries take this approach. Property owners in Switzerland must pay income tax on a property’s perceived rental value, deducting mortgage interest payments and maintenance costs, in addition to taxes on the value of property and wealth. Singapore applies a tax on property ownership, whether the property is occupied by the owner, rented out or left vacant. A tax rate of 12%-36% for non-owner-occupiers is charged on the estimated gross rent of the property with owner-occupiers charged less. In the UK, council tax is the closest to a property tax, with properties put into one of eight bands based on values in 1991. The IFS recently set out how council tax is highly regressive with respect to property values and leads to increasingly arbitrary tax bills.

While some councils are doubling the council tax on second homes and empty dwellings, a more consistent approach nationally would be to create a new Annual Property Tax on a market-based hypothetical rental income. This could be charged to owners of all homes at marginal income tax rates, except UK resident owner-occupiers – so would be paid by owners of second homes, rental properties and vacant properties. Those that are rented out would pay tax on the actual rental income achieved if higher and could deduct relevant costs. If not rented for at least six months of the year, no deductions would be allowed, and a flat 45% tax rate on the hypothetical value would be applied.

4) Prevent individuals with assets in ISAs above £100,000 at the beginning of a tax year from investing in a new ISA that year

Most developed countries offer tax incentives to save for retirement, but very few are as generous as the UK in offering easy access savings accounts sheltered from tax. ISAs allow UK taxpayers to invest £20,000 each year without paying any income or capital gains tax on profits. Those with lower incomes and wealth typically have lower total savings and do not benefit from this significant tax break.

At the same time, the more affluent have accumulated significant savings, returns from which are permanently sheltered from tax. Over 4,000 people have ISA savings that exceed £1 million. It would be considered unconventional and unfair to make ISA savings above a given threshold taxable again. Preventing people with ISA savings above £100,000 at the beginning of the tax year from opening a new ISA that year would mean they would need to pay income and capital gains tax on investment returns from the savings they are no longer able to put into the ISA.

5) Create a new Retirement Savings Allowance tax charge on pension assets above £500,000 at age 70

A common definition of a pension is that it provides those who are retired with a regular income, not that it is a savings vehicle or investment account. Indeed, until it was abolished in 2011, pensioners had to use their (defined contribution) pension savings to buy an annuity, which provided a fixed income for life. Yet, for many wealthy investors whose pension savings exceed the £1,073,100 Lifetime Allowance, their pension is not used to generate an income on retirement but is part of their inheritance tax planning strategy and used as a store of wealth. As such, the upcoming abolition of the Lifetime Allowance is an unnecessary reduction in tax for some of the most wealthy in the country.

The Lifetime Allowance was introduced in 2006, capping the amount of pension savings that can be built up without incurring a tax charge, typically of 25% (it was reduced to 0% this tax year). The limit was repeatedly decreased in real terms but is now due to be abolished altogether in April 2024. The changes reduce the potential tax liability of those with pension savings exceeding the limit when they retire and hence increase inequality. Meanwhile, Australia is raising pension taxes, not abolishing them, introducing a new 30% tax on pension balances above AUD$3 million (roughly equal to £1.56 million) from July 2025.

There would be challenges in reinstating the Lifetime Allowance, so instead, a new Retirement Savings Allowance (RSA) could be introduced set at £500,000, but only applied on savings, not annuities (providing a fixed income) that have been purchased or defined benefit pensions. The vast majority of people are unaffected, and those who use their pensions as intended — to generate an income rather than to store wealth or avoid inheritance tax – don’t lose out. To maximise the impact, while giving people time to buy an annuity at a time that suits them, this RSA test could be applied to all with at least a year’s notice at age 70 or later.

With pensions, there is always a lot of detail to work through, so I don’t pretend this comes close to covering it!

6) Create a new 1% wealth tax charged on net assets above £2 million

In 2020, the Wealth Tax Commission published a report setting out how a one-off wealth tax could be designed as an exceptional response to the fiscal costs of the Covid-19 pandemic. It set out how a 1% tax on individual assets above £2 million could raise £80 billion over five years. It added that a more permanent “annual wealth tax would only be justified in addition to these reforms if the aim was specifically to reduce inequality by redistributing wealth”.

There are additional challenges with an annual wealth tax, including measuring hard-to-value assets, and fears that it would drive away mobile wealthy individuals, damaging the economy. Countries such as Switzerland have shown these can be overcome. All Swiss cantons impose a wealth tax on net assets, even for low levels of wealth. For example, for net assets above 82,200 francs, Geneva has a rate of 0.149%, with marginal rates rising as wealth increases, and exceeding 1% in some cantons. It generates as much as 3.8% of total taxes in Switzerland.

7) Create a new British Citizen Tax, mirroring the wealth tax, payable by all wealthy British citizens living overseas

One issue with a Wealth Tax is it could incentivise wealthy British citizens to move overseas to avoid it, which would reduce the tax raised. In the US, citizens are fully subject to US tax on their worldwide income and gains, no matter where they live, unless they renounce citizenship. Issues such as the administrative burden it creates for those of more modest means, and double taxation of income, means that some specialists say it would be unwise for the UK to replicate it. Instead of taxing income and capital gains, a wealth tax payable by those British citizens living overseas with net assets above £2 million could overcome many of the problems, if it could be designed in compliance with international rules. Those with assets below that would need to make a simple annual declaration listing valuable assets and provide copies of local tax returns to HMRC. Wealthy UK citizens living permanently abroad would need to renounce citizenship if they wanted to avoid the tax.

Some of the revenue from these new taxes could be used to reduce other taxes, both to reduce inequality further and to improve the efficiency of the system. Personal allowances could be increased to improve incentives to work and raise post-tax incomes of lower earners. Incentives for higher earners could be improved by reversing the removal of child benefits and the personal allowance from higher earners that currently creates very high marginal tax rates of 62% or more. Finally, a permanent halving of all basic levels of stamp duty would increase transactions, improving the geographic mobility of workers and removing the incentive to move as infrequently as possible.

Mythbusting: reform is not impossible

I acknowledge that some of the above is necessarily a simplification of a complex system. I don’t underestimate the challenge involved in creating an environment that allows for major change.

But I hope that at least by showing how other countries use similar taxes, it destroys the myth that these taxes are impossible to implement in the UK. And that this brings forward the day we might move to a fairer tax system that reduces inequality.

John Craven is Executive Officer at System 2, a charity set up by The Behavioural Insights Team and Nesta. It aims to solve complex social problems by bringing together behavioural science, systems thinking and insights from deep collaboration with those with lived experience, to co-design, test and scale practical solutions.

He is also an Honorary Fellow in Educational Equity at the University of Birmingham. Formerly he was a Director of Global Wealth Management, Bank of America, and was the former Director of the Social Mobility Commission in the UK.