The Covid-19 pandemic, the war in Ukraine and the economic recession that has followed, has, once again, sparked a new debate on taxing the wealthy.
The gross borrowings of Organisation for Economic Co-operation and Development (OECD) governments jumped by 70% following the outbreak of the pandemic. Despite gradual stabilisation in 2021 and 2022, governments are still looking for financial resources to compensate the effects of these crises, and the subsequent increase in energy prices. This is especially true in certain EU countries such as Greece, Italy, Portugal, Spain, France and Belgium, which had the highest government-to-GDP ratios at the end of the third quarter of 2022. In the UK, public sector net debt (PSND ex) was 99.2% of GDP at the end of February 2023, and a debt-to-GDP ratio at levels not seen in the past 60 years.
In the search of those additional funds, the argument to impose additional taxes on the affluent emerges. Currently, only three European OECD countries have net wealth taxes: Norway, Spain and Switzerland. Other countries, such as Belgium, France and Italy, only tax certain assets. However, the voices calling for taxing rich are mounting.
Nevertheless, as my colleagues Donald N'Gatta from MDE Business School, Gaizka Ormazabal from IESE Business School, and I discovered in a new study, taxes on the wealthy might lead to unintended, negative repercussions, especially in the case of family businesses.
In our research, which will be published in The Accounting Review, we analysed 4,381 publicly listed companies in 26 European countries between 2000 and 2017 whose shareholders or owners, in the case of family businesses, have been subject to a significant increase in wealth through their shareholdings. Then, we focussed on those companies whose shareholders are subject to a wealth tax. Overall, our study showed that higher wealth taxes drove up dividend pay-outs in closely held firms – i.e., corporations controlled by a single individual or by members of a family.Our study indicates that the dividend increases are higher for those companies whose shareholders do not use investment vehicles (e.g., their shares are directly at their name and not through other companies).
In family firms, owners’ wealth is tied to the value of their shares in the businesses they own. Consequently, significant increases in stock prices directly impact their wealth tax bill, although this not always means that their cash holdings also grow.
In order to honour their taxes, these owners can either adjust their life standards, including a change of fiscal residence to pay less in the future, apply for a loan from a financial institution, or sell some of their assets, including shares. These alternatives are costly and, in particular, selling their shares may also result in losing control over the firms they own. An easier solution emerges: distributing extra dividends.
Our research shows that, on average, these shareholders systematically distribute approximately 3.5% more dividends on the years they must pay higher wealth taxes. However, these higher pay-outs are associated with lower stock returns, and, importantly, a decline in future investments. In other words, while tax-driven dividend payouts may help meet tax obligations of the controlling shareholder and provide short-term satisfaction to all other shareholders receiving dividends, it could mean less resources directed to future investments and innovation, which could have resulted in more profitable projects in the long run.
One could conclude that increasing dividend payouts is, in fact, a failure of the firm’s governance where the board value the short-term relief of some shareholders over long-term profitability. This decision has a direct impact on all shareholders. We found that stock price growth was approximately 50 basis points less than what could typically be anticipated following a significant dividend announcement. It is also a failure in the design of some taxes. The tax implications of asymmetrical taxation among various shareholders raise concerns about the fairness in competition and the impact on investor’s liquidity.
Wealth taxes play a vital role in financing our welfare state and in mitigating social inequality, but a more comprehensive approach is necessary to avoid creating unintended situations and ensure a fair redistribution of the value generated by companies.