Newsflash! The super-rich are mobile, and higher taxes incentivise them to move away

The super-rich are super-mobile. So, if a country decides to increase taxes on the super-rich (for example, with a wealth tax), some (but not all) of the super-rich will simply move elsewhere. This should not be a surprise to anyone. And yet, simplistic proposals to tax the super-rich are a favourite policy for some political and advocacy groups.

So, in case there was any doubt about how the super-rich respond to tax incentives, this recent article by Enea Baselgia and Isabel Z. Martínez, published in the Economic Journal (open access), provides some useful empirical evidence. They look at the case of Switzerland which, in addition to being an attractive place for the super-rich to locate themselves, also has taxes at the local (canton) level. Baselgia and Martínez make use of a special tax regime for wealthy foreigners, which was removed by five cantons between 2010 and 2014. As they describe:

One important reason why Switzerland is so attractive for wealthy individuals from around the globe is a special tax privilege the small country offers to wealthy foreigners: the so-called expenditure-based taxation. Those eligible for this special tax regime pay taxes on their (and their spouse’s and dependants’) global living expenses, rather than on their true income and wealth. Living expenses are defined broadly and include all expenditures for food, clothing and housing, taxes and social security contributions (around 25,000 CHF per adult and year), alimony payments, remunerations paid to household employees (in cash and in kind), expenses for education and leisure (sports, travel, cultural events, hobbies), for health and wellness cures, and costs of keeping pets (riding horses, etc.), as well as maintenance and operating costs of cars, motorboats, yachts, aeroplanes, etc.

Then:

Expenditure-based taxation has become the subject of heavy criticism over the past decade, both from outside and within the country. In light of these discussions, several cantons proposed to abolish this practice, usually holding a popular vote... Zürich (2010), Schaffhausen (2012),Appenzell Ausserrhoden (2012), Basel Stadt (2014) and Basel-Landschaft (2014) adopted corresponding proposals and removed the option of expenditure-based taxation. Seven other cantons held a popular vote between 2011 and 2014 that did not find a majority...

Baselgia and Martínez use data from a rich list compiled by BILANZ (the equivalent of the Forbes rich list internationally, or the NBR rich list in New Zealand). They apply a difference-in-differences approach, looking at the difference in the number foreign-born super-rich between the time before and the time after the special tax privilege was withdrawn, between cantons that withdraw the privilege and those that did not. They also apply a different approach, based on a location choice model. Both models result in similar estimates, such that:

...removing this preferential tax treatment reduces the stock of super-rich foreigners by approximately 43% five years after the abolition.

There were no corresponding results for Swiss-born super-rich individuals, who were not affected by the tax change (because they weren't eligible for the special tax privilege). That is an important aspect of the results, because if the Swiss-born also responded to the tax change, it should make us wonder if something else changed at the same time.

Baselgia and Martínez then conduct some back-of-the-envelope calculations, finding that:

...the elasticity of the stock of super-rich taxpayers in a canton with respect to the total net-of-tax rate on wealth lies in the range of 28.4–32.2.With respect to a revenue-equivalent tax on capital income (rather than on wealth), our estimates would imply an elasticity of the stock of super-rich taxpayers of 1.4–1.5.

What that first elasticity means is that a one percent increase in wealth tax rate decreases the number of super-rich taxpayers in a canton by between 28.4 and 32.2 percent. So, as we might expect, tax increases are a big disincentive to the super-rich. And the way that the results are expressed probably understates the magnitude of the effect. Notice that the elasticity is expressed as a one percent increase in wealth tax, not a one percentage point increase. That difference is important. Increasing a wealth tax from two percent to three percent is a one percentage point increase in the tax rate, but it is a 50 percent increase in the tax rate. The elasticity tells us the impact of the latter, which is massive. Now, of course the effect is not likely to be linear, but nevertheless that elasticity is enormous.

The implied elasticity on capital income is also large - a one percent (not one percentage point) increase in tax on capital income decreases the number of super-rich taxpayers in a canton by between 1.4 and 1.5 percent. The effect is not as large, but taxes on capital income are much less consequential for super-rich taxpayers than are taxes on wealth.

Incentives matter, and proponents of wealth taxes and other taxes on the super-rich must not be allowed to ignore the incentive effects. Is it better to tax a larger number of super-wealthy foreigners a little bit, or to tax a much smaller number of super-rich foreigners (or no super-rich foreigners at all) by much more? This research doesn't tackle that question, but that is what needs to be considered.