7.1.1 As appears from the Commission's approach to the overall tax framework in Chapter 2 of this Report, it is appropriate to accord a place in the fiscal structure of South Africa to a wealth tax. References in this Chapter to wealth taxes also include taxes on capital.
7.1.2 There are numerous sound reasons in support of having a form of wealth tax in South Africa. Although it would be premature to set out these reasons in detail in this Report, a reference to certain of the more important considerations is both useful and appropriate.
7.1.3 In the Commission's view, a major justification for a wealth tax is that it promotes vertical and horizontal equity. It is an established fact that there is a huge disparity of incomes and assets between the various groups in South Africa. There is a significant concentration of wealth in the hands of relatively few people.
7.1.4 As pointed out in the Report of the Margo Commission, views may differ regarding the appropriate tax treatment of persons with different taxable capacities, as approaches to vertical equity inevitably involve value judgments. It is recognised, furthermore, that redistribution is better achieved by other means, particularly through the expenditure side of the budget. The actual and perceived redistributive effects of the tax system are nonetheless important, particularly in the current circumstances in South Africa. In the Commission's view, the contribution which a tax on wealth can make to the overall fairness of the tax system should not be underestimated.
7.1.5 Another factor in favour of wealth taxes, also pointed out in the Margo Report, is that capital contributes to a person's ability to pay taxes, and consequently offers a further base for levying tax.
7.1.6 This latter reason was supported in a somewhat reformulated form in a recent publication on tax reform under the editorship of Cedric Sandford. Sandford discusses the taxation of wealth as follows:
There is a strong case in principle for including some sort of wealth tax as part of the tax structure of a country. Wealth adds to the taxable capacity of its owner over and above any income it may yield. Moreover there are three possible bases for personal taxation: income, consumption and wealth; they each tax a different facet of ability to pay and it can be argued that the fairest tax system will utilise them all.
By wealth in this context we mean the generality of wealth. A personal wealth tax is a tax on the whole of a person's assets except for any express exclusions. Thus a real property tax is not a wealth tax as here defined because it relates only to a particular class of property - though real property would constitute part of the assets subject to a wealth tax. In this connection the words 'wealth' and 'capital' are synonymous.
There are two situations in which wealth, as distinct from the income from it, may be taxed:
(1) Taxing the stock of wealth at a particular point in time, say January 1 each year. This is an annual wealth tax (AWT).
(2) Taxing wealth when it is transferred from one person to another by gift or as a result of a death - a wealth transfer tax (WTT). Although a capital gains tax, which taxes the appreciation of wealth, has similar purposes and some similar problems to the other two forms, it is not strictly a wealth tax but ... it is more akin to income tax. Our concern is therefore with the other two - annual wealth tax and death and gift taxes.
Although an AWT and a WTT may have similar objectives, they differ as to emphasis and practicability.
7.1.7 A further benefit of wealth taxes arises from the inevitable defects of the taxation, in practice, of income and consumption. As is pointed out in the international literature on tax design, not all of the objectives of the tax system can be satisfied simultaneously and comprehensively. Trade-offs between the objectives of administrative simplicity and certainty and of equity are unavoidable. In the design of the income tax, for example, it is not practical to include all possible forms of income, nor can the value added tax be designed to impact fairly on all forms of consumption. Taking into account all other tax instruments and rates, and their incidence on the poor, the fairness of the tax system is enhanced by the imposition of some taxation of wealth. In order to compensate partially for the practical deficiencies of income taxes and value added taxes, it becomes necessary, apart from all other considerations, to include wealth taxes in the system. This is a necessity despite the known defects in wealth taxes.
7.1.8 With regard to the difficulties of designing wealth taxes, a recent study states:
In theory, taxes on wealth, on capital gains, and on inheritance could be designed as progressive tax instruments that would cause relatively few distortions. They must be designed carefully, however, to be administrable and to limit disincentives to saving. In practice, neither wealth taxes (other than urban property) nor inheritance taxes are major sources of revenue. The reason is the difficulty of enforcing these taxes. Wealth taxes and capital gains taxes can be evaded or contested in court relatively easily, given the problems of valuing assets, particularly those that are not transacted frequently. Inheritance taxes are more feasible, but to be equitable it is critical that they be complemented by gift taxes - otherwise gifts become a means for reducing the base of the inheritance tax. Gifts, however, are more difficult to identify and tax, particularly when the transfer is in kind. For these reasons, wealth and inheritance taxes in developing countries are likely to remain relatively minor components of the system of direct taxation in the near future.
7.1.9 Having concluded that there is a strong case for taxing wealth, the Commission has examined the various forms of wealth tax which might be selected, taking account of relevant practical and other considerations. The options include:
7.1.10 The Commission's views on a possible national land tax appear in Chapter 4.
7.1.11 In the Commission's view, the arguments against an annual or once-off wealth tax outweigh the arguments in favour. Of particular importance in this regard are the difficulties of assessment and effective administration which are associated with annual or once-off wealth taxes.
7.1.12 The Commission favours a capital transfer tax in South Africa. South Africa effectively has a capital transfer tax at present in that there is both estate duty (payable on death) and donations tax, being a tax on transfers of wealth inter vivos.
7.1.13 Having taken a decision in principle to recommend a capital transfer tax in South Africa, the Commission must immediately point out that it requires to do considerably more work on this topic before it can make detailed recommendations.
7.1.14 The reason why the Commission has considered it appropriate to make a recommendation in principle, even before completing the necessary detailed research, is to defuse speculation. The Commission is aware that a high level of speculation exists as to whether or not wealth taxes will be recommended, and the Commission therefore considers it appropriate to indicate its general approach on this topic at the earliest possible stage.
7.2 APPROACH OF THE COMMISSION
7.2.1 By having a capital transfer tax in South Africa, the Commission hopes to achieve the objectives indicated in section 7.1 above.
7.2.2 The Commission wishes to ensure that there will be a net positive yield to the fiscus arising from this tax. Apart from this being necessary for both administrative efficiency and for the contribution of the tax to vertical equity, the additional revenue achieved by the fiscus from a capital transfer tax might well facilitate other tax reforms. A level of contribution to total tax revenues of approximately 1 to 1,5 per cent of total tax revenues might be an appropriate target.
7.2.3 The Commission is, however, anxious to avoid high administration costs.
7.2.4 The Commission is also concerned that the implementation of its recommendations should not give rise to an unproductive estate planning industry.
7.2.5 The Commission also does not want savings and capital accumulation to be adversely affected by the taxes contemplated in this Chapter.
7.3 IDENTIFICATION OF RELEVANT ISSUES
7.3.1 To give effect to its approach to this topic as set out above, the Commission considers that there are numerous issues, both of principle and detail, which need to be carefully researched to enable the Commission to make detailed definitive recommendations.
7.3.2 The first important issue of principle is what form the proposed capital transfer tax should take. In particular, a choice must be made between an estate tax or an inheritance tax. In this regard, the following passage from More Key Issues in Tax Reform is highly instructive:
The strong case for taxing intergenerational transmissions of wealth on grounds of vertical equity ... leaves open the question of what form the tax should take. In particular, should it be donor- or donee-based, i.e. an estate duty type or an inheritance tax?
The case for the inheritance-type death duty (with accompanying gift tax) is that, better than estate duty, it fulfils what may be regarded as the prime objective of death taxation, i.e. reducing inequality of wealth. An inheritance-type death duty taxes what is received irrespective of the size of estate from which it comes. It thus strikes at the heart of the problem of inequality, for it is large inheritances, not large estates as such, that perpetuate inequality. The inheritance tax also offers an incentive to estate owners to spread their wealth widely, for, by so doing, they can reduce the amount of tax paid and thus exercise control over the ultimate disposition of a larger part of their fortune.
This second argument may be of very limited significance, for most wealth owners may well wish to concentrate their wealth in the hands of their immediate family irrespective of the tax regime. However, the first argument is fundamental.
There are further equity arguments in favour of an inheritance tax. It seems more logical and equitable to tax what is received by a living person instead of imposing tax by reference to a sum which may bear no relationship to an individual's benefit and which, in Winston Churchill's words, 'attempts to tax the dead instead of the living' ... Furthermore, the inheritance tax offers more scope for adjusting tax on the beneficiary according to prevailing concepts of equity. Thus, for example, granting relief by having a higher threshold or a lower rate on legacies to a minor child of a deceased parent, can be simply accommodated under an inheritance tax; and many countries with an inheritance tax provide for different rate scales or/and thresholds according to the relationship between the deceased and the inheritor - the closer the relationship, the lower the scale. (Such a provision, however, is likely to run counter to the primary purpose of reducing wealth inequalities.)
The advantage of an estate duty lies in greater ease of administration. Under an inheritance tax separate accounts are required for all beneficiaries of an estate whose legacies are above the exemption limit, whereas under estate duty only one account is required for each estate. But the modest addition to administrative costs is a small price to pay for the advantages of an inheritance tax.
It is sometimes argued that an estate duty is a better revenue-yielder than inheritance tax; but, save in its ultimate form, this argument rests on a misconception. Of course it is true that if the same rate scale was applied to both an estate duty and an inheritance tax, the estate duty would yield more. Only when an estate was left to one person would the yield by the same; in all other cases the inheritance tax would yield less. But the rate scale does not need to be the same. A rate scale for an inheritance tax could be devised with the equivalent yield to any given estate duty. It would mean that where an estate was left to one or a very small number of people, the inheritance tax rates (and the tax yield) would be higher than under an equivalent estate duty; whereas where an estate was widely dispersed the tax yield of an inheritance tax would be less.
The ultimate sense in which an inheritance tax might raise less revenue, even though established on a revenue-neutral basis with a particular estate duty is that, if, as we would expect, the inheritance tax was more successful than the estate duty in bringing about a reduction in inequality, then the revenue from the inheritance tax would fall. But this would be a sign that it was doing its job!
7.3.3 In evaluating the relative merits of the inheritance tax and the estate duty, the following further factors arise:
7.3.4 The next important issue is the rate of the tax. As noted above, the rate of tax must ensure that the contribution of this tax to total revenues is at an appropriate level. In this regard it is pointed out that some countries have achieved a contribution of these taxes of 1 to 1,5 per cent of total tax revenues. The resulting overall yield of the tax must be considered, together with other factors, in determining the rate.
7.3.5 Another question that arises is whether the tax should be imposed at a flat rate or a progressive or variable rate.
7.3.6 An important further consideration is what rebates should be allowed. Various factors may be relevant in this determination.
7.3.7 The attention of the Commission has also been drawn to several issues which will arise in the detailed statutory provisions for the implementation of a capital transfer tax and which will affect the yield of the tax. These include:
7.3.8 All of the foregoing matters must receive attention.
7.4 RECOMMENDATION
7.4.1 The Commission supports the principle of a capital transfer tax, which would encompass the present estate duty and donations tax. This is a matter to which the Commission will return in a future report. [para. 7.1.12]