Tuesday, 27 September 2011

Taxing the rich

The economist looks at taxation and the class war in Hunting the rich. The article suggests that it would be more appropriate for the rich to pay more - although it advocates doing so through a reduction in deductions rather than an increase in marginal rates.
There is a basic bargain to be had. Imagine a tax system which made the top rates on wages and capital more equal, and which eliminated virtually all deductions. To avoid taxing investments twice, such a system would get rid of corporate taxes. It would also allow for a much lower top rate of income tax. The result? A larger overall tax take from the rich, without hurting the dynamism of the economy. Now that would be worth blowing your horn about.
I guess no one has ever told them about dividend imputation.

As I mentioned, the article advocates making the tax system more efficient by reducing deductions allowed:
The scope for doing so is most obvious in America, which relies far more than other countries on income taxes and has a mass of deductions on everything from interest payments on mortgages to employer-provided health care, so taxes are levied on a very narrow base. Getting rid of the deductions would simplify the code and raise as much as $1 trillion a year. Since the main beneficiaries of the deductions are the wealthy, richer folk would pay most of that. And since marginal rates would be untouched (or reduced), such a reform would do less to discourage them from creating wealth.
I partly agree with this. I personally think that, generally speaking, deductions should only be allowed for legitimate income producing expenses. However, Governments also use deductions as a legitimate way to encourage certain activities - e.g. donations to charity (although you could argue that it's a fairly inequitable method as it tends to favour those on higher marginal rates). I'm not sure what the impact on the rather depressed US housing market would be if the deduction for interest payments on the home mortgage was taken away. On the other hand, it would help reduce the tendency of Americans to over capitalise their family home.

The author of the article also suggests shifting more of the taxation burden from income to property:
In Europe, where tax systems are more efficient, one option would be to shift more of the burden from income to property, which would collect more from the rich but have less impact on their willingness to take risks. The “mansion tax” proposed by Britain’s Liberal Democrats would thus do less damage than the 50% rate. And on both sides of the Atlantic there is room to narrow the gap between tax rates on salaries and bonuses and those on dividends and capital gains. That gap explains why Mr Buffett, most of whose income comes from capital gains and dividends, has a lower average tax rate than his secretary. It is also the one hedge funders and private-equity people have exploited to keep the billions they rake in.
The above paragraph really looks at taxing the value of assets (a "mansion tax"), capital gains and dividends. I think there's a great danger in property taxes - it's very easy to tax someone beyond their ability to pay. An income tax does seem more equitable than a "mansion tax".

Taxing capital gains is a little complicated - on the one hand the gain is income, on the other it's probably not appropriate to tax it at the tax payer's full marginal rate unless there's an offset for the impact of inflation. That's why, in Australia, we only pay 50% of our marginal rate if the asset has been held for more than 12 months. There's also the Laffer Curve to consider as detailed in last year's The Register article Bloody George's Budget: How bad is it really?.

There are several options for taxing income from dividends. Treat them as normal income and tax them accordingly, recognise that tax has already been paid and so tax them at a lower rate, or implement dividend imputation. As a share holder I do prefer the latter and it does seem equitable.

The Economist also suggests removing corporate taxes. This to my mind, would be a mistake. A superficial argument can be made that corporate income would be taxed when it's paid as dividends. However, this ignores certain realities:
  • Not all companies pay dividends
  • Not all dividends are paid to shareholders in the country where the income is earned
  • There would be additional incentive for people, especially higher income earners, to use corporate vehicles to avoid tax
In summary, I think the article in The Economist is interesting, but I don't necessarily agree with some of the solutions they put forward.

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