Former US President Ronald Reagan said that the US tax system was “complicated, unfair, cluttered with gobbledygook and loopholes designed for those with the power and influence to hire high-priced legal and tax advisers”. Paul Solman of PBS News, looks at the US tax system in the video below and compares it to other countries. Even Paul Ryan, Speaker of the House states that the USA has the worst tax code in the industrialised world, bar none. T.R.Reid, author, “A Fine Mess” suggests that New Zealand is a model of good tax policy. “They have done what all the economists think is right, to get a tax code that is simple, fair and efficient”. He mentions the BBLR – broaden the base, lower the rates. You broaden the base by making everything taxable – health insurance, car park, pension contribution. By contrast Americans spend about six billion hours a year collecting the data and filling out the forms. They spend $10 billion to H&R Block and other preparers and, on top of that, $2 billion in tax preparation software, which still takes hours of work. Furthermore there are more than 400 additions to the tax code every year, and most of them are giveaways to one or two taxpayers. Of the 35 richest countries, in total tax burden, U.S. ranks 33rd. And in return, the US government spends less as a percentage of GDP than other governments.
What makes a good tax?
A new part of the AS Level Economics syllabus is Canons of Taxation. Adam Smith’s contribution to this part of economic theory is still regarded as classic. His enunciation of the canons of taxation has hardly been surpassed in clarity and simplicity. His four celebrated canons are as follows:—
- Canon of Equality. Equality here does not mean that all tax-payers should pay an equal amount. Equality here means equality or justice. It means that the broadest shoulders must bear the heaviest burden.
- Canon of Certainty. The individual should know exactly what, when and how he is to pay a tax. Otherwise, it causes unnecessary suffering. Similarly, the State should also know how much it will receive from a tax.
- Canon of Convenience. Obviously, there is no sense in fixing a time and method of payment which are not suitable. Land revenue in India is realized after the harvest has been collected. This is the time when the cultivators can conveniently pay.
- Canon of Economy. This means that the cost of collection should be as small as possible. If the bulk of the tax is spent on its collection, it will take much out of the people’s pockets but bring little into the State’s pocket. It is not a wise tax.
I recently read another piece from the New York Review of Books – a review by Thomas Piketty (‘Capital in the Twenty-first Century’ fame) of the new book ‘Inequality: What can be done?’ by Anthony Atkinson. He is innovative in his ideas and shows that alternatives still exist. He proposes the following:
- Universal family benefits by progressive taxation policies
- Guaranteed public sector jobs as a minimum wage for the unemployed
- Democratisation of access to property via an innovative national savings system with guaranteed returns for depositors
- Inheritance for all with a capital endowment at age18 financed by an estate tax
1908’s – UK and US income tax rate reductions
Atkinson does mention the reduction in income tax rates that were instigated by the Thatcher government. The top marginal rate was reduced to 40% – the rate was 83% when Thatcher’s conservative government first came to power in 1979. A conservative MP got quite excited by this and is reported to have said ‘he did not have enough zeroes on his calculator’ to measure the size of his tax cut that he helped to endorse. This break with a half-century of progressive tax policy in the UK was Thatcherism’s distinctive accomplishment. Across the Atlantic US President Ronald Reagan was also in a tax cutting mood and reduced the top marginal tax rate to 28%. Succeeding governments in the UK under Tony Blair (Labour) and in the US under Bill Clinton (Democrats) didn’t change the tax policy that was left by both the Conservatives and the Republicans respectively. This lowering of the top marginal income tax rates contributed to the increase in inequality since the 1980’s.
A more progressive tax rate
Atkinson proposes top rates of income tax in the UK of 55% for annual income above 100,000 and 65% for annual income above £200,000, as well as a hike in the cap on contributions to national insurance. This will allow for a significant expansion of the UK social security and income redistribution system – family benefits and unemployment benefits. According to Atkinson if these taxes were implemented the level of inequality would be reduced significantly.
New rights for those with fewest rights
Atkinson proposes include guaranteed minimum-wage public jobs for the unemployed, new rights for organized labour, public regulation of technological change, and democratisation of access to capital. Piketty alludes to two of Atkinson’s innovative suggestions:
- The establishment of a national savings program allowing each depositor to receive a guaranteed return on her capital. Given the drastic inequality of access to fair financial returns, particularly as a consequence of the scale of the investment with which one begins (a situation that has in all likelihood been aggravated by the financial deregulation of the last few decades), this proposal is particularly sound
- The establishment an “inheritance for all” program. This would take the form of a capital endowment assigned to each young citizen as he or she reached adulthood, at the age of eighteen. All such endowments would be financed by estate taxes and a more progressive tax structure. He calls for a far-reaching reform of the system of inheritance taxation, and especially for greater progressivity with regard to the larger estates. (He proposes an upper rate of 65 percent, as with the income tax.) These reforms would make it possible to finance a capital endowment on the order of £10,000 per young adult.
A Wealth Tax
He also proposes a progressive tax system on real estate and eventually on net wealth. Stamp duty, which is a tax on real estate transactions, would be implemented as follows:
- 0% tax if property worth less than 125,000
- 1% tax if property worth between £125,000 and £250,000
- 3% tax if property between £250,000 and £500,000
- 5% tax between one and two million pounds (a new rate introduced in 2011)
- 7% tax on properties worth more than two million pounds (introduced in 2012)
Many have called into question the financing of the British welfare state (especially the National Health Service) through taxes. This was seen as an unacceptable form of competition by those countries where the cost of the welfare state rested on employers. A substantial proportion of the British left at the time saw in Europe and its obsession with “pure and perfect” competition a force that was hostile to social justice and the politics of equality.
In order to assist growth higher taxes may seem illogical as they take money out of the circular flow. However developing countries on average collect only 13% of GDP in tax compared to 34% in developed countries. Public investment can encourage private investment and it is estimated that an $1 of public investment increases private investment by $2. At the recent UN conference in Addis Ababa there is a desire to increase the tax take of LDC’s to 20% of GDP.
Why do developing countries not collect much tax?
- most of the population have no money
- most developing countries have a prevalent informal economy
- because of the rural nature of LDC’s the cost of tax collection is often higher than the benefits
The World Bank has suggested improving the tax agencies and tax revenue in Rwanda has increased by 6.5 time after automating the process, which reduced errors and opportunities for fraud. There would be much more tax revenue if LDC’s reduced tax emption and avoidance, including from foreign investors. It is estimated that exemptions have cost developing countries $1bn in lost revenue in 2011 whilst the cost of multinational companies deliberately avoiding tax exceeds $200bn a year.
How multinationals avoid paying tax
The most common way multinationals avoid taxes is through “transfer pricing”, in which their subsidiaries in tax havens buy goods cheaply from arms in more exacting countries, and then sell them on at a higher price, thereby shifting profits to the tax haven. The OECD is trying to combat such schemes by persuading tax authorities to require firms to disclose where they generate their profits and share the disclosures. A proposal from 137 developing-world NGOs goes further, calling for the formation of an international tax agency, although it is unlikely to prosper.
Blatant tax dodging.
This is a major problem as undeclared money transfers, false invoices etc cost developing countries more than $990 bn in 2012 which equates to almost 4% of a developing countries’ GDP.
Source: The Economist 11th July 2015
Currently at AGS doing a 3 day AS revision course. Used this graphic to explain indirect taxes. An indirect tax will have the following effects on the market:
• The supply curve shifts vertically upwards(effectively a shift to the left) by the amount of the tax(gf) per unit. The price increases but not by the full amount of the tax. This is because of the slopes of the demand and supply curves.
• The consumer surplus is reduced from acp to agb. The portion gbhp of the old consumer surplus is transferred to government in the form of tax.
• The producer surplus is reduced from pce to fde. The portion phdf of the old producer surplus is transferred to the government in the form of tax.
• The market is no longer able to reach equilibrium, and there is a loss of allocative efficiency resulting in the deadweight lost shown by the area bcd. This represents a loss of both consumer surplus bhc and the producer surplus hcd that is removed from the market. The deadweight loss also represents a loss of welfare to an individual or group where that loss is not offset by a welfare gain to some other individual or group.
The New Zealand Parliamentary Library “Monthly Economic Review” published a feature on taxes and levies on petrol.
Taxes and levies on a litre of petrol in New Zealand account for approximately 43 percent of the overall price.
July 2014 – Retail price = 223.9 cents per litre
A forecast $1,702 million is expected to be raised through the excise duty on petroleum in the year ended June 2015. This includes:
– $936 million in petroleum excise duty on domestic production
– $766 million on petroleum imports.
The following diagram shows the taxes and levies on a litre of petrol (including GST).
After a year in operation the Danish government recently announced that it was to abolish its tax on saturated fats. The idea behind the Fat Tax was to increased the price of unhealthy foods and therefore reduce consumption and improve the health of the population. However in practical terms the tax was a nightmare to administer as it not only targeted chips, burgers, hot dogs etc but also high-end food including gourmet cheeses. According to some critics this was to the worst example of the nanny state. The Economist reported some of the problems:
* Bakers were concerned with fat content in their cakes.
* Pig farmers said their famous bacon would cost more than imports.
* Independent butchers complained that supermarkets could keep their meat prices down as they could spread the cost of the tax across other goods.
* The tax applied on meat was imposed by carcass not per cut, which meant higher prices for lean sirloin steak as well as fatty burgers.
* Before the tax was imposed there was significant hoarding especially in margarine, butter and cooking oil
However there was also a surge in cross border shopping and a study estimated that 48% of Danes had done shopping in Germany and Sweden – sugary drinks, beer, butter etc were no doubt high on the shopping list.
Robert Frank, author of the Economic Naturalist and The Darwin Economy, wrote a piece in the New York Times on the influence money has on determining the outcome of political decisions. Wealthy donors to political causes will want to make sure that policies implemented by the authorities will mean lower taxes for them and less regulation for their businesses. As their income goes up this will only increase the monetary contribution they can give to demand greater favours.
This invariably leads to greater inequality and eventually may become so acute that even those politicians who have large funding from the corporate sector won’t succeed against opponents who seek major reforms. However, lower tax rates can have both positive and negative impacts on wealthy donors:
Positive – lower taxes mean greater disposable income and more consumption in the private sector.
Negative – budget deficits and the reduced quality and quantity of public services e.g. roads, schools, hospitals etc.
Those on higher incomes have been insulated from the declining quality of public sector goods and services by being able to pay for the equivalent in the private sector – schools, hospitals etc. But with a declining middle class it might be harder to recruit productive workers in addition to a reduction in demand for goods and services. Furthermore there are consequences of poor public goods/services that cut across the inequality of income and affect everyone:
* poor roads, bridges and general infrastructure
* electricity shortages/ blackouts (remember ENRON in California)
* effects of reduced investment in nuclear power that could be detrimental to safety
Frank asks which country would be happier? As improvements to cars are quite costly above a certain value and can be viewed as only minor, most people think that the BMW drivers are better off, not to mention safer. Furthermore the BMW drivers are less likely to feel deprived as societies don’t often mingle.
Frank concludes by saying:
So if regulation promotes a safer, cleaner environment whose benefits exceed those broadly shared costs, everyone – even the business owner – is ahead in the long run.