Sunday, 17 July 2016

Why more taxes on the rich may be a dead end

The debate about inequality has reignited the discussion on taxes. The picture emerging from any analysis of tax revenues is a stark one indeed. Essentially there are two disparities that stand out. The first is the widening gap between the taxes paid by small and medium sized enterprises and those paid by multi-national companies. Figures for the US illustrate this point well. The effective tax rate multinational companies in the US paid on their profits has been 24 percent in 2015 (The Economist, 9th July 2016), yet the official tax rate stands at 39 percent. This means that small enterprises which do not have the advantages of being able to move their profits into low tax havens or to use tax loopholes to shield their profits from tax are effectively paying a higher rate on their profits than the largest top 50 firms.

The second area which contributes to a sense of injustice in tax matters is personal income tax. This debate has been galvanised by the revelations about the superrich hiding their assets in tax havens through tax avoidance or tax evasion, depriving governments of legitimate tax income. So far, the UK government has tried to tackle the disparities in the tax system by taking people at the bottom of the income scale out of tax altogether, raising the income tax allowance.

Whilst reducing the tax burden of the poorest is welcome there are signs that the increasing income and wealth gap creates some limits on what can be achieved through tax policy on its own. The danger is that lowering the reliance of the government's income tax base on tax payers at the bottom of the scale whilst increasing its reliance on top tax payers creates unacceptable volatility in tax revenues in the long term. Take the example of California. On paper, income tax policy in the sunshine state is one of the most radical in the West. The rate of income tax stands at 13.5 percent (on top of federal levy of 39.6 percent). That makes income tax levels in California one of the highest in the Western world, something to be celebrated in the books of campaigners for equality.

However, it also means that about 45 percent of all income tax revenues are now coming from a very small number of superrich people who happen to have their tax base in California. The top 1 percent of tax payers pay almost half of all income tax in the state. Since other taxes are subject to strict regulation and cannot be changed easily, California's lawmakers have little room for manoeuvre when things go belly up. If only a few of the top 1 percent of tax payers decide to leave the state, this creates a considerable gap in the government's coffers rippling through to education and welfare policies with a vengeance.

High dependence levels on very few tax payers, whilst welcome in terms of creating more equitable levels of income, thus looks like a poor mechanism to create stable and effective government revenue streams, which in turn are essential for public services and infrastructure investment. Narrowing the tax base may therefore increase volatility at the expense of tax revenue certainty which is so important for long term strategies to tackle inequality. It seems the debate on how to best address inequality needs a few more ideas.

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