Society and Economics
Issue of Taxation

Taxing the wealthy: Differences at the margins ... More governments are raising taxes for the rich

COMMENTARY
What is the purpose of taxation? If this question is ignored, then the
Peter Burgess

Taxing the wealthy: Differences at the margins ... More governments are raising taxes for the rich

IMAGE Wealth of reform: Occupy Wall Street protesters call on America's richest 1 per cent to bear a greater share of the fiscal burden

Peter Norvig, Google’s director of research, made his fortune in Silicon Valley during one of the greatest eras of wealth creation the world has seen. The sheer thrill of building businesses made him sceptical about the oft-cited link between lower taxes and entrepreneurialism. “The rhetoric didn’t ring true,” he says. “I know a lot of millionaires and a dozen billionaires. They never said that marginal tax rates were too high.” Such doubts about increasingly pre­valent American anti-tax rhetoric are one reason he has decided to speak up in favour of greater taxation. He is one of about 200 members of Patriotic Millionaires for Fiscal Strength, a group formed last year to lobby for the expiry of cuts, introduced in 2001 by President George W. Bush, for people earning more than $1m a year.

The sight of wealthy citizens calling on government to raise their taxes has been met with both bemusement and cynicism. However, to proponents of more progressive taxation – the higher the income, the higher the rate – it is evidence of what some analysts consider a turning point in a long-running trend. After 25 years in which top rates have fallen, defining an era of market-driven economic policy, a growing number of countries are now moving to push them up. From London to Luxembourg, Milan to Madrid, the rich – particularly those in western European countries beset by soaring public debt – are braced to pay more.

But it is not yet clear whether the latest rises are anything more than a blip. For the moment their significance is mainly symbolic. In its latest assessment of taxation trends, the European Commission says that, while increases in top personal rates represent “an important political signal”, their revenue-raising effects are limited.

Still, for many of those involved in Occupy Wall Street and similar protest movements around the world, a move towards higher taxes on the wealthy is a necessary response to an era of growing inequality, which by many measures is now greater than at any time since the 1920s. Their claims have resonated with some commentators. “This is the beginning of change long overdue,” says Jeffrey Sachs, the Columbia University economist, who used a recent visit to the Wall Street protesters to call on America’s richest 1 per cent to pay their dues.

For western governments, political debate is dominated by talk of widening income gaps, unpopular austerity measures and the plight of the “squeezed middle” buffeted by high inflation and stagnant incomes. Asking the rich to do more is, many observers think, a reasonable response. Even some of those potentially on the receiving end agree. Maurice Lévy, chairman and chief executive of the French advertising company Publicis, wrote in the Financial Times in August that it was “only fair that the most privileged members of our society should take up a heavier share of this national burden”.

“To judge by the rhetoric, we are moving into the age of fairness,” says Catherine Tillotson of Scorpio Partnership, a UK-based wealth management consultancy that advises banks and fund managers as well as individuals. But, pointing to the large share of income tax paid by a small minority of taxpayers, she adds: “Fairness is a two-way thing. We hear a lot from politicians about this but how do the people paying the tax get their voices heard?”

In the US, that does not appear to be much of a problem. A fightback is already under way on behalf of rich but reluctant taxpayers. When Barack Obama, president, last month proposed a “Buffett rule” – under which no household making more than $1m annually would pay a smaller share of its income in taxes than middle-class families pay – he was branded a class warrior. Named after Warren Buffett, the veteran investor who has repeatedly drawn attention to this perceived inequity, this proposal would affect a quarter of US millionaires, congressional researchers said earlier this month. Mr Obama’s move is widely seen as an attempt to define battle lines ahead of next year’s presidential election, in which tax reform is set to be a dominant issue for Republicans and Democrats alike.

But many of the highest earners reject the idea they are undertaxed. Harvey Golub, a former chairman and chief executive of American Express, lambasted “the unfair way taxes are collected”. He noted in an article in The Wall Street Journal that almost half of all filers paid no income taxes at all, and that the “the extraordinarily complex tax code is replete with favours to various interest groups and industries”. He also aired another commonly voiced objection, namely that government spending is inefficient and ineffective.

Beyond the charged rhetoric, there is a growing body of economic data that raises questions about the efficacy of raising rates. Sceptics point to empirical research suggesting that higher income taxes are bad for growth. A growth-oriented tax reform would shift part of the tax burden from income to consumption and residential property, according to the Paris-based Organisation for Economic Co-operation and Development. Jeffrey Owens, the OECD’s most senior tax official, says: “Just pushing up rates affects incentives to save, work and take risks.”

Proponents of lower tax rates for the rich often point to the experience of the past 30 years when countries across the world – led by the US and Britain – cut top tax rates. In the UK, for example, top marginal rates for the highest sliver of income were cut from 83 per cent in 1979 to 40 per cent in 1988. The cuts have been associated with a huge rise in the share of in­come tax paid by the rich. For example, the top 1 per cent of US taxpayers paid 40 per cent of income tax in 2007, up from 28 per cent in 1988.

However, the causes of this dramatic rise in the tax take remain unclear and have become fertile ground for heated arguments among economists. Early research suggested it could be ascribed to the tax cuts inspiring people to work harder and put less effort into avoiding tax. But some economists argue that the cuts gave windfalls to those whose in­comes were already rising sharply because of factors such as disproportionate pay rises for top earners.

Evidence about how people respond to tax changes is relatively sparse. In Britain, 20 high-profile economists recently warned that the 50p rate for incomes more than £150,000 (introduced last year by the previous Labour government) was unhelpful in terms of attracting business people and entrepreneurs, but they could point to few examples to make their case. Nonetheless, many governments are convinced of the need to compete to attract and retain highly skilled workers. (US citizens, however, are taxed on a worldwide basis, making them less susceptible to incentives.) Fifteen industrialised countries – almost half of the OECD’s members – have introduced targeted concessions for high-skilled workers, according to a newly published OECD report.

Governments need to ensure that their tax systems compete on a global stage, according to KPMG, a professional services firm. The average top rate in western Europe of 45 per cent was increasingly being compared with Asia’s 23 per cent, it said. KPMG argued that “truly globally mobile international executives move around the world and tend not to stay in the one region. They are not weighing up London against Dublin or Geneva but looking at Hong Kong, Singapore, Dubai, all around the globe.”

Competitive pressures will ensure that top rates stabilise or even fall, according to the OECD’s Mr Owens. Instead of pushing them up, he says, governments should focus on collecting the tax they are due. Concentrating on better compliance will help make the system fairer because, for example, it is usually the wealthy who hide money offshore.

Piling on certain types of tax – those that address inequality but do not damage growth – could also play a part in convincing the public that the tax system is fair. Property taxes and inheritance taxes are the most suitable. For example, says Mr Owens, “Japan is the least unequal industrialised economy because it has an effective inheritance tax.”

This idea is unlikely to go down well with rich individuals, according to Stephanie Jarrett, head of Baker & McKenzie’s Wealth Management Practice Group in Geneva. “In my experience, high net worth individuals don’t like paying capital taxes, such as inheritance taxes and wealth taxes,” she says. “Their feeling is: ‘You have made your money, you have already been taxed and you are being taxed again and again’.”

But they are unlikely to be the hardest hit, she says. “The more seriously wealthy are not going to be so affected. It is those in the middle, moderately wealthy and less flexible, who are going to be hardest hit because they have a greater percentage of their wealth tied up in property.”

The widespread perception that sophisticated taxpayers can use myriad concessions and exemptions to minimise their bills has coloured every aspect of the debate about taxing the rich. There are mutterings among the peers of the wealthy folk speaking out in favour of higher taxes that some of their portfolios are structured in a way that would be immune to rate rises. “There is a feeling that publicity-seeking millionaires here and there are riding on the coat-tails of Warren Buffett, some of whom know that it’s cheap talk for them since they are protected against ‘regular’ tax at home – and so anyone who speaks out is now regarded with a high degree of cynicism,” says one critic.

But in the US, the Patriotic Millionaires for Fiscal Strength brush off accusations of bad faith. Increasing taxes on the richest 1 per cent would make a “significant contribution to deficit reduction”, they say.

For Mr Norvig, the desire to pay more tax is an acknowledgement that his own achievements were built on the back of government investment in education, infrastructure and the internet. In his view, the continued deferral of investment could jeopardise the chances of the next generation. “I see a lot of things in our country and our state that need fixing,” he says.

In recent weeks, plans for new levies for the highest earners have come thick and fast. France has announced a temporary 4 per cent surtax (levied in addition to other taxes) on incomes of more than €500,000; and Japan plans a similar measure to help tackle damage wreaked by the March tsunami. President Barack Obama has proposed a rule ensuring no US household making more than $1m pays a lower average rate than “middle-class” families. Italy has debated a “wealth tax”; Spain plans to reintroduce its own, just three years after it was dropped.

Even Switzerland, known as a refuge for the wealthy, is joining in. Last month Schaffhausen voted to become only the second canton – after Zurich in 2009 – to scrap lump-sum levies offered to foreign residents.

The flurry follows an average rise of 0.4 per cent in the top rate of income tax in 2010, when about one in three countries changed their rates, according to KPMG, a professional services firm. Among the sharpest was a 10 percentage point increase in the UK, where rates rose to 50 per cent on earnings of more than £150,000 a year.

But this year there have been cuts, too. Indeed, a KPMG global survey published in September showed the average top income tax rate has fallen by 0.3 per cent. Notably, Hungary slashed its top rate from 40 to 16 per cent, adopting a flat rate to try to revive the economy and curb evasion. Top rates still look modest compared with previous eras. Following the second world war, Americans faced a rate of more than 90 per cent on income more than $200,000. The UK’s 95 per cent rate inspired the Beatles to sing: “Should 5 per cent appear too small, be thankful I don’t take it all.” In 1967, a UK investment surcharge created a top rate of more than 136 per cent. Yet these rates were accompanied by loopholes that undermined the fairness and efficiency of the system.

The trend for creating new brackets for top-rate taxpayers also pales by comparison with the past. In the 1930s, the US had more than 50 brackets, with a diminishing number of occupants towards the top of the income scale. One bracket established in 1935 – nicknamed the “soak the rich” act by opponents – applied to income of more than $5m. It had just one taxpayer: John D. Rockefeller Jr.

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