How to stick it to the 1% (if you absolutely must)

Posted on July 29, 2016 in Equality Debates – FP/FP Comment
July 27, 2016.   William Watson

In 2008, the OECD published an influential report called “Tax and Economic Growth.” After an extensive summary of the latest economic research on taxation, it concluded that the worst taxes in terms of discouraging growth were, in order of damage done: corporate taxes, as most damaging, followed by personal income taxes, consumption taxes, and, finally, “recurrent taxes on immovable property” (for instance, land taxes). The supply of land doesn’t change much (except when the Dutch build dikes) so taxes on land have minimal effect on behaviour, unlike taxes on work, buying, incorporating and so on, which can discourage all those good things.

In most countries, the big problem since 2008 has been an absence of economic growth, so you’d think a tax system friendly to growth would be even more important now than it was pre-crash. Unfortunately, rich countries’ political systems have decided the real problem today isn’t so much slow growth as the fact that what growth there is allegedly isn’t shared correctly. So the OECD has just come out with a new report that updates the 2008 report and changes its emphasis. Now the OECD is interested in “Tax Design for Inclusive Economic Growth.”

As the new report itself says, “Social preferences for redistribution vary over time within countries.” And how! These days not many western electorates are receptive to arguments for lower corporate taxes and higher consumption taxes, even if that policy would boost growth. The clamour for higher tax rates at the top end of the income distribution is all but deafening. So the new focus on “inclusive growth” is understandable, if disappointing.

Fortunately, the four OECD economists who wrote the report tend with some exceptions to stick to the discipline’s guns regarding economic efficiency. Though it will disappoint Sanderistas and other anti-one-percenters to read this, they write, “Evidence shows that low-skilled and low-income workers, second earners (who are often women), and high-income earners tend to be highly responsive to financial incentives…”

Low-skilled and low-income workers get hit by high tax rates when social programs designed to help them, including things like the U.S. earned income tax credit or Canada’s working income tax benefit, begin to get clawed back as the workers’ income increases, in which case governments face difficult but unavoidable trade-offs between, on the one hand, making such programs generous and keeping the clawback rates low and, on the other, busting their budgets if, with fewer clawbacks, benefits extend into the upper reaches of the income scale.

Get rid of tax exceptions and you’ll distribute less to the rich
Where secondary workers are taxed as members of families and face high marginal tax rates even on small incomes, the report argues, the much-maligned option of income-splitting may help reduce their discouragement to work.

As for high marginal rates at the top end, they: “reduce incentives to work longer and/or harder when in the workforce … (and) to save and invest, (thus) negatively impacting the capital stock of the economy and … reducing growth.” They also “discourage entrepreneurship, innovation and human capital investment, and may be circumvented through tax avoidance and evasion particularly among higher income taxpayers.” Too bad this report didn’t come out before the first Trudeau budget raised top-end tax rates by four points. Not a devastating increase, perhaps, though in a world of tipping points you never know exactly where devastation will kick in.

What the report suggests instead is raising the average rate of taxation that rich people face without raising their marginal rates. How do you do that? By leaving the rate schedule unchanged but removing tax exemptions and deductions that richer people make disproportionate use of. In the U.S., for example, mortgage-interest deductions don’t make sense on efficiency grounds — why favour house purchases over other forms of saving? — and they benefit people who aren’t poor (assuming, that is, they benefit anyone currently declaring them: they may have long since been capitalized in house prices).

The same kind of thinking applies to consumption taxes. The report still thinks they’re efficient, even if in some countries (probably not ours, yet) they may have reached their useful limit. But in most countries, some types of consumption are exempt and many of the exemptions favour rich people. The report mentions, in particular, “reduced rates on restaurant food, hotel accommodation, books and cultural activities such as theatre and cinema.” Get rid of any and all exceptions and you make the tax more efficient, less redistributive toward rich people, easier to collect, and harder to avoid. To spare poor people from paying consumption taxes that would effectively be higher without exceptions, do what the GST tax credit does: Give them cash back to make up for taxes paid and income-test that transfer.

Since time immemorial the mantra of tax economists has been: Broaden the base, lower the rate. Doing so gives you the same tax revenues with less damage to growth. If these days you get a political bonus by first targeting exemptions that benefit society’s one per cent, and 10 per cent, and 40 per cent, all the better.

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