Tax Reform for a Fairer, More Vibrant Economy

Lok Sang Ho, Tianle Zhang
2016 Modern Economy  
The paper reviews the recent literature on tax reform, and recommends abolishing the profits tax and treating personal incomes from all sources as taxable, including capital gains and dividends. Abolition of the profits tax will vastly improve the investment environment and eliminate wasteful distortions. We also offer an intermediate "gradualist" approach involving halving the profit tax rate and taxing half of dividends and capital gains. We augmented a model proposed by Chetty and Saez [1]
more » ... etty and Saez [1] to incorporate the effects of manager effort for investment and showed the strong adverse effect of the profit tax on investment. Given that successive increments in total personal incomes from all sources are typically characterized by increasing intensity in economic rent, a progressive tax structure with high marginal tax rates at the top and wide tax bands is not only more equitable, but can be justified on efficiency grounds. ogy making transactions on the internet increasingly popular, tax revenues from profits taxes are dwindling even without the various allowances introduced by politicians favoring particular industries and particular activities. 2 Raising revenues from the profits tax has become an increasingly daunting task, while tax evasion is distorting activities and causing deadweight loss for society. In order not to lose the tax base altogether, and in order to boost economic activities, most countries have been aggressively cutting the tax rate. For example, despite proclamation to adhere to fiscal austerity, UK Finance Minister George Osborne cut the corporation tax rate another percentage point to 20 percent effective April 1 2015, and promised further cuts, down from 28 percent when the coalition government came to power. While profit tax rates keep falling, penalties for tax avoidance by big corporations have become quite rare. Indeed, David Gauke, the UK tax minister, "is able to declare without a hint of a blush" that such leniency "is as important to tax competitiveness as the tax we set". 3 Citing OECD studies, the report Paying Taxes 2014: the Global Pictures, observed that the "profits tax is the least growth friendly type of tax ..." 4 If the profits tax hurts investment, replacing it with alternative taxes that focus more on "rent-intensive" incomes should spark off an increase in investment and employment opportunities. This paper attempts to tackle the question of how to do this. Section 2 reviews some recent evidence that suggests abolishing the corporate profit tax will improve both efficiency and equity, and removes the objection against taxing dividends on account of double taxation. While there is an argument that a tax on dividend can undermine the quality of investment, there is no evidence from total factor productivity data that the American economy had benefited from President Bush's generous dividend tax cut, which had cost an estimated $100 billion revenue from 2003-2008. On the other hand, Desai and Goolsbee [3] noted that while this dividend cut had little, if any, impact on investment, the partial expensing of equipment provisions, at a revenue cost of approximately $130 billion from 2002-2003, which translates into a profit tax cut, did have a small positive effect on investment. Section 3 makes the observation that for each person, as personal incomes from all sources go up, typically the percentage of economic rent in each increment in income rises. Some evidence to this effect is presented. From this observation it is suggested that raising the top marginal tax rates need not affect incentives on effort, provided that they apply to increases in income that are on top of already very high incomes. Since people with higher incomes (from all sources) tend to earn proportionately more economic rent than people with lower incomes, widening tax bands and increasing progressivity will have positive effects on working incentives for workers and little behavioral effects on rent-earners. Section 4 presents a tax calculation for revising tax bands and tax rates and examines implications on behavior and on efficiency, and possible needs for tax harmonization. Section 5 considers the question of progressive income tax versus progressive consumption tax, and whether taxing consumption is superior to taxing incomes. Section 6 concludes the paper, making some additional remarks on taxes on environmental disruption and on diamond goods.
doi:10.4236/me.2016.78092 fatcat:e7j7brlqyrax3eagbjgl5hewl4