Taxing the wealthy

Alok Ray | Updated on July 04, 2019

Taxes beyond a point can be counterproductive

Rising concentration of income and wealth has become a big popular concern in most countries. So much so that even in US, the citadel of capitalism, the major Democratic Party contestants for US Presidency have all come up with their respective proposals to address this problem.

The alternative proposals in US are a top tax rate of 70% on income above $10 million (proposed by Alexander Ocasio-Cortez) as against the current highest Federal income tax of 37% applicable to income above $5,00,000; a progressive annual wealth tax (proposed by Elizabeth Warren) at 2% on wealth above $50 million with a top tax rate of 3% on wealth above $1 billion as against no wealth tax at present; and an estate tax (imposed on the transfer of property upon death – nick named ‘death tax’) at the top rate of 77% (proposed by Bernie Sanders ) as against the current top rate of 40% on wealth above $1 million.

Some tax experts believe that all of these should constitute a comprehensive package. This is because the super rich, having control over the enterprises they own/ manage, can manipulate their income/wealth in ways to show a low current salary income which attracts higher tax rates and more capital income (like long term capital gains or dividends) where tax rates are much lower. In addition, by not selling some of their assets till their bequest, they avoid realizing capital gains and hence the capital gains tax while the wealth at death attracts a low rate of tax at present. In addition, by transferring wealth to a ‘charity’, the person may avoid the estate tax altogether.

To cite a glaring example, Jeff Bezos, the founder and CEO of Amazon and the richest American, had a meager salary income of $82,000 in 2017 but the valuation of his Amazon stock was $185 billion.

The opponents of the proposals argue that high marginal rates of taxation on income and wealth would produce adverse incentives to work which would reduce the overall size and growth of the national pie. According to the supporters, historically, much higher rates of taxes on income had existed in US which did not produce any adverse growth effects. Also, even now, there are several advanced industrial nations (like Canada, most Scandinavian countries) which have much

higher rates of taxes financing universal health care, subsidized higher education and better supply of public goods without any noticeable disincentive effects.

Theorists are also pointing to another hitherto neglected positive incentive effect of high rate of income tax on the rich, called ‘wage bargaining effect’. They argue that very high rate of income tax, by reducing the net benefit of earning marginal income by the rich, may induce them to be less resistant to the demand for wage increases by the ordinary workers. That way, it may open up another avenue for reducing inequality. Inheritance of large wealth may also produce disincentive to work in the recipient, justifying high rate of taxes on inheritance.

Most economists accept the existence of some kind of a ‘Laffer Curve’ which suggests that, as tax rates go up, initially tax revenue increases but eventually at some ‘very high’ rates of tax, tax collection begins to fall. For instance, 97% rate (the top tax rate, including surcharges, in Indira Gandhi’ s Budget of 1970-71) is generally regarded as ‘too high’ as tax payers in that bracket would either prefer not to earn extra income or make all kinds of efforts to evade paying taxes, including sending capital abroad or migrating to countries with lower taxes. That probably explains why Ocasio Cortez does not push the highest rate above 70% or the annual wealth tax rate proposed by Warren is kept between a modest 2 to 3%.

The situation has become particularly difficult in today’s globalized world where it has become so convenient for the rich to transfer wealth in tax havens like Cayman Islands, Bahamas, Bermuda, Singapore or Dubai. It is also easy for the rich to get foreign citizenship and settle in countries with low rates of tax by investing a certain amount of money there. Without international cooperation to dismantle this highly unethical global infrastructure for tax avoidance, newer tax havens are thriving even as Switzerland has lost its appeal (due to recent international agreements to share information on bank deposits of foreigners between Switzerland and other countries including USA and India).

Finally, however radical be the electoral promises on taxing the rich, these are sure to be diluted to some extent once the person becomes the President, as he/she will have to get approvals from both Houses of Congress.

[The author is a former Professor of Economics, IIM, Calcutta.

Published on July 04, 2019

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