Taxing Capital Income: Problems and Possibilities

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Taxing Capital Income Problems and
Possibilities

• Richard Bird
• University of Toronto

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A Lifetime View of Income Taxation

• ChildhoodSchedular taxation
• YouthHaig-Simons Comprehensive Income Tax Model
• Maturity.Consumption vs. Income Tax Debate with
  a Flat Tax Variant
• Old ageSchedular taxation?

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Comprehensive ProgressiveIncome Tax

• Comprehensivenesshorizontal equity treats
  capital and labor income equally
• Progressivityvertical equity requires taxing
  income at progressive rates
• Efficiencyallocative efficiency of different
  types of capital income (elasticities of
  different types of capital vs. same marginal rate)

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Problems in Taxing Capital Income (1)

• The Administrators Problem(s)
• What measuring it (real, net)
• Where source, residence
• When accrued, realized, derivatives
• Who really benefits?
• Problems also arise both in distinguishing
  capital and labour income and in determining how
  it was earned

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Problems in Taxing Capital Income (2)

• The Economists Problem(s)
• effects on investment allocation
• effects on capital structure
• effects on saving
• Everybodys Problem tax arbitrage

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Many Solutions Floating Around

• Tax individuals, not business
• Keep headline CIT low
• Reform CGT to reduce lock-in
• Pay more attention to losses
• Dont be too kind to the dead
• Move to consumption tax
• Flat tax.

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The Income Tax Challenge in Todays World

• Maintain substantial revenue from income tax
• While reducing economic distortions from taxation
• Maintain horizontal equity and progressivity
• While avoiding massive movement of portfolio
  capital from domestic markets

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Somethings Got to Give

• Add international tax competition to the mix
• and.
• Sacrifice comprehensiveness?
• Sacrifice efficiency?
• Sacrifice progressivity?
• Or sacrifice competitiveness?

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World Trends

• Cut both CIT rate and PIT progressivity
• But no marked shift to consumption tax
• Integration? Yesand no
• Base broadening? Much talkaction?
• Restraining competition
• Ban the bad guys
• More interchanges among the good guys

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A Northern Star to Watch?The Dual Income Tax

• Maintain progressivity for labour income
• Flat rate on capital income (and CIT)
• But what rate?
• Top PIT?
• Bottom PIT?
• Achilles heel mixed income?
• Dual rate capital tax?

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Dual Income Tax Possible Advantages (1)

• Rationalize the taxation of portfolio capital
  income
• Reduce use of corporate tax incentives perhaps?
• Simplification of both individual and corporate
  taxes and administration
• Increased information reporting?
• Increased (provisional and final) withholding?

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Dual Income Tax Possible Advantages (2)

• And, some argue, perhaps even possible
  progressivity gains?
• Reduce tax on low income wage income
• Increase tax on higher income wage and capital
  income
• Possible revenue gains do capital income taxes
  yield revenue?

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Dual Income Tax Possible Disadvantages (1)

• The First Normative Question
• Taxing different types of income at
  different rates?
• But is this all that different from real
  current regime?
• The Second Normative Question
• The effect on progressivity?

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Dual Income Tax Possible Disadvantages (2)

• The First Practical Question
• Controlling arbitrage opportunities to convert
  labor into capital income
• The Second Practical Question Effects on
  revenue

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Dual Income Tax vs. Flat Tax

• If the world sets CIT at X (/- e), what is
  gained by having higher rate on labor income?
• Progressivity?
• Tax revenue?
• More flexibility in setting rates on capital
  income?
• What is lost by having higher tax on labor
  income?
• Arbitrage opportunities?
• Fairness?
• Progressivity?

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Dual Income Tax vs. Consumption Tax

• Labour income tax prepaid consumption tax?
• Why not skip the interim stage and go right to
  consumption tax?
• The Meade solution(s)revisited
• Countries, like people, are better off with a
  diversified portfolio
• Should the book of wealth taxation be re-opened?

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Dual income tax presents an interesting option

• How far away from it are we now?
• Possible gains
• Rationalizing current tax regimes for portfolio
  income and business income?
• Reducing reliance on tax incentives??
• Simplifying the tax system and improving
  compliance?
• Possible costs
• Arbitrage opportunities
• Uncertain revenue and progressivity consequences

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Finally Remember The Context

• International concerns no longer an add-on but a
  starting point
• To tax capital income must be able to tax
  cross-border flows
• To tax cross-border flows need to do so in
  concert with others to some extent
• Paradoxically, to exert national tax sovereignty
  effectively countries thus need to give it up to
  some extent
• May part of the deal be to go back to the
  future in the form of schedular taxation at
  uniform regional source withholding taxes on
  capital income?
• To be continued..