Raising Taxes on High Income Earners

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Taxing high income earners is again on the global agenda.

French President Francois Hollande recently attempted to pass a 75% marginal tax rate for personal income over €1 million (approximately AU$1,287,000)1. The legislation failed after its implementation was deemed unconstitutional by a French court. The government did manage, however, to create an additional tax bracket on income earned after 1 January 2012. Previously, the top tax rate had been 41% for incomes over €70,831 (AU$91,209). The new bracket sits on top; those earning over €150,000 (AU$193,155) are taxed a 45% marginal rate. As a temporary measure, the government also implemented a temporary “exceptional contribution on high revenue”. Those on incomes above €500,000 (AU$643,850) pay the highest level of this tax, 4%, bringing their top marginal rate to 49%.

In fiscal cliff negotiations, the US government negotiated an extra tax bracket with a 4.6% higher rate than the former top bracket, raising the top marginal tax rate for income over US$400,000 (AU$381,880) to 39.6%.

Japan is also implementing a tax increase for high income earners, putting a package together that will see an additional 45% tax bracket added for those earning 40 million yen (AU$420,000) on top of the existing 40% bracket for those earning over 18 million yen (AU$188,937).

 Global top marginal tax rate comparisons

Country

Threshold in local currency

Threshold in $AU

Current/planned top marginal tax rate (%)

Australia

$180,001

$180,001

45

US

US$400,000

$381,886

39.6

UK

£150,000

$225,525

45

France

€500,000

$643,850

492

Germany

€260,731

$321,925

45

New Zealand

NZ$70,001

$55,942

33

Japan

¥40,000,000

$420,000

45

Singapore

S$320,000

$247,352

20

This rate does not take into consideration consumption taxes or  concessions that would be used to calculate an effective tax rate.

Israel passed legislation to increase taxes from 1 January 2013, implementing a 2% surcharge for those earning over NIS800,000 (AU$201,440), whose usual marginal rate was 48%.

Spain implemented a “complimentary tax” of up to 7% in January 2012 which raised the tax rate from 45% to 52% for those earning over €300,000 (AU$386,310). Portugal has introduced a temporary “special income tax” and “solidarity levy”, which increase the top marginal tax rate for those earning over €80,000 (AU$103,016) to 54.5%.

In Australia, the Greens believe our 45% marginal rate (not including the Medicare levy) should be increased by 5% for personal incomes over $1 million to fund increases in the NewStart allowance. Although there is little public discussion among major parties of raising personal income tax rates, concessions for the wealthy have been cut in recent times: the government means tested private health insurance, and now is threatening additional superannuation taxes.

The trend to extract taxes from high income earners unravels decisions made over the past decades to reduce top tax rates. According to the OECD Taxing Wages report released last year, the average top statutory personal income tax rate for the OECD decreased significantly from 1980 to 2010. In parallel, the average number of tax brackets and the income threshold for the top rate was reduced.

The KPMG Individual Income Tax and Social Security Rate Survey observed a similar pattern of decline, although it noted a rise in the average tax top rate in 2010, followed by another increase in 2012. KPMG attributed the rise to governments’ increasing debt concerns.

The question is whether further countries, including Australia, will follow the lead in this pendulum swing to higher tax rates for high income earners? If they do, is it the right thing to do in terms of equality and economic prosperity?

The Australian recently argued having a more progressive tax system was farcical, given Australian Tax Office statistics show the top 1% of taxpayers in the financial year ended 2010 pay about 17% of all income tax. The top 10% of taxpayers pay more than 45% of all income tax, while the bottom 35% of taxpayers pay about 5%.

Yet, during the decades of tax reduction, the share of income held by the top 1% of the US population has more than doubled, according to economic researchers Piketty and Saez, who were a major influence on US President Barack Obama. They noted that the trend had also occurred in other countries, especially English speaking ones. The researchers attributed much of this increase in inequality to lower taxes for the wealthy and went on to surmise that the optimal tax rate for high income earners would be above 50%.

Naturally there are economists who champion the contrary view, arguing first that governments have not always proven adept managers of wealth and second that higher tax rates do not always generate more revenue. As an illustration of the latter point, the UK recently cut its top tax rate from 50% to 45%, since the higher rate only generated a third of the revenue expected. According to Chancellor George Osborne, the tax hurt the economy and, due to tax avoidance, didn’t raise enough to justify it.

Aside from fostering tax avoidance, higher taxes can become a disincentive to work and discourage investment in employee education or new business in the country.

Taking such issues into consideration, Piketty and Saez estimated the revenue maximising top marginal tax rate would be 57%, which means countries like the US and Australia would have leeway to raise taxes, but not some European countries. However, they also stated there is no correlation between cuts in top tax rates and average annual real GDP-per-capital growth, pointing out that since the 1970s, countries with high marginal tax rates on personal income have not grown significantly slower than those with low marginal tax rates. This meant, in their judgement, that a country’s tax rate could be raised as high as 83% without killing growth.

As a counterpoint, Harvard’s Martin Feldstein argued in 2006 that deadweight losses from a US federal income tax rate increase would be $1.76 for every dollar of tax increase, meaning that a $1 billion government spending program would torpedo $1.76 billion of activities in the private sector.

Another researcher, Richard Burkhauser, questions whether the Pikkity and Saez work provides the whole picture on inequality, given the exemption of employee sponsored benefits such as health insurance and its use of tax units (individuals) rather than households, which might hold multiple tax units. Many have also scoffed at an idea of inequality that rests on the belief that as the rich get richer, they take away money from the poor, saying that it is not a zero sum game and high earners generate additional wealth through their own efforts.

This debate will continue as income becomes an increasing problem for governments struggling with the costs of funding their nation.


[1] All currency conversions carried out using rates as at 30 January 2013.

[2] Includes temporary exceptional contribution tax. When France’s debt is reduced, the top marginal tax rate will be 45% for incomes over €150,000.

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