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Personal Tax Review

By Editorial
July 17, 2012

In the years preceding the onset of the financial crisis, personal income tax rates were, by and large, on the way down across the OECD member states. However, while some of these countries have managed to maintain, or in some cases modestly reduce, income tax for the low-paid, the highly-paid and the wealthy have become an easy target for governments in their search for revenue, and this has led to upwards pressure on top income tax rates. In this review, we summarise some of the most notable recent examples of this trend.

We start our round-up in the United States, where decisions about tax and spending have come to encapsulate the deepening enmity between the Democrats and Republicans over issues related to the economy, and how best to fix it. Ever since President Obama arrived in the White House he has made it clear that wealthy individuals and households should be prepared to pay a little more in tax so that the burden of closing the federal deficit does not fall disproportionately on those of more moderate means. The line in the sand that Obama has drawn is USD250,000 per year in income for households and USD200,000 for individuals, below which nobody, he says, should suffer an increase in income tax. Therefore, he argues, when the temporary income tax cuts enacted under President Bush expire on December 31, they should not be renewed for those with annual income above these amounts.

Obama has failed to get this policy onto the statute book however, because the Republicans vehemently oppose this proposed tax increase (or any tax increase for that matter). In large part this is because they fear the effect it could have on the many small businesses arranged as pass-through entities for tax purposes; and with the Democrats lacking a majority in the House of Representatives, unfortunately for Obama the Republicans currently hold all the legislative cards.

President Obama chose to focus on the ‘middle class tax cut’ debate, as it has become known, in his most recent Weekly Address from the White House, delivered on July 14, in another attempt to press home his case that tax cuts for the wealthy will not help the economy.

“Over the past couple weeks I’ve been talking with folks across the country about how we’re going to rebuild an economy where if you work hard, you and your family can get ahead. And right now, there’s a big debate going on in Washington over two fundamentally different paths we can take as a country to do that,” Obama observed.

“One path – pushed by Republicans in Congress and their nominee for President – says that the best way to create prosperity is to let it trickle down from the top.  They believe that if we spend trillions more on tax cuts for the wealthy, it’ll somehow create jobs – even if we have to pay for it by gutting education and training and by raising middle-class taxes. I think they’re wrong. We already tried it that way for most of the last decade, and it didn’t work.  We’re still paying for trillions of dollars in tax cuts that benefitted the wealthiest Americans more than anyone else; tax cuts that didn’t lead to the rise in wages and middle class jobs that we were promised; and that helped take us from record surpluses to record deficits,” the President remarked.

Under current policy, there are six taxable income brackets - 10%, 15%, 25%, 28%, 33% and 35%. The President’s proposal would let part of the 33% tax bracket and the entire 35% tax bracket rise to Clinton-era tax rates: 36% and 39.6%. Nothing in life, and especially in taxation, is so simple, however, and the Tax Foundation, in a new study, has pointed out the complications that would be caused by the President’s proposal. For example, it said: “The Bush tax cuts included much more than just marginal rate reductions - they also changed the way dividend income is taxed, reduced capital gains tax rates, and phased out various limitations on exemptions and deductions for upper income taxpayers.”

“Additionally,” it adds, “marginal tax rates apply to taxable income, while President Obama’s thresholds apply to adjusted gross income (AGI). Finally, the President first proposed those USD200,000/USD250,000 thresholds back in 2009; using the same numbers four years later in 2013 would cause this tax increase to affect significantly more taxpayers than initially intended because of inflation.”

In any case, with bipartisanship in short supply in Congress these days, Obama’s proposal stands little chance of becoming reality in the short-term, especially with November’s presidential elections looming large on the horizon, and it appears likely that lawmakers will end up rushing through a ‘tax extenders’ package, renewing several tax provisions due to expire at the end of this year, in the ‘lame duck’ session of Congress between the election and the start of the new Congress.

President Obama must wish he was in a similar position to Francois Hollande in France, who, having ousted the charismatic Nicolas Sarkozy from office in May, now has the backing of the National Assembly after elections in June produced a majority for the Socialist Party to which the new President belongs.

That the wealthy must pay for both the fiscal wreckage caused by the financial crisis and the maintenance of France’s welfare state was the mantra which got Hollande elected, and he has wasted little time in putting these policies into practice in this year’s second supplementary finance bill, published on July 4, which was recently waved through by the parliamentary finance committee. Key tax measures provided for in the bill include plans to: repeal the planned 1.6% rise in the 19.6% standard rate of value-added tax (social VAT); impose an exceptional contribution on wealth in 2012; subject to social contributions the property income of non-residents; increase the taxation of stock options; review the measure exempting overtime hours from social charges; impose a 3% tax on dividends distributed by companies with a turnover in excess of EUR250m; and increase social levies on income from capital by 2%. The government also wants to tax high salaries, likely those in excess of EUR1m per year, at the rate of 75%, but has chosen to delay this measure while it thinks how best to implement it without harming economic growth, while always ensuring that ‘fiscal justice’ is served.

While they stand quite far apart on the political spectrum, British Prime Minister David Cameron must be rubbing his hands at the thought that France could be contemplating such a punitive tax rate, and has already indicated that he would welcome with open arms those French entrepreneurs looking longingly over the English Channel at ‘low tax’ Britain. The inverted commas are needed here because the UK is really a ‘high tax’ country in comparison with places like Hong Kong or Cyprus for example; but taxes have traditionally been lower in the UK than in France, and the UK’s coalition government is seeking to restore the country’s reputation as a place friendly to business, having cut the controversial 50% top rate of tax at the last Budget in March. While only a 5% cut, and not due to come into force until 2013, it was probably the maximum that Chancellor George Osborne could extract from his Liberal Democrat coalition colleagues who were mostly hostile to the idea of ‘tax cuts for millionaires’. As a quid pro quo, Osborne introduced a sort of ‘mansion tax’, as demanded by the Lib Dems, with a new 7% top rate of stamp duty introduced on purchases of high value property (worth in excess of GBP2m) and a new 15% stamp duty imposed on real estate bought by ‘non-natural’ individuals and companies (also above GBP2m), in a bid to stop stamp duty avoidance by wealthy foreigners. It remains to be seen whether the Chancellor will dare cut the top rate further, given the fragility of the coalition.

If any country in Europe has had room to cut income tax recently it is Germany. With its economy relatively strong, there has been an unexpected tax revenue windfall for the federal government in the past year. However most of the main political parties, with the exception of the Free Democratic Party, which shares power with Chancellor Merkel’s Christian Democrats, seem quite reluctant to dish out any fiscal gifts at the moment. With Germany footing a substantial share of the bill for cleaning up the eurozone debt mess, this comes as no surprise. However, even the most moderate of tax cuts have been hard work.

In May, Germany’s coalition government failed to secure a majority for its EUR6bn (USD7.7bn) tax cut plans in the German Bundesrat, or upper house of parliament, despite predicted additional tax revenues of around EUR30bn by 2016, compared with the November 2011 tax estimate. As expected, Germany’s main opposition parties the Social Democrats and the Green Party firmly rejected the government’s latest bill aimed at alleviating ‘fiscal drift’(whereby tax brackets fail to keep pace with wage inflation, thus acting as an automatic tax increase), in the country’s income tax system, insisting that the tax cuts are diametrically opposed to budgetary consolidation, and would be simply “irresponsible” without measures to counter-finance the proposals, particularly given the debt brake rule enshrined in basic law.

Adopted by the German Bundestag, or lower house of parliament, at the beginning of April, the coalition’s tax cut bill provides for a progressive rise in the personal income tax allowance by a total of EUR350, or 4.4%, by 2014, to be achieved in two stages: by EUR126 (rising to EUR8,130) from January 1, 2013, and by a further EUR224 (rising to EUR8,354) from January 1, 2014. In accordance with the bill, income tax bands in German will also rise by a total of 4.4%. The ‘black-yellow’ coalition hopes to salvage its tax cut proposals by submitting the bill to a mediation committee for examination.

There is hardly a country in Europe which has not felt the impact of the credit crunch and the Eurozone sovereign debt crisis, and, having slashed taxes in the 1990s and 2000s, the former Eastern-bloc countries have found themselves particularly vulnerable. So having successfully forged ahead with ‘flat taxes’ on income to the applause of liberal economists in the West, some of the region’s governments are now considering un-flattening their tax regimes in a bid to raise more in revenue – although a desire to punish the rich through more progressive taxation is also playing its part in the process.

Slovakia is one country which has taken a decisive step towards terminating its experiment with a flat tax. Following weeks of debate, in May the Slovakian parliament adopted by 82 votes to 53 the government’s austerity programme, designed to reduce the budget deficit from 4.8% currently to below 3% of gross domestic product (GDP) in 2013, and containing plans to increase taxes on the rich and on banks as well as providing for savings of around EUR1.5bn (USD1.9bn). Within the framework of its austerity programme, the government has announced its intention to 'unflatten' the 19% flat income tax by introducing a higher rate of 22% for high earning companies and a 25% higher rate for individuals earning more than EUR33,000 per year, to ensure that the fiscal burden is increased on both top income earners in Slovakia and companies realizing large profits.

Perhaps ‘flat taxes’ could also appear on the endangered list in Switzerland, where voters have approved plans to scrap or increase these special taxes which are designed to attract wealthy foreigners. During recent federal and cantonal votes, canton Appenzell Ausserrhoden in the north of Switzerland voted in favour of abolishing the flat rate of tax currently benefiting tax exiles - the third canton after Zurich and Schaffhausen to abolish the longstanding tradition, which was introduced in the Swiss canton of Vaud in 1862. In contrast, although again clear evidence that the tax perk is becoming increasingly unpopular among the Swiss population, voters in the canton of Lucerne voted in favour of plans to tighten the system, by increasing the amount of tax paid by wealthy foreigners domiciled in the region to seven times the presumed rental value of their houses and to insist on a minimum taxable income of CHF600,000 (USD650,000, EUR500,000). The news follows hot on the heels of the Swiss Council of State’s decision to back a bill maintaining, although increasing, the minimum flat tax rates.

Switzerland’s flat, or lump sum, tax basis is currently accorded to wealthy foreigners provided that they are not gainfully employed in the Confederation. The tax is based on the cost of living rather than the individual’s wealth or income, making the benefit a highly attractive proposition. Such taxes benefit a relatively small number of people however; currently twenty-two wealthy foreigners in Appenzell avail of the tax perk, which generated CHF1.5m in tax revenues in 2010, corresponding to 0.53% of the total communal and cantonal tax revenues (CHF284m). Around 160 foreigners currently benefit from the flat tax in Lucerne, and over 5,000 nationally. Proponents of the tax argue that the special regime serves to generate around CHF668m in direct taxes (federal, cantonal and municipal), and around CHF300m in value-added tax (VAT).

There are ways in which governments can give a tax cut without lowering rates, and often these types of tax reductions can be equally as effective than lowering rates, if not more so. Adjusting tax brackets upwards is one way, as the German government is attempting to do. Another is by increasing the individual tax-free allowance, thereby raising the income threshold at which tax becomes payable. The UK is currently in the process of raising the tax allowance by around GBP3,000 to GBP10,000 in stages, which, it is said, will lift millions of low-paid workers out of paying income tax altogether.

Australia has also chosen to go down this path, and is using money raised by a new tax on coal and iron ore mining firms to pay for a dramatic increase in the personal tax allowance. The changes, described by the government as "landmark" reforms, entered into force on July 1, and on that date, the personal tax-free threshold rose from AUD6,000 (USD6,160) to AUD18,200 - the largest rise in the history of the threshold. The increase means that 7m low- and middle-income earners will receive a tax cut, with more than 6m of these workers benefiting to the tune of more than AUD300. Around 1m will no longer have to lodge a tax return, as they will have been lifted out of income tax altogether – a not insubstantial number of people in a country with a population of just over 20 million.

By exploiting the mining boom and taxing large mineral extraction companies, Australia has avoided raising taxes on higher incomes in order to finance government spending. Other countries are also increasing a range of different taxes, especially indirect taxes like sales and consumptions taxes, to avoid steep rises in income tax. However, in the current economic climate, where the financial and tax affairs of the wealthy are coming under more public scrutiny, it has become not just fiscally necessary, but politically expedient, for governments to raise more in tax from those at the top, and this is not about to change.


Tags: United States | small business | gross domestic product (GDP) | Hong Kong | education | artisans | Cyprus | mining | law | business | budget | inflation | Australia | Switzerland | Slovakia | stamp duty | Germany | France | individuals | tax rates | tax



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