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Personal Tax Review

By Editorial
April 23, 2013

In our last review of personal taxation we observed governments, anxious to appear to be taxing their subjects fairly, were by and large keeping lower rates of income tax on hold, while targeting high income individuals in their seemingly never-ending quest to raise the tax take. This trend, with few exceptions, has continued from 2012 into 2013.


According to KPMG’s most recent analysis of global personal tax rates (published in October 2012), income taxes on the world's highest earners have crept ever higher this year, rising by an average of 0.3% since the previous year’s review.

According to Brad Maxwell, a partner with KPMG's International Executive Services practice in Switzerland, the upward tick in personal tax rates during 2012 "is the result of a lack of economic recovery and increasing debt concerns".

“Many economies deemed it necessary to increase their highest rate of personal income tax through one of two approaches: either through the creation of new income tax rate bands for very high income earners, or through the introduction of temporary taxes to address immediate budgetary deficit concerns.” The most prominent examples of this pointed out in the survey are seen in the recent French and Spanish reforms, he said.

France’s reforms saw the introduction of two new tax rate bands for high income earners which has resulted in the top rate increasing from 41% to 45%. The rate increases are generally deemed as an ‘exceptional contribution’ which affects individuals reporting incomes of above EUR250,000 (USD324,000).

Meanwhile, Spain introduced its ‘complementary tax’ in January 2012 to help address its deficit. The tax applies to all taxpayers, and ranges from 0.75% to 7% depending on an individual’s income level. This effectively means that the rate of tax for individuals earning above EUR300,000 has risen from 45% to 52%. Spain has leaped in KPMG's rankings to having the third highest tax burden on earners, up from tenth last year.

Western Europe continues to have the highest personal tax rates of any sub-region globally (46.1%). Sweden leads the rankings of advanced nations with a combined effective top rate of 56.6%, followed by Denmark (55.4%) and the Netherlands (52%). The average rate for Eastern Europe (16.7%) is still less than half of that of other European sub regions, largely due to the prevalence of low flat tax initiatives. Poland and the Ukraine are notable for being the only two Eastern European countries of those surveyed to maintain a progressive tax band structure.

Asia was largely quiet on the rate change front. South Korea introduced an additional tax band with a 3% increase in an effort to target high earners as a source of additional revenue. Hong Kong and Singapore continue to offer very attractive personal income tax rates, and rates remained constant in the other Asian heavyweights (China, Japan and India) who have not altered their top rate of tax in the last ten years.

Top rates across North America remained relatively unchanged throughout the year, while Latin America has also kept top rates constant during 2012.

Since KPMG published its review, upward pressure on higher rates of tax has been maintained, although few changes have actually taken place.

Of note, the United States Congress passed a package of fiscal measures including tax hikes for high income households at the start of the year, and President Obama’s latest Budget asks for the wealthy to make an additional contribution to narrow the federal deficit.

In France, President Francois Hollande is still battling to force through his “super tax” on high incomes, while in Germany, the left-wing Social Democrat Party is agitating for a substantial increase in the top rate of tax as the general election approaches.

The United Kingdom stands alone as a country which has cut its top rate.

These developments and other recent news items of interest are outlined next.

A Small Victory For Obama

In the early hours of New Year’s Day, President Barack Obama, the Senate and the House of Representatives finally approved a deal that avoided the first step of the "fiscal cliff" that would have affected the United States from January 1, 2013. However, the President had to accept many compromises.

His previous position was that he would never sign an extension of the Bush tax cuts for those earning over USD250,000, but the agreement will now see income tax raised only on those individuals with annual earnings over USD400,000 and households earning over USD450,000. This means that the top two individual tax brackets rise from 33% and 35% to 36% and 39.6% for this group of taxpayers.

Tax rates on dividends and capital gains also were not increased as far as the Democrat Party had suggested. For individuals on incomes over USD400,000 and joint filers earning over USD450,000, these taxes rises to 20% from 15%, while the provisions ended by the Bush tax cuts of 2001, that phased out personal exemptions and deductions for the more wealthy, will be reinstated, beginning at USD250,000 for individuals and USD300,000 for couples.

Importantly, the annual Alternative Minimum Tax (AMT) patch has been renewed. Without it, the 26% AMT, or 28% on higher incomes, would have become payable by 33m taxpayers for tax year 2012 (with returns filed in the spring of 2013).

President Obama’s 2014 Budget, published last month after weeks of delay, calls for additional taxes on the wealthy.

As he has proposed before, the President would limit the value of itemized deductions for high-income households and introduce a "Buffett Rule." To raise up to USD530bn over ten years, the Budget would limit the value of deductions at a cap of 28%, below the two top income tax rates, while the Buffett Rule (which, by itself, would raise only USD53bn in ten years) would impose a 30% minimum effective federal tax rate on those with adjusted gross incomes above USD1m, although the rate would be phased in for those making between USD1m and USD2m.

In addition, managers of private equity, venture capital and hedge funds would begin to pay their marginal income tax rates on the portion of their income known as "carried interest."

It must be remembered that many of these proposals have been included in all of the President’s previous Budgets, none of which were agreed upon by Congress. Given that the Republicans are now more insistent that ever that new revenue should not figure in a deficit reduction plan after compromising on this issue in January, it looks very unlikely at present that these measures will come into force.

Hollande Sticking To His Guns

After the United States, the Government that is probably generating the most interest with its personal income tax plans is the French administration, which is trying to introduce some form of “super tax” on high income at a rate of 75%.

For now, the Government’s plans are somewhat up in the air after a decision against the proposed tax by the French Constitutional Court last year. In its ruling, the Court noted that article 12 of the 2013 budget, which institutes an exceptional solidarity contribution of 18% on income from activity in excess of EUR1m (taking the marginal rate of tax to 75%), is based on individual income. The Court pointed out that two fiscal households, benefiting from the same level of income from professional activity, could either be subject to the exceptional solidarity contribution or exempt from the levy, depending on the particular income distribution among taxpayers in the household. According to the Court, the government had not taken into consideration ability to pay, and therefore censured article 12 for breaching the principle of equality before public charges.

President Hollande was undaunted by this repudiation of a key element of his fiscal plans however, and in late March he unveiled the Government’s alternative plans, which essentially shifts the tax from individuals to businesses. That’s easy, then.

Hollande insisted that the measure is not designed "to punish" companies, but merely to ensure that corporations assume responsibility. Companies will therefore be subject to the 75% tax for remuneration paid out to top executives in excess of EUR1m (USD1.28m). The charge is to include all taxes and to apply for a period of two years.

Although the French President's remarks might come as somewhat of a shock announcement, the idea that companies should shoulder the contribution is not new, and was first put forward by French National Assembly budget rapporteur Christian Eckert.

Despite the Government’s apparent breakthrough in its plans to tax the country's highest earners, careful legal analysis must still be carried out. Many experts warn that companies will simply circumvent the levy using various loopholes in the tax system, for example by differing income from one year to the next.

Hollande may yet be foiled however. The French State Council (which performs an advisory and judicial function above the Government) is expected to recommend that the Government’s future super tax be limited to no more than 66.66%. The Council’s finance section is believed to have concluded that if the tax is any higher, it runs the risk of being deemed confiscatory and therefore rejected by the Constitutional Court.

The situation therefore remains uncertain. However, what is clear is that the individuals who will be subject to the tax will find ways to legally avoid it. One of these methods might be to decamp across the Channel and take up residence in London – indeed, anecdotal evidence suggests that there has been a steady trickle of French men and women moving to the UK, or considering such a move.

United Kingdom Bucks the Trend

Having studied the French situation, it is understandable that, despite being an electorally unpopular move, David Cameron’s British Government recently decided to cut the UK top rate of personal tax.

The UK was in fact ahead of France in this respect, with the outgoing Labour Government introducing a 50% rate of tax on incomes in excess of GBP150,000 in its final Budget in 2010. But even though it was designed to send the signal that everybody – rich and poor – was sharing in the pain of fiscal retrenchment, the 50% tax raised little in the way of new revenue. Indeed, although the evidence isn’t clear, it has been suggested that it actually led to a fall in tax revenue.

The 5% cut in the top rate was announced in the 2012 Budget and took effect in April this year. It was something of a compromise measure, designed to appease both the Left and the Right, but Osborne has found himself defending this measure on a regular basis.

In a recent speaking engagement, Osborne described the 50% rate as “a big con” and defended his decision to lower it by asserting that it was an “economic essential.” He compared the UK with France, where, he claimed, "job creation is down as people are leaving the country." According to Osborne, the 50% rate had discouraged enterprise and led to a fall in income tax revenue of "billions of pounds." 

Highlighting the failings of the 50% income tax rate, the Director General of the Institute of Economic Affairs Mark Littlewood recently called for the Government to alter personal income tax rates based on presumptive revenue yields, rather than headline rates, to create a more efficient tax system that better incentivizes work and enhances the UK's competitiveness.

Discussing individual income tax policy on the rich, in comments to the BBC's Radio 5, Littlewood said: "To my mind the question is what can you actually do to maximize the amount of money you get from very affluent people. The 50p rate brought in enormously less than we were told it was going to bring in – I think it was about GBP3bn – and we don't know what the disincentive effect [was]; how many people moved their money offshore... I think we'll probably find that the 45p rate will end up meaning that the rich - in total, in terms of pounds in - contribute more."

"Certainly we found in the past when we stuck up rates as high as 60%, I think it was even 98%, under the last Labour Governments but one, it just didn't bring any money in," he said. Recommending a change in approach from UK policy makers, Littlewood suggested that: "It's not the percentage you should look at, it's the cash through the gate."

"What the Government [is] doing right, at the bottom end of the scale, is to start to get the incentives right," he continued, referring to the Government's decision to significantly increase tax exempt thresholds to benefit lower earners in particular. "I think it's important that, whether you're a millionaire or a person looking for work, there are the right incentives facing them."

German Left to Bash the Rich

The Finance Ministry’s latest publication comparing the German tax system to its international competitors reveals the unsurprising truth that, despite its track record of economic growth, Germany is a high-tax economy with one of the highest tax burdens on top earners. However, this could be higher still if the opposition SPD has its way.

In its 2013-2017 Government program, setting out the party's tax manifesto, notably its wealth tax plans for the next legislative period, if elected, the SPD underlines its commitment to a "fair tax system" and stresses the importance of increasing tax revenues.

Generating additional income is to be achieved primarily by increasing the top rate of income tax, by abolishing a raft of existing tax shelters, and by raising taxes on wealth, the party explains. The SPD intends to increase the top rate of income tax from 42% currently to 49%, for individuals with taxable income in excess of EUR100,000, and from 45% to 49% for a married couple with income above EUR200,000.

The SPD says that it will increase wealth tax in Germany to a "reasonable level," to enable the federal states to increase investment in education, pointing out that the taxation of wealth in Germany is currently below the international average. The SPD nevertheless emphasizes the need to protect the middle class and family businesses, to guarantee that such companies remain in a position to amass own capital and to invest. Furthermore, the party pledges to introduce high tax-free allowances for private individuals, so that normal households are not affected by wealth tax.

The SPD plans to repeal certain inheritance tax breaks introduced by the black-yellow coalition Government, and to ensure in future that inheritance tax perks are more closely linked to long-term job preservation. The party is determined to guarantee that income from work is not taxed at a higher rate than income from capital.

Finally, the SPD aims to limit the tax-deductibility of executive pay, including bonuses and severance remuneration, to 50% of salaries exceeding EUR500,000. It also intends to abolish the VAT perk currently benefiting hoteliers in Germany.

Although Germany is shouldering a large share of the burden of supporting the Greek and other moribund EU economies, in revenue terms the Government has been showered in cash recently. It is therefore debatable whether the SPD really needs to raise taxes. Indeed, the French and British experiences in this area suggest that such a move could ultimately be counter-productive.

Anyway, don’t move back to France just yet; there seems zero chance that the SPD will gain power.

Conscientious Canadians

In the 2013 Budget, Finance Minister Jim Flaherty left individual income tax rates on hold for another year. In fact, for many taxpayers, Budget 2013 was a rather dull affair. However, we choose Canada to end this piece on a little bit of a high note. And this is not because Canadian taxpayers have been spared from a Budget full of bad news, but to show that taxpayers aren’t all feverishly attempting to dodge their taxes, as tax authorities so readily assume.

According to a recent study by the Bank of Montreal Financial Group, "Canadians are conscientious and responsible with their taxes."

94% of Canadians say that they file a personal income tax return each and every year, according to the results of a new survey and more than CAD119bn (USD117.3bn) in federal income tax was paid in the last financial year. Almost half of the 1,002 surveyed last month claimed that they preferred to prepare their own returns, while 35% said that they will be using tax software to file this year.

Commenting on the results, John Waters, Vice President, Head of Tax & Estate Planning, said: "It's commendable that the overwhelming majority of Canadians are doing the responsible thing and filing annually. It's not only the responsible thing to do, but also the smart option given the penalties that you can incur should you owe money and don't file."

Such levels of conscientiousness cannot be limited to Canada however, and conducting a similar survey internationally would likely bring up similar results in many other countries. A shame then that so often we feel browbeaten into paying taxes. Perhaps the answer is to reward the taxpayer for his or her diligence, rather than wield the big stick as many Governments and mainstream political parties are so willing to do.


Tags: tax | individuals | tax rates | Germany | France | budget | United States | interest | business | individual income tax | Spain | United Kingdom | inheritance tax | Canada | Finance | Denmark | venture capital | offshore | Hong Kong | India | Japan



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