Thursday, June 17, 2010

Taxing the Rich

A reader of this blog, Chris, posed the following thoughtful question:

What do you think the implications would be if Canada were to implement more tax brackets? For example, if federal tax tiers were added at $200k and $300k with a federal rate of say 33% and 37% respectively?

I'm not sure why the government hasn't gone in this direction because the majority of voters are not anywhere near these levels. This would help redistribute the tax burden and work down more of the country's debt.

It's always tempting to tax the rich more. This idea isn’t new. In fact, back in 1963 Quebec's top marginal tax rate was over 93%!. This rate applied to income over $400,000 (the equivalent of about $2.9 million today).

Chris's proposal is certainly a lot less punitive, but it still represents a significant tax increase for wealthier people. However, the world is a much different place than it was in 1963. The wealthy have much more freedom for where they choose to live and where they produce their income. So, even if you believe in taxing the rich more, many of them have the ability to simply leave the country if they can find a better tax deal elsewhere. I don't know whether this exodus would be large enough to make a big difference, but it is something to keep in mind.

As an example of a wealthier person who chose where to live based on tax considerations, a former colleague of mine with a large number of stock options chose to live a few years in a country that didn't tax his stock option gains. Once he satisfied the rules for having been out of Canada long enough to avoid paying Canadian taxes on the income, he came back.

Another thing to consider is that people who are able to get themselves into a position to earn large incomes also tend to have the savvy to influence the political process. So, even if taxing the rich more is the right thing for the country, the wealthy people who would be affected are likely to mount an effective opposition to this change.

Deciding exactly how much to raise taxes on the rich without causing undesirable side effects is a difficult question that I can't answer.

7 comments:

  1. I believe the Beatles had a song called "Mr. Taxman", that outlined how much they had to pay in taxes in the UK, and thus explaining why they LEFT the UK.

    The rich are much harder to tax, because they can afford accountants to tell them how to get tax breaks, and they can afford alternate living arrangements in much nicer Tax havens too!

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  2. The counter-argument has been for years that lowering the tax rates may minimize tax losses to the underground economy and pushing up the tax brackets only encourages people to avoid taxes.

    The larger policy argument is what type of society do you want? If you want a society of entrepreneurs/self employed, you keep the tax code simple and taxes low (see Hong Kong). If you want a society of middle class employees, you have a progressive tax regime. It is one of those policy debates that is, sadly, missing right now.

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  3. We don't want to have a brain and capital drain; therefore it is a bad idea to punitively tax the rich.

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  4. This debate would not be as necessary if our fearless leaders spent existing tax revenues more efficiently.

    I'm afraid that, like most Canadians, I don't feel like I know enough about the details of how our money is spent to render an informed opinion on this debate. Maybe that's why we keep going in circles.

    Perhaps the best idea, as proposed here by TMW, would be to look at what works elsewhere and use it as a model. I think we would all appreciate more simplicity.

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  5. @Big Cajun Man: That's another good example of the mobility of the rich.

    @Thicken and @Dale: Good points. It is definitely counter-productive to heavily tax people in the private sector who create jobs. As evidence of the effect progressive tax rates, I find myself wondering why I bother to continue working in the later months of the year. Each dollar of income gets hit so hard that it's not worth my time. If I thought my employer would go for it I'd take 3 months additional vacation in trade for a 25% pay reduction.

    @Balance Junkie: I don't know what the answer is to using tax money more effectively. Every time I've had a chance to see org charts for a part of the government at any level (municipal, provincial, or federal) it seems to be obviously overloaded with administration. This means there are a bunch of well-meaning people working hard at the tasks assugned to them, but producing little of any consequence.

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  6. @Balance Junkie: the spending side of the argument is very important, but no matter how efficient we make government, there will still be the need to collect hundreds of billions in tax revenues, which leads us to consider (and argue) how best to go about that.

    Personally, I'm in favour of potentially making the income tax system a little more progressive by adding another bracket to the top end.

    Some rich people (and their assets) are obviously mobile, but T4 earners can't really escape. Although almost any tax regime will face the criticism of avoidance, whether it's income taxes (rich people moving) or sales taxes (smuggling, unreported cash sales).

    The theory behind progressive tax brackets is that you have more ability to pay at the higher end: you're "taxed" on your first bit of income by the daily necessities of life: food, shelter, clothing. As you make more and more, more of your income can go towards luxuries and savings, so you can better afford to pay taxes, and I think there is enough of a difference between say $250k and $127k to make it worthwhile adding another bracket to the system...

    Of course, there's a large array of ways for the government to raise money. We could instead add more sales taxes, especially for "luxury" items, or things that pollute; the dictum of "tax what you don't want." But it's a lot harder to smuggle in a car with say a 100% tax on it than perfume or designer bags... and carbon taxes are a good idea except when even poor people need to heat their homes... so it's also a hard dilemma to come to a balance point.

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  7. Thanks for discussing my question. When I was analyzing the question myself I imagined that most end of career rich folks would be leaving the country anyway (to avoid taxes), since that is what my business school tax teacher told us all to plan for at retirement.
    I agree with Potato that if you have the means to pay more, you should pay more to help out those that can not. I'm not worried about the people leaving, just the people working away everyday like me. I know everyone wants to get 'ahead' and gather up piles of money, but I can't see what the point is when you look at guys like Warren Buffett who amassed billions of dollars, only to give it all away in the end. Don't you think all that money could have helped some people along the way?
    Now don't get me wrong, I also strongly agree that the government needs to trim it's expenses and would love for the governments books to be open for all of us to see where all this money goes ... but that's just dreaming right? I'm sure McGuinty has our best interests at heart right? I guess we'll just have to trust his judgement .......................

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