On 20 July 2016 the OECD Centre for Tax Policy and Administration issued a taxation working paper entitled Tax Design for Inclusive Economic Growth. This looks at the design features of tax systems and looks at how they can be strengthened to allow them to support inclusive economic growth.
The paper will be an important subject of discussion at the ministerial-level G20 Tax Symposium on 23 July 2016 that precedes the meeting of G20 Finance Ministers and Central Bank Governors on 23 and 24 July 2016.
A 2008 report by the OECD entitled Tax and Economic Growth looked at the effect of taxes on economic growth from the angle of efficiency. The current paper aims to make a new assessment of the policy recommendations taking into account considerations of equity to a greater extent. The study therefore takes into account developments in academic literature and tax policy to look at how the design aspects of each tax can be better tailored to achieve inclusive economic growth.
The study examines how the interaction of taxes with other factors in tax and non-tax policy areas impacts on the efficiency of the taxes and on the extent to which outcomes are equitable. The efficiency and equity implications of tax policies can only be assessed for example by looking at tax and benefits systems as a whole. The implementation of tax policy also needs to go together with implementation of international tax mechanisms to prevent tax evasion and tax avoidance.
Taxation of income from capital
The OECD study suggests that according to recent research the arguments in favor of reduced capital taxation are not as clear-cut as was previously supposed. An investment in physical or financial capital can be recovered when the underlying savings vehicle or asset is sold; but an investment in human capital loses its financial value when the worker leaves the labor force. The effect of optimal capital income taxes may be positive in certain situations.
In addition to this the increased international cooperation represented by the automatic exchange of financial account information in tax matters could make it possible to raise personal capital income taxes at a lower cost in efficiency. One of the main reasons why countries lowered the tax burden on capital income was the reduction of incentives for taxpayers to resort to tax evasion by using foreign savings accounts and not declaring the income in their residence country. The increased international cooperation in reporting of capital income and exchange of information will allow countries to better align taxes on capital and labor and this may allow them to reduce tax at the corporate level while increasing tax at the personal level.
One way to raise taxes on personal capital income could be to return to comprehensive income tax systems that jointly tax both labor and capital income at the personal level. However the study suggests that as certain savings vehicles such as pension savings and owner-occupied property might continue to benefit from tax relief this would increase tax-induced savings distortions.
The study considers that another possibility would be to broaden the capital income tax base and begin taxing capital income under a separate rate schedule at slightly progressive rates (a “Dual Progressive Income Tax”). The total household capital income including income from interest, shares, government bonds and indirect savings vehicles such as life insurance policies that are below a certain threshold could be exempt from tax or taxed at a low rate. Alternatively a normal return on savings (e.g. the risk free rate found by looking at interest on government bonds) could be exempt from capital income taxes at the personal level.
This reform could increase efficiency by encouraging savings and reducing tax related distortions in savings. At the same time progressivity of the tax could be increased. The top rates of personal income tax on labor and income could be aligned to prevent any incentive to shift labor income to capital income or the other way round for tax reasons.
Tax Policy Principles for Inclusive Economic Growth
The study mentions broadening tax bases as one of the principles for inclusive economic growth. This would involve ensuring there is a broad tax base with low tax rates and removing tax expenditures such as reliefs and allowances that are not well targeted towards redistributive goals. The social security base should also be broadened.
Capital and income from capital should be taxed in an efficient and equitable way. This should include introducing or strengthening progressivity and horizontal equity. The link between taxes paid and benefits received, viewed in the longer term across the lifecycle, should be strengthened. Adequate relief should be targeted towards the groups that lose out as a result of pro-growth tax reforms.
The study also recommends that tax behaviors and opportunities should be influenced by giving an incentive for agents in the informal economy to become part of the formal economy. The tax system should promote greater equality of market income and opportunity. Tax reform should align private and social costs and returns.
Tax policy design should be feasible and the tax administration should be enhanced for example by enhancing revenue collection; providing tax certainty; delivering high quality taxpayer services and increasing value for tax money. The tax administration should be able to tackle tax avoidance and evasion. Intergenerational and gender equity should be a part of tax policy design. The quality of tax statistics, data and tax policy indicators should be improved and there should be better analytical frameworks to assess tax policy.