Wednesday, January 02, 2013

Soaking the rich won't work

The decision by French actor Gerard Depardieu to flee to lower-taxing Belgium serves as a high-profile example of the folly of targeting the rich for additional taxation.

While the actor stated his reasons for moving were numerous, the 2012 election commitment of French President Francois Hollande to impose a ''temporary supertax'' of 75 per cent on individuals earning more than €1 million ($1.3 million) annually clearly figured in Depardieu's decision.

Although the French Constitutional Court has recently declared Hollande's 75 per cent rate tax unconstitutional, the French government has signalled its determination to persist with its tax policy, albeit in revised form.

The concerning aspect of the ''Depardieu Shrugged'' affair is that the French policy stance is hardly an isolated instance in the post-global financial crisis economic environment.

Numerous Western governments have already implemented, or are advocating, extra taxes on the wealthy as an apparent quick-fix to plug burgeoning budget deficits and runaway public debts created by years of excessive expenditure.

Eurozone countries such as Greece, Ireland, Italy, Portugal and Spain have joined France in raising top marginal income tax rates, while France and Spain have increased or re-introduced wealth taxes respectively.

Over the past few years Britain has introduced a raft of tax increases, including on personal incomes and capital gains, targeting the wealthy:  In the US, Barack Obama called for raising taxes on families earning more than $250,000 during his 2012 re-election campaign, and has used this proposal as a key plank of recent ''fiscal cliff'' negotiations with his Republican adversaries.

Those possessing wealth may well be regarded by politicians as an instant source from which to collect extra revenues, but cases abound where governments pursuing ''soak the rich'' tax policies are subsequently frustrated by lower-than-expected revenues.

An important reason for such outcomes, as has been witnessed, for example, in Britain, as tax increases have not translated into substantial extra revenues, is that increasing taxation tends to dampen labour supply and capital accumulation, thereby hampering economic growth.

As a result of the disincentive effects of taxation, it is conceivable that present tax rates may be set so high that further increases in rates will actually reduce tax revenues received by the government.

Another important dimension to the problem, which seems to be continually discounted by revenue-hungry governments, is that the wealthy can prevent tax discrimination against them by relocating to lower-taxing jurisdictions.

In France, more than 400 homes have been placed on the Paris luxury property market since Hollande's election victory last May, and a number of French high net worth individuals have reportedly already relocated to countries such as Belgium, Luxembourg and Switzerland:  It has also been estimated that about two-thirds of Britain's millionaires left the country when the Cameron government increased the top marginal income tax rate to 50 per cent.

Movements by the wealthy to escape the burden of high taxes are also prevalent within highly decentralised federal systems, such as the US.

Data from the US Internal Revenue Service indicates that the numbers of wealthy tax filers in high-tax states, such as California and New York, have declined in recent years.

By contrast, the numbers of wealthy individuals have grown significantly in recent years in the likes of Texas, which does not impose a state income tax, suggesting some element of mobility from high-tax to low-tax US states in the process.

Even if the wealthy decide to physically remain in their country or region of residence, the integration of the global economy ensures they could relocate their finances or capital to less fiscally oppressive areas of the world with fewer obstacles.

One of the great paradoxes is how the political popularity of taxing the wealthy often overshadows the lack of economic and financial success that such policies deliver.

There seems little question that exorbitant taxes on the wealthy might appeal to the economically prejudiced who believe that rich people attained their wealth through ill-gotten profits raked from poor consumers.

To the extent that tax policies are rationalised on these grounds, the imposition of higher taxes on those with higher incomes in fact represents a political disendorsement of consumer choices.

After all, Bill Gates and Steve Jobs made their abundant fortunes by providing products which pleased customers around the world, just as Gerard Depardieu earned an enormous salary by gaining numerous admirers of his films.

Another populist view is that losing extra dollars in taxation will be far less painful to the wealthy than it would be for those in low to middle income brackets, so the wealthy ought to have their wealth shared about by the force of taxation.

But if high taxes on the wealthy indeed come with little or no pain, why is it that the wealthy often don't sit still, making efforts to relocate their wealth, and even their own person, to lower-taxing environments?

While tax-baiting the wealthy minority might bring politicians some plaudits among the less-wealthy majority, such policies are strewn with dashed revenue expectations and a lack of investor confidence of doing business in countries or regions that partake in such practices.

The weight of economic history will surely adjudge the Hollande supertax experiment as being not unlike a French souffle collapsing upon itself.

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