Which type of tax is levied at the same percentage for people at all income levels *?

The Nature of Income Taxation

The income tax is the prime example of a direct tax; it is levied directly on the incomes of the individual consumers in the economy, and it can be designed to take account of the individual circumstances of the taxpayer. In contrast, indirect taxes are levied on anonymous market transactions and are paid at the same rate irrespective of the taxpayer's income, number of children, age, health – to mention just a few of the taxpayer characteristics that have over time been taken into account in the design of the personal income tax. It is this tailoring of the tax to the individual's ability to pay, which makes it a potentially important instrument for the redistribution of income and for reducing differences in the standard of living among individuals and families.

The definition of taxable income varies in the legal systems of different countries and over time. Labor income – wages and salaries – forms the central element of the tax base. To this is added income from capital in the form of interest, dividends, etc. However, income from capital is a more elusive concept than income from labor. Thus, countries differ in the extent to which capital gains are subject to taxation, and they differ in the extent to which noncash income, such as the imputed income from owner-occupied housing, is subject to tax. Perhaps even more importantly, rules differ regarding the deductibility of negative capital income, such as interest payment on mortgage loans. Tax laws also differ in the extent to which they allow the deduction of particular expenses, such as the cost of travel to work, the cost of child care, trade union fees, etc.

These differences in the tax base may reflect different perceptions among policy makers of what is a just and fair tax system; they may also reflect differences in the balance of political power among various special interests. What is clear is that different legal definitions of the tax base create different economic incentives for the taxpayers as well as different consequences for the after-tax distribution of income.

The income tax may be progressive, proportional, or regressive. A proportional tax is one where the average tax rate is constant; the proportion of income paid in tax is the same for all levels of income. Note that this implies that the marginal tax rate – the percentage tax paid out of a small increase in income – is also constant. In a progressive tax system the average tax rate increases with income, and this implies that the marginal rate is higher than the average rate. Finally, in a regressive tax system the average tax rate is decreasing, with the marginal tax rate being lower than the average rate.

Countries differ considerably both in their legal definitions of the tax base and in the degree of progressivity of their income tax schedules. There is also significant variation between countries as regards the importance of taxes on income as a source of revenue. To illustrate, in 2010 according to official Organisation for Economic Co-operation and Development statistics, the share of income taxes (as levied on all sources of income and inclusive of social security taxes) in total tax revenue varied from about 45% in Chile, Mexico, and Israel to around 70% in countries like Norway, Switzerland, and the United States. Of course, these percentage shares are reflected in a correspondingly high share of revenue from indirect taxes in the former group of countries and a low share in the latter.

This article discusses the structure and economic effects of income taxes. It provides a survey of various types of income tax with respect to the tax base and the degree of progression. It then turns to an analysis of the effects of income taxes on economic behavior, particularly as regards labor supply, saving and portfolio choice, home production, and tax evasion. This involves both an outline of the basic economic theory of taxpayer response and brief characterizations of the state of empirical research in the area. Income tax is often regarded as one of the main tools for redistribution policy, and the article also considers its effects on the distribution of disposable income. Issues related to the design of tax policy are discussed as a matter of striking a reasonable balance between social efficiency and distributive justice. After describing the nature of recent tax reforms in some Western countries, the paper also considers two proposals for more radical tax reform, viz., expenditure tax and flat tax. While the main emphasis of the paper is on personal income tax, some attention is also paid to the taxation of corporate income.

14.3.1 Concept of taxable income

Income tax is levied on persons who have earned taxable income for the relevant tax period. Whether an individual generating or trading in bitcoins can be regarded as having taxable income depends on the income definition of a particular country.

From a structural viewpoint, two basic types of income tax systems can be distinguished: schedular and global (Burns and Krever, 1998). In a schedular tax system, income tax is levied tax on selected income categories. If a benefit does not fit into any categories, it is not subject to tax. In contrast, in a global tax system, all receipts, irrespective of their source, are subject to tax. In practice, most existing income tax systems lie on the spectrum between global and schedular (mixed systems).

An example of a country with an income tax system of a global nature is the United States. Under the Internal Revenue Code (IRC), receipts from whatever source derived are subject to tax. In such a system, a receipt qualifies as taxable income without having to meet any additional criteria (such as periodicity, profit motive, and market participation). Thus, in the United States, the receipt of bitcoins gives rise to gross income.

An example of a country with a schedular income tax system is Germany. It imposes income tax on seven categories of receipts and there is no all-encompassing provision that would tax income from whatever source derived. If a taxpayer's income does not fall into any of the categories, it is not subject to income tax. Among benefits that are not covered by the income categories are gifts, bequests, lottery winnings, and prizes granted for personal achievements or a successful participation in an event. Thus, before tax can be imposed on income in the form of bitcoins derived from a particular transaction, it is necessary to examine whether such income meets the criteria of any of the income categories. In Germany, income generated from bitcoin transactions could fall within the business income or the miscellaneous income category.

There are some income categories that are common to many jurisdictions. Almost all countries distinguish between business activity (which gives rise to business income) and sales transactions performed in a private capacity (which may give rise to capital gains).

The starting point in determining whether an item of income is business income is to determine whether the underlying activity is properly characterized as a business. In the absence of a definition in the income tax law, the term “business” has its ordinary meaning. In broad terms, a business is a commercial or industrial activity of an independent nature undertaken for profit (Burns and Krever, 1998).

The rules on taxation of gains from transactions performed in a private capacity vary from country to country. In the United Kingdom, there is a separate capital gains tax on disposal of assets (which also include intangibles and currency other than sterling). In Germany, casual sales of assets give rise to taxable miscellaneous income provided that the asset is sold within a year from its purchase and the total profit from disposal of private assets has exceeded the threshold of EUR 600 in a calendar year.

The fact that Bitcoin does not constitute money (either in the economic or in the legal sense) does not prevent profits expressed in bitcoins from taxation. Sales of goods and services for bitcoins constitute barter transactions, which are subject to the general income tax rules. In transactions where the consideration does not involve monetary amounts but benefits in kind, the determination of value of the exchanged objects becomes a pivotal issue. The basic valuation standard in many countries is market value, defined as the amount for which an asset could be exchanged between knowledgeable individuals in an arm's length transition. Market value is based on a hypothetical transaction (ordinary) and hypothetical participants (knowledgeable and willing) and assumes informational symmetry and profit maximization. Under perfect competition, there would be only one market price in a long-term equilibrium. However, as most markets are characterized by informational asymmetry, uncertainty, and imperfect competition, an asset can have more than one market value.

Lump-Sum Redistributions and Public Sector Theory

Are lump-sum redistributions a feasible policy tool for the government? This may appear to be a relatively uninteresting question. One is tempted to answer: “Probably not, but even if they are feasible, it hardly matters because few governments use lump-sum taxes and transfers. For instance, no major US tax or transfer program is lump sum.” All this is true, yet it is hard to imagine a more important question for normative public sector theory. The answer has a dramatic impact on all normative policy prescriptions in every area of public sector analysis, whether they are directed at distributional or allocational problems. In public sector theory, lump-sum redistributions stand at the border between first-best and second-best analyses.

The issue is not so much the existence of lump-sum redistributions. Lump-sum tax and transfer programs are easy enough to describe. Poll taxes have occasionally been used as revenue sources and they are certainly lump sum from an economic perspective. On the transfer side, many countries have instituted per-person demogrants (e.g., Canada, which provides a grant to all the elderly). The United States allows a personal exemption for each dependent child under the federal personal income tax. It might be argued that decisions on family size are essentially economic and would influence the amount of transfer received. If so, then tax exemptions and demogrants to children are not strictly lump sum, although the legislation could be drafted such that only children already living at the time of passage would receive the transfers.

The mere existence of lump-sum taxes and transfers is not enough, however, to render them feasible policy tools in the pursuit of equity. The lump-sum taxes and transfers must be flexible enough so that they can be designed to satisfy the interpersonal equity conditions for social welfare maximization, and this is a very tall order indeed. To be effective, the taxes and transfers would almost certainly have to be related to consumption or income or wealth in order to distinguish the haves from the have-nots, but then it is doubtful that they would be lump sum.

Income taxes were thought to be essentially lump sum before 1970, because empirical research had been unable to discover any relationship between income tax rates and either work effort or saving. Research since then, employing detailed micro data sets and sophisticated microeconometric techniques, suggests that labor supply does respond to changes in after-tax wages, certainly the female labor supply. The evidence on saving behavior is more mixed, but saving also appears to respond somewhat to changes in after-tax rates of return.1 In any event, no one today believes that income-based taxes and transfers are lump sum. Therefore, the assumption that the government can pursue an optimal lump-sum redistribution policy is heroic in the extreme. Nonetheless, public sector economists have been quite willing to employ the assumption of optimal lump-sum redistributions to analyze allocational policy questions in a first-best framework.

15.4.1 Scope of tax

Singapore income tax is imposed on a resident company in respect of:

income accruing in or derived from Singapore, and

income received in Singapore from outside Singapore (i.e. foreign source income received in or remitted to Singapore).

There is no capital gains tax in Singapore. However, gains from short-term real property transactions and gains from short-term transactions of shares in private real property companies are deemed to be “income” and chargeable to income tax.

A foreign source income is deemed to be received in Singapore from outside Singapore where:

it is remitted to, transmitted or brought into Singapore;

it is applied in or towards satisfaction of any debt incurred in respect of a trade or business carried on in Singapore; and

it is applied to purchase any moveable property which is brought into Singapore.

A non-resident company carrying on business in Singapore through a branch is taxable on income accruing or derived from Singapore. It may also be taxed on income received in Singapore from outside Singapore only to the extent that the offshore income is directly attributable to the branch’s operations.

Conclusion

This article has surveyed the policy issues, historical development, and contemporary realities of taxation of housing.

The income taxes of most countries contain significant tax expenditures that subsidise homeownership relative to private rental housing. As a result of political and administrative pressures, imputed rental income and capital gains on homeownership are not taxed in most income taxes, while home mortgage interest continues to be deductible in a number of countries. Broad-based indirect consumption taxes, such as the VAT, that are applied in many countries are generally more neutral with respect to housing tenures.

Property taxes are commonly applied at the local government level, but there is increased scope for the application of land taxes to housing. In an era in which economic globalisation renders capital investment increasingly mobile and governments respond by reducing taxes on mobile capital, land as a sustainable tax base is likely to become more important. However, governments face formidable political obstacles in increasing taxes on housing, particularly in countries where homeownership is both a widespread reality and a widely held ‘dream’ of the population.

15.4.1 Scope of tax

Singapore income tax is imposed on a resident company in respect of:

income accruing in or derived from Singapore, and

income received in Singapore from outside Singapore (i.e. foreign source income received in/remitted to Singapore).

There is no capital gains tax in Singapore.

A foreign source income is deemed to be received in Singapore from outside Singapore where:

it is remitted to, transmitted or brought into Singapore;

it is applied in or towards satisfaction of any debt incurred in respect of a trade or business carried on in Singapore; and

it is applied to the purchase of any movable property which is brought into Singapore.

A non-resident company carrying on business in Singapore through a branch is taxable on income accruing in or derived from Singapore. It may also be taxed on income received in Singapore from outside Singapore only to the extent that the offshore income is directly attributable to the branch’s operation.

Methodological Differences in the Measurement of Tax Incidence

The tax incidence literature is bound to be confusing to a beginner in public sector economics. Empirical studies of individual taxes are fraught with controversy, in part because the empirical analysis of tax incidence is inherently so difficult, but also because there exist serious methodological differences among experts in the field, on the appropriate theoretical approaches to the measurement of incidence.

By way of illustration, consider the incidence of the U.S. corporate income tax, which a large number of researchers have studied. Their results could not possibly be more divergent. They range all the way from Richard Musgrave's early finding that the tax is borne at least 100% by the consumers of corporate output, to Arnold Harberger's estimate that corporate stockholders almost certainly bear virtually the entire burden of the tax, to Joseph Stiglitz's conjecture that the tax may be nondistorting. To confuse matters further, Ann Friedlaender and Adolph Vandendorpe showed that the analytical framework that Harberger used to determine the incidence of the tax should have generated the result that no one bears a burden (Krzyzaniak and Musgrave, 1963; Harberger, 1962; Stiglitz, 1973; Friedlaender and Vandendorpe, 1976). This was an important qualification, because Harberger's model is frequently used to study the general equilibrium incidence of taxes.

The corporation income tax may be the most dramatic instance of empirical uncertainty with regard to tax incidence, but the incidence of most other important taxes has hardly been settled either. To give one other example, most public sector economists had long believed that local property taxes were at least mildly regressive. In the 1970s, a “new view” consensus emerged that the property tax is almost certainly progressive.2

Perhaps it is not surprising that empirical estimates of the incidence of any tax should vary considerably, given the nature of the problem. Empirical researchers must select what they think are the most important market reactions to the tax from a staggering set of possibilities, and methods of selection are bound to differ. Unfortunately, empirical tax incidence analysis appears not to be especially robust to assumptions made about sectors of the economy not explicitly under examination. Another confounding factor, mentioned earlier, is that researchers often employ different theoretical measures of incidence as a basis for their empirical work, and it is the theoretical differences that we wish to focus on here.

5.3 The Government’s Policy Functions

The individual income tax function follows Gouveia and Strauss (1994). The parameters of the progressive tax function are estimated using OLS regression across the statutory marginal tax rates in 2011. One of the parameters, φt, is the limit of the marginal tax rate as taxable income goes to infinity. It is computed as follows. First, φt is set at 0.35, the highest marginal tax rate in 2011. The other two parameters, φ1 and φ2, are then estimated by OLS (equally weighted for taxable income between $0 and $500,000), assuming 60% of the households are married and 40% are single.16 Then, φt is reduced to 0.2957 from 0.35 so that the ratio of the income tax revenue to GDP, T I,t/Yt, is 10% in the baseline economy. Figure 3 shows the statutory, estimated, and effective marginal income tax rates.

As explained above, one unit in the model economy corresponds to $142,582 in 2011. (Recall that average household labor income is 0.4648 units.) In the same year, the standard deductions of a single household and a married household are $5800 and $11,600, respectively, and the exemption is $3700 per person. 60% of the households are assumed to be married and 40% are single. So, the average deduction and exemption per household is $15,200, and d is set at 0.1066 in the model economy. For simplicity, exemptions for dependent children are not considered in this calibration.

The OASI payroll tax rate is 5.3% for an employee and 5.3% for an employer. The payroll tax rate, τ¯P,t , for earnings below the maximum taxable earnings is set at 0.10, which is approximately equal to (5.3+5.3)/(100+5.3)=0.1007 . The maximum taxable earnings of the OASI payroll tax are $106,800 in 2011. When 2/3 of married households are two-earner households, hence, 40% of all households are two-earner households, the average maximum taxable earnings are $149,520 and ϑmax is set at 1.0487. In the current US Social Security system, the thresholds to calculate primary insurance amounts (PIAs) are set for each age cohort when they reach age 62. In the model economy, the growth-adjusted thresholds are assumed to be fixed for all age cohorts, and the PIAs are adjusted later by using the long-term productivity growth rate and years from age 60. Thus, the model simply uses the thresholds for the age 62 cohort in 2011 after scale adjustment. Again, since 40% of all households are assumed to be two-earner households, the two thresholds are, on average, $12,583 and $75,886, respectively, and the parameters are set at ϑ1=0.0883 and ϑ2=0.5322. The OASDI benefit adjustment factor, ψt, is set at 1.0153 in the baseline economy so that the OASI budget is balanced.

For simplicity, non-Social Security government spending is assumed to be government consumption. So, government consumption, CG,t, is equal to tax revenue, TI,t +TC,t=3.3757. The lump-sum transfer, trLS,t , and the government’s net worth, WG,t, are both set at 0 in the baseline economy. Accidental bequests per working-age household are calculated as 0.0244 in the baseline economy.

6.2 Moving from an income tax to a consumption tax

Under the income tax, the user cost of capital is influenced by the corporate tax rate, investment tax credits, and the present value of depreciation allowances. Under a broad-based consumption tax, firms pay tax on the difference between receipts and purchases from other firms. That is, there is no investment tax credit, and investment is expensed. In this case (assuming that the corporate tax rate does not change over time), the user cost of capital no longer depends on taxes. That is, under a consumption tax, taxes do not distort business investment decisions; investment decisions are based solely on non-tax fundamentals. Because US tax policy currently increases the user cost, the switch to the consumption tax lowers the user cost and increases investment.

Of course, other aggregate variables are also likely to change in response to such a large change to the tax code. For example, nominal interest rates and the supply of savings are likely to change. While it is difficult to say how large the net stimulus to investment would be, the consensus of the recent investment literature suggests that the partial-equilibrium impact on investment may be quite large.