New Thinking on Taxation and Inequality from OECD

Paul Sweeney: The previous blog on the recent OECD paper on taxation pointed out its new recognition that taxation systems are not just about efficiency but must include other principles like equity. The paper sets out trends in inequality and the use of taxes and transfers to reduce it.

The OECD paper takes a tax-by-tax discussion on tax design that supports inclusive growth. It discusses the efficiency and equity implications of each tax and offers options to reconcile both objectives. It argues that, “while a tax-by-tax assessment is critical, the possibility of reconciling efficiency and equity through tax policy will depend on the interaction of many elements within and beyond tax systems.”

It argues that “recurrent taxes on immovable property are the least damaging tax to long-run economic growth,” which is probably correct, and it is against property transactional taxes. It debates the impact of property taxes in general eg its impact on middle classes versus the very rich, etc., and how to design effective and fair inheritance taxes (p18-24). Other taxes such as consumption taxes including VAT, and environmental taxes are also discussed.

It says that “Environmentally-related taxes are generally perceived to be highly regressive – hitting the poor harder” but that studies show that ‘how that for these (mainly European) countries, the distributional effects of energy taxes differ by energy product.” For example “transport taxes tend to be progressive across the first half or more of the expenditure distribution, although tax burdens (sic) tend to fall for the very richest households”. Very poor household tend not to have cars.

It reiterates its 2008 paper’s assertions that “high average tax rates on labour income will reduce incentives to participate in the workforce, while high marginal tax rates will reduce incentives to work longer and/or harder when in the workforce” - a disputed ideological view.

It then admits that “income tax is the main source of progressivity in most countries’ tax systems.” So when you cut it, you are usually regressing. It does argue, however, there is significant scope for income tax reform that would support more inclusive growth, by lowering it on low incomes and raising it on high incomes (though it equivicates here a bit).

It also reiterates the old 2008 “Tax and Economic Growth” line that “the empirical analysis found that corporate income taxes were the most detrimental to economic growth” but here it’s a bit more nuanced it its anlaysis. It now admits that “empirical research on corporate tax incentives shows that in some cases they may be successful in attracting more investment but fails to confirm that they are beneficial overall.” It says that such “tax incentives are costly not only in terms of foregone revenues but also because they generate economic distortions between different types of companies and industry sectors.’

OECD report also admits now that “recent research has suggested that the arguments in favour of reduced capital taxation are not as clear-cut as previously thought.”

It also concedes that ‘it is essential to view the tax system as a system rather than consider its different elements in isolation” because “tax policy affects inequality in many different ways and because the magnitude of the efficiency-equity trade-offs depends on the interactions between many factors both within and beyond tax systems.”

Finally, it declares that “on average, tax progressivity has increased at the bottom of the income distribution but decreased at the top.” Ireland is a prime example. We have a very progressive income tax system at the bottom, but not so at the top, a point ignored by some Irish tax “experts.”

The OECD unweighted average top personal income tax (PIT) rate fell from 67% in 1981 to 49% in 1994 and 41% in 2009. However, the decline in top marginal PIT rates has not been uniform across countries.

On top of these regressive actions on tax by governments, the report found “Other taxes affecting top income earners have gone down too, lowering the overall progressivity of tax systems. Some countries introduced dual income tax systems which tax capital income at flat and lower rates compared to labour income.”

TASC has pointed out how deeply income tax has been cut. For example, the top rate was never as low as it is today, being fully 25% lower than it was in the 1980s.

Further, the unweighted average statutory Corporation Tax rate declined from 47% in 1981 to 25% in 2013 and the unweighted average tax rate on dividend income for distributions of domestic source profits fell from 75% to 42%, it found.

Wealth taxes have been abolished in about a third of the OECD countries since the mid-1990s (including Austria, Denmark, Germany, the Netherlands, Finland, Iceland, Luxembourg, and Sweden) which is a major reason for growing inequality.

It says that “in the few OECD countries that still tax net wealth, the tax only applies to a small fraction of the population. Finally, while inheritance and gift taxes are applied rather widely, several countries have reduced or abolished them since the mid-1990’s.”

No wonder inequality is rising!

Has there been a major turnabout in the OECD? Not a major change but nonetheless a welcome one. The OECD has taken inequality and social issues into its economic views increasingly, under Angel Gurria, its boss, who was given a new term of office. Gurria concludes “We are confident that the OECD’s latest research on tax design for inclusive growth can become part of a new tax policy contribution to the G20 agenda.”

Of course, this is about time and one wishes that more economists would recognise the role of inequality in economics. Inequality is the most pressing and destructive economic issue, reducing demand, impoverishing many and thus driving the Brixit vote, the Trump vote, the rise of the right over Europe and general alienation.

Taxation is one of the main ways of addressing inequality. It is a policy instrument which many politicians, including many on the left, fear to use effectively.