Debating taxes with Nick Pearce at the IPPR

January 25, 2012 10:25 AM

Yesterday evening I took part in a debate on Radio 4's PM programme, with the IPPR think tanks's Nick Pearce, about high marginal taxes rates, particularly on income and capital gains.

You can listen to it here:

[soundcloud url="http://api.soundcloud.com/tracks/34403379" params="auto_play=false&show_artwork=false&color=669933" width="100%" height="166" iframe="true" /]

Last year Nick wrote that, the "over-reliance of the UK on revenues from financial services, the housing market and wealthy individuals was brutally exposed in the financial crisis".  The kind of argument he was making on Radio 4 yesterday would exacerbate that problem.



The amount people pay in Capital Gains Tax is often quoted and it can often sound low, many politicians have argued that we need to increase the Capital Gains Tax rate to the Income Tax rate as a result.  What they miss is that Capital Gains have already been taxed.  To understand why look at the Gordon Growth Model:

P = frac{D_1}{(r - g)}

Where P is the price; D1 is the value of next year's dividends; r is the cost of capital; and g is the rate at which dividends are expected to grow.  Of course, things can get a lot more complicated than that in the world of high finance.  But the fundamental picture is the one that simple equation sets out: the value of shares is the earnings they will pay to the current owner or someone else who might own them in the future.

If a company's profits rise then that currently gets twice.  Once by Corporation Tax as profits (and often when it is paid out in dividends too).  Then again because the rise in profits increases expected dividends, immediately or in the future, and thereby increases the price of the shares (producing a capital gain).

If we want more good jobs to go around then people who invest in rapidly growing new companies, the ones who get hit by that double tax, are really important.  Back in 2009 we set out just how important  in a paper on tax and entrepreneurship.

So no, Mitt Romney almost certainly didn't pay just 13.9 per cent tax and it will be a huge risk to our future prosperity if we started setting new tax rates as if he did.

Some rich Americans probably do find elaborate ways of avoiding paying their fair share in taxes.  One of the problems with a tax system that is too complicated and poorly designed is that those with the most expensive lawyers and accountants to work the system can get a better deal.

But actually the United States, with its relatively low marginal tax rates, gets more revenue out of the rich than any other developed country, according to research by the Tax Foundation based on OECD figures.  Far more than many European countries that have much higher rates.  Over time, and as the success of tax cuts in the 1980s shows, tax cuts can be so economically successful that they increase revenue.

Lower spending and lower taxes, particularly lower marginal rates of tax on your income, have a great track record - established by years of academic research which we're working to summarise with the 2020 Tax Commission - of delivering greater prosperity.  And simple, proportionate taxes are a more reliable way of ensuring everyone pays their fair share.Yesterday evening I took part in a debate on Radio 4's PM programme, with the IPPR think tanks's Nick Pearce, about high marginal taxes rates, particularly on income and capital gains.

You can listen to it here:

[soundcloud url="http://api.soundcloud.com/tracks/34403379" params="auto_play=false&show_artwork=false&color=669933" width="100%" height="166" iframe="true" /]

Last year Nick wrote that, the "over-reliance of the UK on revenues from financial services, the housing market and wealthy individuals was brutally exposed in the financial crisis".  The kind of argument he was making on Radio 4 yesterday would exacerbate that problem.



The amount people pay in Capital Gains Tax is often quoted and it can often sound low, many politicians have argued that we need to increase the Capital Gains Tax rate to the Income Tax rate as a result.  What they miss is that Capital Gains have already been taxed.  To understand why look at the Gordon Growth Model:

P = frac{D_1}{(r - g)}

Where P is the price; D1 is the value of next year's dividends; r is the cost of capital; and g is the rate at which dividends are expected to grow.  Of course, things can get a lot more complicated than that in the world of high finance.  But the fundamental picture is the one that simple equation sets out: the value of shares is the earnings they will pay to the current owner or someone else who might own them in the future.

If a company's profits rise then that currently gets twice.  Once by Corporation Tax as profits (and often when it is paid out in dividends too).  Then again because the rise in profits increases expected dividends, immediately or in the future, and thereby increases the price of the shares (producing a capital gain).

If we want more good jobs to go around then people who invest in rapidly growing new companies, the ones who get hit by that double tax, are really important.  Back in 2009 we set out just how important  in a paper on tax and entrepreneurship.

So no, Mitt Romney almost certainly didn't pay just 13.9 per cent tax and it will be a huge risk to our future prosperity if we started setting new tax rates as if he did.

Some rich Americans probably do find elaborate ways of avoiding paying their fair share in taxes.  One of the problems with a tax system that is too complicated and poorly designed is that those with the most expensive lawyers and accountants to work the system can get a better deal.

But actually the United States, with its relatively low marginal tax rates, gets more revenue out of the rich than any other developed country, according to research by the Tax Foundation based on OECD figures.  Far more than many European countries that have much higher rates.  Over time, and as the success of tax cuts in the 1980s shows, tax cuts can be so economically successful that they increase revenue.

Lower spending and lower taxes, particularly lower marginal rates of tax on your income, have a great track record - established by years of academic research which we're working to summarise with the 2020 Tax Commission - of delivering greater prosperity.  And simple, proportionate taxes are a more reliable way of ensuring everyone pays their fair share.

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