Does Increasing Tax Rates Make Sense? | CunningamBlog.ca ...

Two interesting topics have surfaced in newspapers across the country this week. In the first, Canada?s Finance Minister, Jim Flaherty, announced that even though corporate tax rates have decreased, corporate tax revenues increased 5.8% year over year. In the second piece of news, The Broadbent Institute released an income equality research study that revealed 83% of Canadians interviewed would support higher income taxes for the wealthy and almost 75% said they want corporations to pay higher income taxes. Assuming the government actually pays attention to the media and is influenced by studies such as this, should the government take any action to adjust tax rates? One the one hand, it appears that most Canadians feel high income individuals and corporations are not paying their fair share of taxes, but, on the other hand a reduction in tax rates appears to have led to an increase in tax revenues.

Mitt Romney tried to explain this concept, commonly referred to as the ?Laffer curve? by economists, to Barrack Obama in their recent televised presidential debate. Over the past decade, in both the United States and Canada ? the statistics have revealed that a reduction in tax rates actually leads to an increase in tax revenues. This may seem counterintuitive and it is certainly not without controversy (as a side note, I think this would be a good correlation theory for Steven D. Levitt and Stephen J. Dubner, the guys behind Freakonomics and SuperFreakonomics, to investigate). People often cite the fact that there are other factors at play here, which there likely are. However, it appears that at least in some circumstances a reduction in tax rates has led to an increase in tax revenues. After George W. Bush introduced tax rate cuts, the top 5% of taxpayers went on to pay $1.28 trillion more in federal income taxes than they did under the previous president?s tenure. In addition, the share of income tax paid by the top 1%, the top 5% and the top 10% of income earners all went up. Similar increases in tax revenues as a percentage of Gross Domestic Product occurred when Regan slashed the personal tax rate in the US in the 1980s, when Ireland decreased their corporate tax rates between 1985 and 2004, and when Russia implemented a flat tax in 2001. Not to mention the recent increase in Canadian corporate tax revenues, despite the decrease in the Canadian corporate income tax rate.

Why does this happen? Well, there are a few explanations. Some people suggest that as tax rates decrease, a country becomes more attractive for foreign investors. Foreign investment and capital creates a larger tax base, i.e. more people and corporations to pay tax, which leads to higher overall tax revenues. Another theory is that when taxpayers pay less tax, they have more money to spend. If both individuals and corporations spend more, this benefits the economy, businesses earn more profit, and more profit leads to more tax revenues paid and collected. The last theory suggests that taxpayers are more likely to declare all of their income when taxes are lower. When tax rates are higher, some taxpayers feel that the risk of not declaring and paying taxes on all of their income is less than the benefit of following the law and paying the additional tax upfront. When tax rates are lowered, the risk-benefit analysis shifts and taxpayers are less inclined to cheat the taxman.

These explanations make the French government?s recent proposal to tax the super rich at a higher rate all the more perplexing. France is considering taxing individuals who make more than 1 million Euros at a rate of 75%! Talk about creating a disincentive for wealthy individuals to remain a tax resident of France. With movement particularly easy within the European Union, a taxation policy, especially one as drastic as this one, we will likely see a mass exodus of capital leaving France and headed to more tax-friendly EU countries.

It will be interesting to see whether this new tax policy in France will have the desired effect, i.e. increase tax revenues for the government, or whether history will repeat itself and the government?s tax revenues will decrease or, at best, remain the same.

Source: http://www.cunninghamblog.ca/cunninghamblog/2012/10/does-incr-tax-rates-make-sense/

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