Don’t punish the rich with taxation … incentivise them

It’s a Sunday morning and I’m asked to contribute to a debate on the BBC’s Sunday Morning Live (using awful Skype webcam) about whether the rich should feel a moral obligation to pay more tax.*

My take on this is that the rich make their money through businesses generally that are tax efficient through tax avoidance strategies in offshore tax havens.  Our top 20 largest companies have over 1,000 subsidiaries in offshore tax havens.

This is because companies are there to make the maximum return to shareholders.

In so doing, it creates a culture of tax avoidance and the ultrarich are very effective at avoiding tax as a result.

It’s the reason why the UK became so attractive to non-domiciled residents, also known as non-doms, as their tax thresholds were set so low.  In so doing, it also meant that many company executives registered as non-domiciled to limit their tax payments.

But there are other benefits that the rich bring other than tax payments.

As was pointed out on the show, paying 50% tax on a million is half a million versus £50,000 on £100,000.  Wouldn’t you rather have the larger tax payments?

This was evidenced by the recent spate of redundancies in the City.

For example, the expectations are that as many as 15,000 City-workers, or about five percent of London-based financial services staff, will lose their jobs before the end of the year, resulting in a drop of more about £1.3 billion in lost income tax revenues for the Exchequer.

This is based on an average salary of £150,000 and income tax of 50pc, employer national insurance of 2pc and employee national insurance of 2pc, this works out an average lost tax income per lost City job of £81,000, or a total loss of about £1.3 billion in tax revenue.

To put this into context, financial services workers paid a total of £18 billion income tax for the tax year 2009/10, or 15 percent of the UK total, so this year's redundancies alone could lower the sector's income tax contribution by about 7 percent.

Equally, as evidenced by research published last week, London is no longer the #1 place to work if you’re in investment banking.  In a survey of 300 UK investment bankers, 27 percent named Singapore as their preferred place to work, compared with 22 percent who chose London. 20 percent picked Hong Kong, 19 percent New York and 13 percent opted for Dubai.

There’s plenty of choice out there and with tax on bonuses, job uncertainty and worse in the UK economic prospectus, the likelihood that more tax will be lost as the superrich move overseas is highly likely.

Some say this is unlikely, but an FT article last year does support the notion that unhappy investment bankers will easily move companies and continents if conditions do not match up to expectations and needs.**

So what’s the answer?

Well, the debate was kicked off by an article Warren Buffett wrote in the New York Times in mid-August: “Stop coddling the super-rich”. 

In the article, he explains that as America’s third richest man he was paying too low a tax – “only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.”

His recommendation is that “for those making more than $1 million — there were 236,883 such households in 2009 — I would raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains. And for those who make $10 million or more — there were 8,274 in 2009 — I would suggest an additional increase in rate.”

Barack Obama unfortunately misread the article and is proposing a tax on those earning over $250,000, which Warren Buffett does not endorse.

Nor do many other millionaires.

Newsmax.com reports that  “44% of millionaires think a flat rate tax across all income brackets is the fairest system, according to a survey from Spectrem Group, a research firm specializing in affluent Americans, according to CNNMoney.” 

And they quote a guy called Jon Hoch, the owner of a power equipment company, who says that “the Buffett Rule works great if you're 80+ years old and already successful.  At 40 years old, the vast majority of my profits are reinvested back into my business. As an S-Corp, I pay huge quarterly taxes even though I reinvest the majority of our profits to increase our inventory.”

In other words, his riches are not being used for a lifestyle of fun, but to grow the business.

If you want to investigate more about the different arguments for and against Buffett's proposals, Minyanville.com gives a great summary.  

So the first question we need to ask is: how rich is rich?

Are you rich if you’re earning a million?

What about if you have three million in loans and credit to substantiate the lifestyle you’re supposed to have to go with it, e.g. the big house, kids at the right school, nice car, etc.

Or what about if you're reinvesting nearly all your income back into growing your business, as Jon Hoch says?

Should tax therefore be on disposable income, after expenses and loans, rather than income?

And how do you enforce that: there's far too many options there for avoidance.

Equally, is the bar set too low if you increase taxation for those earning 100k ... what about 250k … is it too low at a million … ten million?

I’d rather take a different tack.

There’s a case to argue that lower tax rates for the rich encourage them to pay more.

This was evidenced by the industrialist Andrew Mellon in the 1920’s, as discussed in a recent Bloomberg article.  Mellon fought to encourage the rich to pay more tax by lowering the tax overhead upon them and therefore made it more conducive to pay rather than avoid:

“By 1925, Mellon got the rate down to 25 percent. He was a political realist, and allowed other changes in the name of fairness, but the lowering of the top income-tax rate was his centrepiece. The prediction that reducing top rates would benefit the poor proved correct. Jobs proliferated, unemployment stayed at less than 5 percent, real wages grew and the federal budget was in surplus. By 1928, with the top rate still at 25 percent, those earning more than $100,000 paid 60 percent of all the tax. That same set of earners had paid only 30 percent of the income taxes in the early part of the decade, when the top rate had been 73 percent.”

Equally, rather than naming and shaming people for not paying taxes and forcing them to avoid payment due to the approach taken, why not encourage those who would like to pay more tax to do so by rewarding them.

Offer them incentives, such as “Good Citizen” awards from the Big Society.

Allow the ultrarich to choose how their overpayments are directed, so that they can push their tax payments towards the causes – health, defence, education, policing, etc – that they want.

Give the wealthy a tax relief on an overpayment that means they increased governmental support towards employee rewards and other company benefits.  This would allow the wealthy to see their employees pay less national insurance for example as a quid pro quo.

There are multiple ways you can structure it, but calling for increased taxes for the rich is an easy idea in theory, but a devil in practice.

Far better to keep a base level of taxation, close the loopholes and encourage overpayment in return for rewards.

That’s my two penneth anyway.

* There was  a telephone, text and online vote of the Sunday Morning Live audience to ask whether the rich had a moral duty to pay more tax.  Unsurprisingly, 84% of viewers said they should.

** City trading desks often are poached in entirety by competitors, and the FT story quoted the then Chairman of UBS, Kaspar Villiger, who said that the bank “cut back too much last year, causing us to lose entire teams, their clients and the corresponding revenue”.  In the biggest of a series of departures, Mr Villiger revealed an entire team of 60 employees had left UBS investment bank’s equities unit, resulting in the loss of some SFr800m (near enough $800m) in revenues.