Tuesday, 17 June 2014

Taxation for the 21st century

This article was published in The Malta Independent on Sunday 15 06 2014

It is not often that a book dealing with economic and financial matters creates vibrant discussion in the wider society as has been the case with Thomas Pikkety’s “Capital in the 21st century”.

Pikkety tracked, amalgamated and analysed data related to income and wealth in various countries going back two centuries and concluded that inequality in various countries, but particularly in the United States, has now grown to the same levels that were last seen in the Belle Epoque[i].

Pikkety’s argument is that unless we wish to go through the same experience of the 20th Century where excessive inequality was scaled back by the horrors of two world wars that sandwiched the great depression of the 1930’s, governments should set economic policies that reduce excessive inequality.

The beneficiaries of present inequalities have used all arguments in an attempt to discredit Pikkety and defend the status quo.   They have depicted Pikkety as a re-incarnation of Karl Marx with a mission to destroy capitalism and restore a socialist society.    This is a gross exaggeration as Pikkety in no way challenges the benefits of controlled capitalism that must tolerate substantial inequality among society to ensure that people are motivated to deliver to the best of their abilities. There is no argument about the power of fair capitalism to extract people out of poverty as is happening in China, India and other emerging markets that are giving a fair chance for the markets to work while controlling excesses.

Pikkety’s core argument in his seven hundred page book is that capitalism builds its own dynamics that concentrates wealth in the hand of the few and if such dynamics are allowed to build on their own momentum, especially considering the rent-seeking potential of those in possession of excessive wealth, within a generation wealth will be in the hands of very few who inherited their riches and this would become socially less acceptable than when wealth is the hands of the few that can actually claim they worked for it.   Basically he argues that society can accept that Bill Gates[ii] is super rich because he pioneered Microsoft but will struggle to maintain acceptance if Bill Gates’ wealth is inherited by his (not necessarily deserving) descendants.

Unfortunately as with so many things in life the diagnosis comes easier than the solution.   Pikkety recommends the introduction of a global wealth tax but this is as feasible as Honduras winning the Brazil World Cup.   However the absence of a practical solution does not mean there is no problem.

To some extent we can argue that in Malta we do not have a problem of extreme inequality and that we somehow have hit a fair balance between having sufficient inequality to maintain the enterprise spirit to generate growth and development and  offering a social structure which prevents extreme poverty.   We have also adopted policies that maintain fairly good equality of opportunities giving flexibility for people to move up the social ladder according to their skills rather than their parentage.

In this context one can understand the importance of free education up to university and beyond, the stipend system which give students from families in low levels of society a fair chance to overcome the social barriers that would otherwise condemn them eternally to their low social status, and the free health care system.     We must ensure sustainability of such policies that have protected the social fabric of society.   We must avoid the extremes one finds in the USA where the atrociously poor share sovereignty with the incredibly rich.  To maintain such sustainability we must inevitably question from time to time whether the system can carry the load of universality where the rich and poor are equally entitled to free health care rather than focus the scarce resources of the public purse only on those that cannot afford it.

This brings me to the need that we from time to time challenge the status quo entrenched in our systems of taxation and to open a debate about whether changing circumstances merit adopting our systems of taxation for the 21st century.

We have a system of taxation that discriminates in favour of unearned income and against earned income.   Whereas earned income is taxed at 35% at the margin for income over sixty thousand Euro, we have final withholding tax at 15% on a variety of unearned income (investment income and property rentals) irrespective of their quantum.   Furthermore we have no taxation on capital gains.

We have to open a discussion about whether this is socially just and whether it is conducive to becoming an economy based on enterprise rather than on rent seeking.  We have to take into consideration that in order to protect our attraction as an international investment centre we have to continue reducing direct tax rates. This could be forced on us by international competition and could address the offensive differential in tax rates applicable to earned and unearned income.   However how would government protect its finances while reducing direct tax rates to competitive international levels?  Probably it will have to make up for loss of direct tax revenue by compensatory increases in indirect tax rates and by relying on taxes on capital rather than taxes on income.

Which would bring us back to many of Pikkety’s arguments.  Should capital gains continue to remain tax exempt?   Not even in conservative USA are capital gains completely tax exempt although they are taxed at much lower rate than earned revenues.

Should we continue to tax earned income at the highest rates but exempt inherited capital other than real estate completely from inheritance and donation taxes? And why should real estate be treated differently from other asset classes, simply because it is less mobile and more visible?

There are no easy answers to these questions and changes to taxation systems have to be done with hands that have the sensitivity of  a brain  surgeon.   But this discussion has to start among society so that our political leaders will gain the courage to plan the necessary changes for the longer term in the knowledge that society has been involved and all points of view have been taken into account.

[i] The Belle Époque or La Belle Époque was a period in history that is conventionally dated as starting in 1871 and ending with the start of World War I in 1914. This period was characterized by optimism, peace in Europe, new technology and scientific discoveries. The peace and prosperity in Paris allowed the arts to flourish, and many masterpieces of literature, music, theatre, and visual art gained recognition. The Belle Époque was named, in retrospect, when it began to be contrasted to the horrors of World War I.
[ii] In the particular case of Bill Gates most of his wealth has in fact been donated to his charitable Foundation so Bill Gates may not be a fair example of the risks that Pikkety defines.


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