Taxing the rich - a global agenda?

Rising income inequality prompts a global push to tax the rich more heavily.

Summary: By 2016, US households earning an average of $1.7 million will pay an average tax rate of 34 per cent – up from 31.4% today. But this may be just the start of a rebalancing of the US tax system as politicians warn that that the burden cannot be borne by lower and middle-income citizens because they haven't yet recovered from the recession.
Key take-out: A diverse group of politicians and business leaders are pushing to address income inequality in the US by lifting rates for high income earners.
Key beneficiaries: General investors. Category: Economy.

Ed’s note: Our friends at Barrons have been among the first to notice and quantify the shifting tax landscape which puts more onus on the richer elements of society to pay tax: The economics of the equation are relatively simple…growing inequality of income increases pressure on governments to raise revenues from the strata of society with the highest income.  The US, for decades the country most noted for relatively light taxes on high income earners,  has been steadily lifting its tax take from the wealthy.  Though it should be noted the level at which the top tax bands kicks in within the US tax system remains remarkably high ie 39.6% on income in excess of $450,000 for married couples. In Australia the top tax rate of 45% kicks in at a much lower $180,000.

The piece below from the US investment magazine Barrons (a Eureka Report partner in the News Corp network) reports on how the IMF is now pushing for higher marginal tax rates across the OECD – an initiative that would of course include Australia. With Treasurer Joe Hockey preparing his first Federal Budget for May 13 tax economics and the pressure to raise tax rates on the wealthy investors will be in the frame.

(Managing Editor James Kirby)

Nobody wants a return to the seventies -- for any reason. Flashbacks of disco and polyester suits are bad enough, but there's something worse: The threat of 1970s-style tax policy, which is quietly making a comeback for the nation's wealthiest.

Thankfully, we're not talking about a return to top tax rates of 70%. But the effective rate -- the average rate that people actually pay -- is inching closer to the highest it's been. Economist Roberton Williams, the Sol Price Fellow at the Urban-Brookings Tax Policy Center think tank in Washington, analyzed federal tax rates projected out to 2024. The top 1%, households with average income of $1.7 million, pay an average federal tax rate of 31.4%. Williams expects that figure to near 34% in 2016, which, he points out, is at the doorstep of the 35% effective rate paid in 1979 and 1995 by the nation's top earners.

"With incomes rebounding and most of the temporary stimulus tax cuts expiring earlier this year, average rates will rise by two or three percentage points between 2009 and 2015 for all but the top 1%, who will see a steeper, seven-percentage-point jump," Williams recently wrote in the Tax Policy Center's TaxVox blog.

Economic rebound lifts tax take

People are paying more in taxes primarily because they're simply making more money, Williams says. But there are other factors at work as well. For starters, the recent expiration of the temporary tax cuts implemented by President Bush sent the top income-tax rate back to 39.6% in 2013, from 35%, on all earned income in excess of $450,000 for married couples. The reduction of how much high earners are allowed to claim in terms of personal exemptions and itemized deductions is also back this year, and will increase many tax bills. Plus, two brand-new taxes appeared this year: The additional Medicare tax on wages imposes another 0.9% on earned income exceeding $250,000 for married couples (making the top rate 40.5%); and the net investment income tax imposes an additional 3.8% tax on capital gains, interest, dividends, and certain other investment income.

The most dramatic changes, however, are yet to come. Income inequality is becoming a bigger concern among researchers and policymakers, and not just in the United States. Global organizations are setting the tone at a macro level.

IMF argues for higher top tax rates

The International Monetary Fund's most recent Fiscal Monitor, released in October, made the case that governments could generate some much-needed revenue by raising top marginal tax rates to an average of 60% for the 34 developed countries that are members of the Organization for Economic Cooperation and Development. For the US, the IMF suggested raising the top rate to between 56% and 71%, a significant increase from today's 40.5%.

University of California researcher Emmanuel Saez, among others, has documented the growing gulf between the richest and the middle class in the US. In a September 2013 paper, Saez found that since the 2008 financial crisis, the "top 1% incomes are close to full recovery, while the bottom 99% incomes have hardly started to recover." Even Larry Summers recently penned an editorial titled, "Changing the Tax Code Could Help Curb Inequality."

The populist solution to redistribute wealth via the tax code is hardly a new idea, but it is gathering steam. According to the conservative Tax Foundation, government policies have already redistributed $1.2 trillion from the top 40% of households to the bottom 60% since 2006. But politicians are essentially saying that we can't tax lower and middle-income citizens because they haven't recovered from the recession. New York Mayor Bill de Blasio's platform, to raise taxes on city residents who earn more than $500,000 per year to fund an expanded pre-kindergarten program, is likely the start of similar tax increases. Expect such clamor to continue well through November's mid-term congressional elections.

"We're seeing pretty consistent messaging by Democrats on what they think the 2014 mid-terms will be about -- income inequality," says Jon Traub, managing principal of the tax-policy group at Deloitte Tax. On the other side of the aisle, meanwhile, Republicans have preferred to make elections a rather tired referendum on the Affordable Care Act legislation.

Romain Hatchuel, managing partner of investment manager Square Advisors in New York, is among those predicting that taxes will likely continue marching upward. "The burden of any extra taxation will have to fall primarily on the shoulders of those who have been doing better, relatively and in absolute terms," he says.

The populist message has some very wealthy adherents. In October, Bill Gross, head of bond giant Pimco, called for investment gains to be taxed at the same rate as earned income, eliminating the lower rate investors pay on long-term investment gains. Gross and others have also called for carried interest, or the share of profits that hedge-fund and private-equity managers earn, to be taxed the same as ordinary income.

Pensions in the cross hairs

Individual retirement accounts (IRAs) are also in the cross hairs. The president's latest budget proposed eliminating the tax break on new contributions to retirement accounts for taxpayers whose total retirement savings had amassed enough ($3.4 million for a 62-year-old) to buy an annuity generating more than $205,000. "The argument goes that the purpose of all the various tax preferences for these retirement accounts is to encourage people to save for retirement," says Joseph Rosenberg, a senior research associate with the Tax Policy Center. "Once you've reached the point you can meet normal goals for retirement savings, it's no longer important to provide the tax subsidy on any further retirement savings."

Then there is the so-called Buffett rule. In an August 2011 op-ed in the New York Times, Warren Buffett called for higher taxes on households with more than $1 million in income. He later proposed a minimum tax of 30% on households that make between $1 million and $10 million per year, and 35% on those making more than $10 million. That's an idea that will come up again this year, predicts Deloitte's Traub. Senator Sheldon Whitehouse introduced a version of this rule in February 2012 and again a year later; in the House, Republican David Cicilline  authored a companion version of the bill at the same time last year.

Pitcairn, a multifamily office outside of Philadelphia, uses a technology-driven "tax overlay program" to identify the most tax-efficient trades and monitor the overall tax efficiency of investor portfolios. "It's not how much you make," says Rebecca Meyer, Pitcairn's managing director of client strategy. "It's what you keep." 

This article was first published in Barron’s, and is reproduced with permission.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles