Tax Design for

Inclusive Growth

ECFIN Workshop 19 June 2017

Bert Brys, Ph.D.

Senior Tax Economist,

Tax Policy and Statistics Division

Centre for Tax Policy and Administration

Aim of the workshop is to “Improve our understanding of how tax (and other) policies can be better designed to enhance equality while fostering growth”

1. “Tax design for inclusive growth” (OECD Taxation Working Paper, no. 26)

http://www.oecd.org/ctp/tax-policy/tax-policy-working-papers.htm

2. “Taxation of household savings” (forthcoming)

3. “Taxation and skills” (OECD Tax Policy Study, no. 24)

http://www.oecd.org/tax/taxation-and-skills-9789264269385-en.htm

30/6-1/7/2016 2

“Tax policy to enhance equality while fostering growth”

Channels through which tax policy affects inequality

• Most redistribution occurs through transfers

Tax revenues finance expenditure which may reduce inequality

• PIT progressivity is the key tool to narrow the distribution of disposable income

Taxes can reduce disposable income inequality

• Taxes affect pre-tax opportunities and behaviours

Taxes can reduce market income inequality

• Intra-personal as opposed to inter-personal redistribution, e.g. SSCs to finance future benefits

The tax system can redistribute income across the lifecycle

3

• Equality in income or equality in wealth?

• Fostering “growth” or fostering “well-being”?

• “Equality” or “Horizontal Equity” and “Vertical Equity”?

• Differences in income as a result of differences in effort or personal taste for leisure are not necessarily undesirable (although tax systems ignore “effort”)

• Not only “tax progressivity” matters but also “tax affordability” (for both households and businesses)

• Narrow focus on “after-tax disposable income” versus focus on “equality of opportunity”

• “Inclusive Growth” puts emphasis on a more dynamic definition of equity, taking into account well-being over the life-cycle and across generations

• From a narrow country focus to the incorporation of country spill-over effects

4

“Tax policy to enhance equality while fostering growth”

Efficiency

and equity

implications

of taxes

Design of individual taxes

• Economic structure and challenges

• Interactions with benefit systems

• (Non-tax) drivers & characteristics of informality

• Social preferences for redistribution

• Existence of compensation mechanisms

• Time horizons

• Tax administration and tax enforcement

• Tax remittance

• Behavioural responses to tax changes

• Tax planning and income shifting

• Tax incidence

• International tax rules

Tax system factors

Non-tax system factors

A systems approach to tax design for inclusive growth

• Increasing top PIT rates may induce the self-employed to incorporate and earn capital instead of labour income

• Impact of introduction of mortgage interest relief differs from impact of the withdrawal of such tax relief (due to capitalisation in house prices)

• Distributional impact of recurrent taxes on immovable property depends on home ownership rates, distribution of housing values and whether the incidence of the tax lies on renters rather than owners.

• Reduced VAT rates for basic goods are poorly targeted but can be considered (only) if direct compensation of the poor is difficult

• Decreasing returns to tax rate reform (e.g. standard VAT rate increases)

• Progressivity should not be introduced on a tax-by-tax basis!

• Increase top PIT rates/ taxing super rich >< ensuring that remuneration of all workers increases

• Tax Admin capacity and enforcement possibilities are crucial – the move towards “Automatic Exchange of Financial Account Information for Tax Purposes” between tax administrations could be a tax policy game changer

6

Examples of the “Tax Systems Approach”

Taxation of household savings

7

Strengthening capital taxation

-40%

-20%

0%

20%

40%

60%

CAN FRA DEU ITA JPN GBR USA

Bond Interest Bank Deposit Interest

Dividends Investment funds

Private pensions: deductible contributions

Effective tax rates on savings by asset types • Capital income is more

likely to be earned by those on higher incomes.

• Taxing capital at higher rates can increase the overall progressivity of the tax system.

• Bank deposits that are a common form of savings vehicle for those with low incomes are comparatively heavily taxed.

• Private pension savings are often subsidised.

Making capital taxation more progressive

Effective tax rates on savings by asset type and income level, G7 averages

-60%

-40%

-20%

0%

20%

40%

60%

Bank Interest Bond Interest Shares: CapitalGains

Shares:Dividends

Investmentfunds

Privatepensions:deductible

contributions

Low Income Individual Medium Income Individual High Income Individual

• The taxation of savings is broadly progressive, except for private pensions.

• Tax rates are nonetheless usually below those for labour income (though CIT is not included).

Reforming regressive tax expenditures

Effective tax rates on savings with tax-deductible private pension contributions

-45%

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

CAN FRA DEU ITA JPN GBR USA

67% Average Wage 100% Average Wage 500% Average Wage

• Tax expenditures for pensions often result in ETRs that are negative, and regressive.

• Capping these provisions could be an inclusive growth oriented policy measure.

• EOI should reduce the extent to which individuals and companies are able to use offshore structures to avoid and evade tax.

• Needs a continued focus on the peer-review process and also the development of the network of EOI agreements

Expanding the exchange of information

Bilateral Relationships and the Multilateral Convention on Mutual Administrative Assistance in Tax Matters (MAC)

0

20

40

60

80

100

120

2000

2500

3000

3500

4000

4500

5000

5500

6000

6500

7000

2009 2010 2011 2012 2013 2014 2015 2016

Nu

mb

er o

f ju

risd

icti

on

s

Nu

mb

er o

f re

lati

on

ship

s

Bilateral relationships Relationships by MAC Jurisdictions joined MAC

AEOI allows countries to revisit the way they tax

capital income at the individual level

• Information exchange agreements will reduce opportunities for evasion of tax on capital income

• Trend towards lower statutory CIT rates, but EOI allows shifting the capital income tax burden from the corporate towards the individual level

• Rethink Savings Tax Expenditures

• Dual Progressive Income Tax

• Strengthening inheritance and gift taxes can support inclusive growth

• Use household wealth more effectively in income tax design (e.g. income and wealth testing of benefits)

OECD ongoing work on the Effective Taxation of Household Savings in all OECD member countries

Taxation and Skills

13

• Investment in skills lowers market income inequality

• The tax system has an impact on the incentives to invest in skills

• Huge literature on Tax and physical capital but limited focus on Human Capital?

• Are we getting the mix right between physical and human capital?

• Are we over-subsidising physical capital through the tax system and under-subsidising human capital?

• Does it pay for students to invest in skills? What is the impact of age?

• What is the effect of tax progressivity, direct costs including tuition fees, scholarship income and skills tax expenditures on the financial incentives to invest in skills?

• How much of government spending on education and training is returned to the governemtn in the form of future tax revenue?

• If the government decides to raise tuition fees, can it use the tax code to compensate workers’ incentives to upskill?

• OECD Tax Policy Study on “Taxation and Skills” aims at starting this discussion.

14

Taxation, Skills and Market Income Inequality

New indicators returns to costs ratios BEI – METR - AETR

15

Type of costs Government Student

Costs (Direct) • Direct EDU Spending • Scholarship Spending

• Tuition Fees • Books, Materials

Costs (Indirect) • Foregone Tax Revenue • Cost of Skills Tax

Expenditures (STEs) • Cost of student loans

• Foregone After-Tax Income

• Net of value of STEs

Returns • Higher Tax Receipts Post-Education

• Higher After-Tax Income

The tax system apportions the costs and returns of skills

investments between governments and individuals

• Tax and skills provisions build into the OECD Taxing Wages models

• OECD data on costs of tuition and direct costs of education for government

• Use of actual average college premiums earned in labour market

• Debt (i.e. tax implications when students borrow) and equity -financed investment in skills

• Calculation of:

– Break even earnings increment, METRs, AETRs (BEI = cost of human capital)

– Marginal and average returns to costs Ratios (Tobin’s Q)

• Different scenarios modelled: 17-year student who follows 4-year degree/ 32- year worker who follows a short training course/ 27 year worker who does a one-year master degree/ 50 year old worker who retrains during 1 year

• King and Fullerton & Devereux and Griffith methods but for Human Capital

16

Skills tax provisions in Taxing Wages

17

Break-Even Earnings Increment and METR on Skills

• “If a worker decides to get a Master’s degree, how much will she need to earn to recoup the costs?”

• “How much of the extra earnings needed to breakeven on a skills investment is because of taxation?”

18

For a 17-year old student, education pays for itself

0

50

100

150

200

250

Den

mar

k

Irel

and

New

Zea

lan

d

No

rway

Turk

ey

Gre

ece

Swed

en

Bel

giu

m

Esto

nia

Spai

n

Au

stri

a

Au

stra

lia

Icel

and

Fin

lan

d

Net

her

lan

ds

Isra

el

Ital

y

Un

ited

Kin

gdo

m

Swit

zerl

and

Can

ada

Luxe

mb

ou

rg

Slo

vak

Rep

ub

lic

Cze

ch R

epu

blic

Po

rtu

gal

Po

lan

d

Mex

ico

Hu

nga

ry

Slo

ven

ia

Ch

ile

% o

f W

age

Bef

ore

Ed

uca

tio

n Actual Labour Market Premium for Education Required Breakeven Premium

Results presented for the 17 year old university student case

Gap between actual return on investment and breakeven return

19

AETRs on skills investments

Results presented for the 17 year old university student case

05

10152025303540

Ch

ile

Po

lan

d

Turk

ey

New

Zea

lan

d

Esto

nia

Un

ited

Kin

gdo

m

Slo

vak

Rep

ub

lic

Swed

en

Swit

zerl

and

No

rway

Isra

el

Spai

n

Cze

ch R

epu

blic

Mex

ico

Gre

ece

Slo

ven

ia

Irel

and

Can

ada

Au

stri

a

Ital

y

Hu

nga

ry

Den

mar

k

Bel

giu

m

Po

rtu

gal

Icel

and

Au

stra

lia

Fin

lan

d

Luxe

mb

ou

rg

Net

her

lan

ds

Ave

rage

Eff

ect

ive

Tax

Rat

e, %

Average Effective Tax Rate on Skills

20

Average Returns to Costs for governments

0

0,5

1

1,5

2

2,5

3Tu

rkey

Swed

en

New

Zea

lan

d

Irel

and

Den

mar

k

No

rway

Esto

nia

Po

lan

d

Spai

n

Ch

ile

Slo

vak

Rep

ub

lic

Swit

zerl

and

Can

ada

Bel

giu

m

Fin

lan

d

Au

stri

a

Gre

ece

Mex

ico

Isra

el

Un

ited

Kin

gdo

m

Ital

y

Cze

ch R

epu

blic

Icel

and

Slo

ven

ia

Au

stra

lia

Hu

nga

ry

Luxe

mb

ou

rg

Net

her

lan

ds

Po

rtu

gal

Ave

rage

Ret

urn

s to

Co

sts

Rat

io

Lower Returns to Government From Education Spending

Higher Returns to Government From Education

Spending

Breakeven Point (Income Taxes Only)

Results presented for the 17 year old university student case

• While progressivity taxes away the returns to skill investments, investment in skills pay a healthy return to the individual on average…..

• …..but not for students who earn a small return in the labour market

• There is a need to provide information to students on the financial returns to skills which they can expect in the labour market……

• …….as Government is a stakeholder in the investment of skills, so it may want to ensure it earns a healthy return on its investment in skills as well

• Effect of tuition fees is small on incentives to invest in skills

• Tax support for skills is generally modest

• Tax support is often provided only for training related to the worker’s current job (in an attempt not to subsidise skills spending as consumption)

• Skills Tax Expenditures (STEs) are often regressive: higher incomes gain more

21

Tax and Skills Policy Insights (I)

• Older workers face higher BEI which makes up-skilling less (or not) financially worthwhile

• Early retirement leads to lower incentives to skills which leads to early retirement

• Idem for other situations where labour market attachement is weak!

• Skills Development and Skills Activation are complementary

• Policies to reduce credit constraints and reduce market failures potentially most effective, e.g. training funds & accounts, and income-contingent loans

• Higher skills = higher productivity so you can support higher tax wedge on labour income • Higher tax wedge on labour is particularly challenging when skill levels are low

• Impact globalisation

• Do not include firm training provisions as taxable income for PIT purposes 22

Tax and Skills Policy Insights (II)

23

Contact Details

Bert Brys, Ph.D. Senior Tax Economist

Head of the Personal and Property Taxes Unit Leader of the Country Tax Policy Team

Centre for Tax Policy and Administration

2, rue André Pascal - 75775 Paris Cedex 16 Tel: +33 1 45 24 19 27 – Fax: +33 1 44 30 63 51

Bert.Brys@oecd.org || www.oecd.org/tax