High Range

14.25. It is sometimes argued that there is considerable scope for redistributing the income tax burden from the lower to the higher income groups. That is to say, tax reductions on lower incomes could be financed by tax increases on higher incomes. However, from the data of the distribution of the tax burden by grade of net income summarised in Table 14.B, it is readily apparent just how little scope there is for such redistribution. The 0.4 per cent of taxpayers in 1971–72 with net incomes in excess of $20,000 received only 3.0 per cent of taxable income, contributing 7.9 per cent of total tax collected. Given that the average rate of tax on a taxable income of $20,000 was over 40 per cent, further significant increases in revenue could not have been obtained from taxpayers in that range. An increase to 75 per cent in the average tax liability of a taxpayer on $20,000 would have left him with after-tax income of $5,000 and involved a near 100 per cent marginal tax rate. Such a change for all taxpayers with taxable incomes in excess of $20,000 would have added only about 3.5 per cent to total revenue, and then only if the taxpayers concerned had continued to earn the same income as before—a dubious assumption given the confiscatory marginal tax involved.

14.26. Hence in establishing what the maximum income tax rate should be, factors other than simply contribution to revenue must be the chief concern. As already indicated in paragraph 14.15, the question of the income tax scale inevitably merges with the wider issue of the progressivity of the tax system as a whole and the character of other taxes in the system. Within a narrower compass, considerations of some relevance in fixing the top rates of personal income tax include the relationship between the systems of personal and company income taxes, the effect of taxation on incentives to work and save, and the incentives provided by high rates of taxation for tax avoidance and evasion.

14.27. As is pointed out in Chapter 16, there may be some advantage in linking the maximum rates of personal and company income tax. This was, for example, a key element of the proposal of the Carter Commission for full integration of personal and company income tax, and West Germany is considering a scheme to link the maximum marginal rates of both taxes. Such a link affords a means of limiting the purely tax advantages of retaining undistributed profits in the hands of companies: the tax burden on undistributed profits would equal the top marginal rate of income tax and for most taxpayers this rate of tax would exceed the rate of personal income tax. Such a relationship, however, involves setting the maximum rate of tax applied to all personal income in the light of considerations relevant only to dividend income, which might easily lead to inappropriate results.

14.28. In fixing the maximum marginal rate of tax, as well as in framing the rate scale lower down, some account must be taken of possible effects on the incentive to work. A taxpayer's incentive to work is affected by both the ‘income’ and ‘substitution’ effects of income tax. Because income tax reduces a taxpayer's net of tax income, he will to that extent have an incentive to increase his work effort to recoup at

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least some of the income taken in tax. The extent of this income effect will be determined by the taxpayer's average rate of tax: the higher the average rate, the greater will be the influence of the income effect. However, the substitution effect works in the other direction. The effect of income tax is also to reduce the return from additional work effort, and the higher the marginal rate of tax the greater will be the incentive to reduce work effort and substitute leisure in view of the increased relative attractiveness of leisure.

14.29. Economic theory is thus inconclusive as to whether high rates of income tax adversely affect incentives to work. Commonsense reasoning suggests that the higher are marginal rates of tax in relationship to average rates the more is the substitution effect likely to outweigh the income effect; but psychological and sociological forces obviously play a major role in determining the work ethics of particular individuals, while the ability of taxpayers to vary the number of hours they work may be limited by such factors as the length of the miniumum working week or the state of demand in the labour market. It is little wonder that empirical evidence on the effects of income tax on incentives to work has tended to be inconclusive and of hardly any guidance to policy-makers.

14.30. The implications of income tax for personal saving are clearer, for here the substitution and income effects tend to reinforce each other. High marginal rates of income tax encourage the substitution of immediate consumption for saving; high average rates, especially at the upper end of the income scale where saving features more prominently, mean lower disposable incomes and hence less opportunity to save. But it must not be overlooked that a large part of saving today is undertaken in the business sector and by government; and the Committee has already expressed the view in Chapter 4 that incentives to save, like incentives to work, are important but not crucial in deciding how progressive the tax system ought to be.

14.31. What it is possible to be rather more certain about is the encouragement high marginal rates of income tax give to avoidance and evasion. The large number of professional people who own farms is not necessarily a reflection of a love of the land: tax considerations often loom large. High marginal rates of income tax substantially increase the reward from an activity of this kind, and attempts to avoid the workings of the law pose serious problems for the equitable administration of the tax system. As far as loopholes in the legislation or in the administration of the law are concerned, a frequent criticism of the tax system raised in many countries with high rates of taxation is that the tax system is steeply progressive only in form and that in substance many wealthy taxpayers are able to avoid the full effects of the progressive rate schedule. The Committee has been concerned in various of its recommendations in this report to limit the scope for tax avoidance.

14.32. Evasion of the law raises separate though to a large extent interrelated issues. Taxpayer compliance is an essential feature of the administration of a comprehensive income tax levied on a large number of taxpayers; and while evasion will always be a problem for tax administration, the problems can be expected to be more severe the lower the willingness of the public to accept that the tax system is a fair and equitable one. Except in special situations such as war-time, a high burden of income tax is unlikely to be favourably received by the population at large. This is a factor of considerable practical relevance to the design of a progressive rate schedule and explains in some measure why the Carter Commission in Canada and tax authorities elsewhere have been attracted by the prospect of a maximum marginal rate of 50 per cent.

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14.33. The Committee, too, sees advantages in top marginal rates of tax lower than at present. As a first step it might be possible, in the more immediate future, to lift the points on the income scale, in the top range, where the highest marginal rates start applying: for example, the 64 per cent rate could cut in at a taxable income of $40,000 instead of the present $20,000, and the 67 per cent rate at $80,000 instead of $40,000. But in line with the Committee's view that more reliance should be placed on the taxation of goods and services and less on personal income tax, a reduction in the maximum marginal rate to the region of 50 per cent would be thought an appropriate long-term target.