Published:  12:32 AM, 10 February 2019

Higher tax rate: US experience of hundred years

Higher tax rate: US experience of hundred years

The revenue department of the country appears to have only one objective that is to increasing revenue to meet the expenses of government and development. The political leadership tries to relieve small taxpayers by getting the largest possible contribution from the people with large incomes. But if the rates on large incomes are so high that they tend to evade tax, the small taxpayers will be left to bear the entire burden. On the other hand, there is a class in the community which cannot be reached at for tax purposes.

In most of the countries government fixes the rate of tax through independent department such as Bangladesh Tariff Commission and revenue department collects the tax but in Bangladesh National Board of Revenue (NBR) fixes the income tax, customs duty and  other taxes as well collects revenue.

There is a general impression that NBR can collect higher tax with higher rates of tax imposed on different section of tax payers. But global experience does not show that the higher rate produces the larger revenue.  The welfare of the society in form of employment and other is another option of determination of taxes. The problem is to find a best rate which will produce the largest returns.

It is a strong argument that lower tax rate increases higher revenue collection because the trained income of tax payers would lead to more economic activity, resulting in more revenue generation out of rising incomes, even though the tax rate was lowered. High tax rates encourage many people to avoid paying tax and do not necessarily bring in as much revenue to the government.

Bangladesh is heaven for investors in savings instruments due to government determined higher interest rates. Invertors earn more money from saving instruments than investment in the stock market. Lower tax rates bring more tax, when these lower tax rates make it safe for investors to invest their money where they can get a higher rate of return in the economy than they get from tax-exempt securities and generate employment opportunity and produce goods and services.

There is no dependable research on the impact of taxation policy to know the pros and cons of tax policy in Bangladesh. American study and research may be a reference for our policy makers. The US politics are centre around foreign policy as a global leader. But the national tax policy, social welfare and health expenditure and creation of jobs are major factors of mobilizing opinion of voters.  The evaluations of history of tax for last 100 hundred years are reflecting the history of reduction and increase of taxes.

During the tenure of President Franklin D Roosevelt' it was believe that the object of government was to provide prosperity for those who lived and worked at the top of the economic pyramid, in the belief that prosperity would trickle down to the bottom of the heap and benefit all. Then in practice, the situation has turned otherwise. Tax payers had been put vast amount of money into tax shelters such as tax-exempt municipal bonds, instead of being invested in the private economy, where this money would create more output, incomes and jobs.

The Woodrow Wilson administration sharply raised the tax during 1st world war and unfortunately fewer and fewer people reported high taxable incomes and had avoided tax by putting their money into tax-exempt securities or by any of the other ways of rearranging their financial affairs to minimize their tax liability. The number of people reporting taxable incomes of more than $300,000 (higher income segment of that time) declined from well over a thousand in 1916 to fewer than three hundred in 1921.

The statistics revealed that total amount of taxable income earned by people making over $300,000 declined by more than four-fifths during those years. The Treasury Department's estimated that the money invested in tax exempt securities had nearly tripled in a decade.

The total estimated value of these securities was almost three times the size of the federal government's annual budget, and more than half as large as the national debt. These investments in securities could be channelized to investment for a better impact on the economy. The than Treasury Secretary repeatedly sought to get Congress to end tax exemptions for municipal bonds and other securities, pointing out the inefficiencies in the economy that such securities created.

In 1921, when the tax rate on higher income group making over $100,000 a year was 73 percent, the federal government collected a little over $700 million in income taxes, of which 30 percent was paid by those making over $100,000. By 1929, after a series of tax rate reductions had cut the tax rate to 24 percent on those making over $100,000, the federal government collected more than a billion dollars in income taxes, of which 65 percent was collected from those making over $100,000.

The number of tax payers in higher segment changed ups and down. There were 206 people who reported annual taxable incomes of one million dollars or more in 1916. But, as the tax rates rose, that number fell drastically, to just 21 people by 1921. Then, after a series of tax rate cuts during the 1920s, the number of individuals reporting taxable incomes of a million dollars or more rose again to 207 by 1925.

Under these conditions, the government collected more tax revenue after tax rates were cut. Moreover, with increased economic activity following the shift of vast sums of money from tax shelters into the productive economy, the annual unemployment rate from 1925 through 1928 ranged from a high of 4.2 percent to a low of 1.8 percent.

In 1933, the US policy makers realized that taxation may be so high as to defeat its object, that given sufficient time to gather the fruits, a reduction of taxation will run a better chance, than an increase, of balancing the Budget.

In 1962, Democratic President John F. Kennedy, pointed out that "it is a paradoxical truth that tax rates are too high today and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now." He realized that investors always efforts to avoid tax liabilities and make investment in less productive but more profitable bonds and securities. It has inhibits the growth and efficiency of the economy. He realized the "purpose of cutting taxes" is "to achieve the more prosperous, expanding economy."

"Total output and economic growth" were italicized words in the text of John F. Kennedy's address to Congress in January 1963, urging cuts in tax rates. The tax policy advocated by President Kennedy was about inducing changes in behavior designed to increase aggregate output, not changing the allocation of existing income flows, in hopes that more prosperity at the top would "trickle down."

Much the same theme was repeated yet again in President Ronald Reagan's February 1981 address to a joint session of Congress, pointing out that "this is not merely a shift of wealth between different sets of taxpayers."President Regan expected that "real production in goods and services will grow." 

In short, He was advocating about after-tax income flows but about changes in behavior anticipated to increase aggregate output in the wake of changing tax rates. In 2001, President George W. Bush also proposed his tax rate cuts, citing the success of Kennedy administration and Reagan administration to boost the economy and employment.

The economic policy of the Barack Obama administration was characterized by moderate tax increases on higher income Americans designed to fund healthcare reform, reduce the federal budget deficit, and improve income inequality, while his predecessor Bush cut the tax for the highest income taxpayers. Obama's economic philosophy was also with same argument of the tickle down of prosperity from higher to everyone else. But the economy was performing well during Obama administration.

Andrew Mellon was Secretary of the Treasury by President Warren G. Harding in 1921. He served for 10 years and 11 months, the third-longest tenure of a Secretary of the Treasury. He had arguments that that it was better to place the burden of taxes on lower-income groups" and that a "share of the tax-free profits of the rich, Mellon reassured the country, would ultimately trickle down to the middle- and lower-income groups in the form of salaries and wages."

The free market economy has changes the tax and investment scenario to another dimension. Free and globalized economy makes overseas investments a readily available alternative to buying tax-exempt bonds domestically. Even if the domestic tax rate is not "high" compared to tax rates in other countries may attract investment in lower taxed countries by way of formal and informal transfer. At the same time, unemployed workers cannot nearly so readily relocate to other countries to take the jobs created there by investments fleeing higher tax rates at home.

Unfortunately, over the years, the arguments of the proponents and opponents of tax rate reductions have been arguments about two fundamentally different things. Proponents of tax rate cuts base their arguments on anticipated changes in behavior by investors in response to reduced income tax rates, so that their prosperity will somehow "trickle down" to others. The behavioral changes by investing in further business to create job and income for the citizen should develop the economic prosperity for all by trickle down of benefits.

The income tax in Bangladesh on individual and corporate is highest among the competing countries for FDI and local investment. Again, interests paid on government sponsored savings certificate are higher than Bank interest. The high income tax on business income and tax free high interest rate of savings certificates are double edged cutting on revenue collection, investment and employment creation.

The writer is a legal economist.
Email: mssiddiqui2035@gmail.com

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