INSIGHTS into the WORLD / Global tax reform necessary for equality

By Hiroshi Watanabe / Special to The Yomiuri Shimbun

15:47 JST, October 29, 2021

A sense of inequality is growing around the world about issues such as income distribution. In the coming decade, a pivotal challenge for the international community certainly will be how it should address this feeling of unfairness.

From the perspective of alleviating economic inequality, namely the wealth gap between rich and poor, one may readily envision setting an upper limit on personal income.

This concept is similar to a company’s board determining to keep the annual salary of its chief executive below ¥100 million. If such a decision is aimed concurrently at correcting income inequality and raising the wage floor, it may be conceivable to specifically set “the CEO’s salary at up to 50 times that of newly recruited employees,” for instance.

However, the abovementioned limitation can lower the correlation between achievements and rewards. An approach that makes light of performance evaluation tends to entail a decline in the so-called time-cost awareness that eventually impairs work efficiency.

Those who become subject to upper limits on their salaries supposedly are far from convinced and feel dissatisfied. This dissatisfaction with restraints on salaries often motivates people to find alternative ways to earn money. Even if they dare not commit a crime such as embezzlement, they tend to have a warped sense of being entitled to certain privileges within a company. Each of them may insist: “I should be given special treatment in return for the salary cap.”

On the other hand, the measure to put a limit on executive salaries cannot help correct income inequality on its own if there is an increase in the number of board members receiving compensation in the form of share allotments and dividend payments.

Against this background, I propose that income inequality be corrected by the statutory tax burden — which varies depending on income levels — instead of having the private sector adopt informal restraints on personal income.

In the area of personal income taxation, the existing tax rates should be reconsidered with a view to strengthening the progressive taxation structure that requires higher taxes for those with higher income. To that end, one possible solution can be a change in the taxation method — from applying different tax rates on different types of income to putting in place a comprehensive tax to be levied on aggregate income.

Fifty years ago, the highest tax rate on personal income in Japan stood at 93% with the national and local income tax rates combined. Many readers must be surprised to know how heavy the tax burden used to be. In the past 30 years or so, many countries in the world have pursued considerable lowering and flattening of tax rates based on the Laffer Curve theory, which argues that tax revenue decreases when the tax rates become too high. For its part, Japan has decreased the highest tax rate on personal income to 55%.

In my view, there is room for Japan to resume raising the highest tax rate by reviewing such aspects as the existing highest taxable income bracket. For example, there must be some people who will question the advisability of imposing a tax rate of as high as 80% on those with annual incomes of more than ¥100 million. How will they then react to an idea of lifting the applicable income level to more than ¥5 billion? I think fresh discussions from such a viewpoint now are necessary.

It is known that the more one earns, the less one feels satisfied with additional income, a state that is described as “utility” or the quality of being useful. Higher income tax rates are applied to people in the higher income brackets on the basis of the “law of diminishing marginal utility.” It is high time to assess and review the balance between personal utility and social utility, while giving due consideration to not deterring high-income earners’ motivation to work.

When someone comes up with a proposal that the tax burden of high-income people be increased, it usually will be strongly refuted because “an excessive hike in the tax rates will likely trigger an exodus of wealthy taxpayers to foreign countries with lower tax rates.” Of course, such an argument should not be ignored, given that contemporary society enables a person to easily move from country to country in both systematic and physical terms. Nevertheless, tolerating the presence of countries with lower tax rates is unproductive in that it will unnecessarily result in tax revenue contraction worldwide.

In reality, lower-tax countries certainly will stay for a while as they are. If other countries want to prevent their taxpayers from migrating to lower tax countries for tax avoidance, they will have to introduce some preventive measures, including collecting an inhibiting tax on remittances to lower tax destinations. Of course, there are acts of tax avoidance via third countries that place no restrictions on remittances to lower tax countries. Those countries should be classified as “quasi lower tax countries” and made subject to similar measures.

We have another big issue — a cutback in special taxation measures. The personal income tax regime offers a variety of special measures for asset building, primarily benefiting the wealthy. Many of the “have-nots” apparently feel dissatisfied with those measures.

No doubt, there are few people willing to pay as much tax as possible. However, U.S. billionaire Warren Buffett once raised the question about tax breaks for the rich, rhetorically asking if it was right that he pays a lower tax rate than his secretary. He and other wealthy Americans have said publicly that they should pay more taxes. As such, there has been an increase in voices calling for the use of taxation to respond to the growing sense of inequality.

In the area of personal taxation, asset transfer taxes such as the inheritance tax and gift tax as well as asset holding taxes also should be considered as effective measures for rectifying inequality. Reviewing these taxes should also be considered.

As for corporate income taxation, it is essential to expand and standardize the list of taxable objects and maintain the relevant tax rates.

First, let me focus on taxable objects. With regard to information technology-related taxes that have been drawing much attention, video games, digital content and information distribution, including those sold and purchased online, should be covered, without fail, by the list of consumption-related taxable objects.

In the United States, for example, there is a one-off opportunity to collect taxes, making interstate taxation difficult. To resolve this drawback, I would like to call for greater international cooperation, including making a strong recommendation to the United States to introduce a multi-stage value-added tax that is charged on the same goods and services at successive stages of production and distribution.

Second, the international community needs to adopt an international standard set of tax rates. Corporations currently continue abusing tax havens of certain tiny countries, causing other countries to lose tax revenue. Moreover, a considerable number of countries continue trying to attract foreign companies with lower tax rates. This tax-reducing competition will go nowhere but to a “zero tax” world, a development that will not benefit any country, including any of the tax havens.

All countries in the world should agree to adopt an across-the-board tax regime that will have the taxable consolidated income of all corporations in the world taxed above a certain threshold rate. In this connection, 136 countries and jurisdictions recently reached a groundbreaking tax deal to ensure that multinational corporations will be subject to a global minimum corporate tax rate of 15% from 2023. I welcome the agreement as a step forward, but, in my view, it is desirable to set the minimum tax rate at 20% to 25%.

The overall tax burden of each corporation will be determined by an internationally agreed tax rate. It can be up to each corporation to determine how to allocate tax payments among countries and jurisdictions, depending on the scale of business activities and other factors.

If a company bases much of its business activities in a lower tax country, it may not be able to allocate all its tax payments. In the event of any remaining balance of tax revenue allocations, there may be two options: 1) the balance will be paid as an international contribution tax to either the United Nations or the World Bank or a new multilateral institution yet to be formed; or 2) countries with the taxing rights will reallocate the balance to them according to a new international rule.

The ideas presented above are not so easy to realize. There will be considerable resistance from the countries and corporations concerned.

However, the issue of cross-border corporate taxation can no longer be resolved through minor alterations. The world, in the meantime, has changed to so great an extent that the environment for worldwide taxation reform is now in place. For example, the progress of digitization has already helped markedly reduce pressure associated with the paper-based tax-related administrative process, which had been thought to be a hindrance for any revamping of global taxation.

By the way, the relationship between the United States and China — which both once moved together to offer tax exemption or lower tax rates to information technology companies and digital information providers — now is in a deepening phase of confrontation.

Britain, for its part, has opted for a sea change from its feverish push for lower corporate tax rates in the wake of the twin challenges of the Brexit withdrawal from the European Union and the COVID-19 pandemic. The country now plans a personal tax hike in 2022 and a corporate tax increase in April 2023 to repair government finances.

The international community now should move forward to share a grand design for a new tax regime it should pursue by taking advantage of the tailwind surrounding tax reform efforts, and take a step forward to realize it.