Taxes and Growth

October 15, 1962

LONDON—There is no such thing as an ideal tax system, especially when the total burden is heavy. Every tax is a deterrent to production or consumption.

When we compare the British and American tax systems from this point of view, we find that the British system is better than ours in some respects, but even worse in others. It is much better, for example, in its treatment of corporations. We tax the net income of our own corporations 52 percent. (This comparison throughout is in broad outlines and ignores many qualifications on both sides.) The British tax the net profits of their corporations only 15 percent. In addition they levy an “income” tax on corporate profits of 7 shillings and 9 pence in the pound (38¾ percent), bringing the total to 53¾ percent. This seems equivalent to ours. But this full rate applies in effect only to undistributed profits. For when the corporation pays out dividends, the individual shareholders are credited with having already paid their “standard rate” (38¾ percent) of personal income tax on these dividends.

DEPRECIATION

British companies also have an advantage over their American counterparts in depreciation allowances. The system is complex, but a typical example might work out like this: First, the corporation is allowed an “investment credit” equal to 20 percent of the cost of the investment. This is not deducted from its depreciation allowance. Then it is allowed an “initial” depreciation deduction of 10 percent. It may also take, say, a 10 percent depreciation at the end of the first year. In this way, it may write off 40 or 45 percent of a new investment in the first year.

All this is much more favorable than the depreciation treatment given to our own corporations, even under the new tax proposals. But British industrialists still complain that they are at a disadvantage with their competitors in the Common Market because of the much shorter period over which many of the latter may write off their investments entirely.

When we come to taxation on personal income, there seems to be only one major respect in which the British taxpayer enjoys an advantage over our own. This is in the treatment of capital gains. Until this year, Britons paid no tax on these at all, unless capital gains were a regular part of business income. Now short-term capital gains (within six months for most property, three years for land) will be taxed as ordinary income. But long-term gains are still completely exempt from tax. And owner-occupied dwellings and other property are still exempt even from short-term capital-gains tax.

HIGH RATE, LOW YIELD

In practically every other respect the British taxpayer seems much worse off than his American opposite number. Compared with our “normal” tax of 20 percent, the British “standard rate” (beginning at about $1,000 of taxable income) is 38¾ percent. Our surtaxes, it is true, go as high as 91 percent, but stiff British surtaxes begin at much lower income levels and they reach a top rate of 88¾ percent for incomes above $42,000. And the British death duties rise to 80 percent for those estates in excess of $2.8 million.

The harm that such tax rates do to economic growth can hardly be calculated. Neither in the U.S. nor in Britain do they raise any revenue to speak of. In the U.S. the personal income tax rates over 50 percent raise less than $1 billion—about 1 percent of the total Federal budget and enough to run the government for only three or four days. In Britain all the surtax rates together bring in only £188 million out of total revenues of £6,807,000, or less than 3 percent. All the death duties together bring in £265 million, or less than 4 percent. Yet in both countries such taxes gravely undermine incentives to production and saving. They siphon off the very funds most likely to go into investment. Both hurt wage-earners by retarding the rise in their productivity and real wages. Yet such destructive taxes are kept in the name of “social justice,” and both British and American government officials publicly wonder why the rate of economic growth in their respective countries is so disappointingly low.