Università Bocconi, A.A: Mec – Comparative public economics 1 Università Bocconi A.A Comparative public economics Giampaolo Arachi

Università Bocconi, A.A: Mec – Comparative public economics 2 Course presentation Objectives and main topics Tax law fundamentals Introduction to “Tax Planning” References: M. Scholes, M. A. Wolfson, M. Erickson, E. L. Maydew, T. Shevlin (SWEMS), Taxes and business strategy: a planning approach, Pearson Prentice Hall, third edition, 2005, ch.1 and 2 K. Messere, F. de Kam, C. Heady, Tax policy: theory and practice in OECD countries, OUP, 2003, ch. 2, 6, 8, 10

Università Bocconi, A.A: Mec – Comparative public economics 3 Course presentation Objectives and main topics Tax law fundamentals Introduction to “Tax Planning”

Università Bocconi, A.A: Mec – Comparative public economics 4 Objectives The course provide an analysis of one of the main channels through which the State affects the allocation and the distribution of resources in the market economy, namely the fiscal system. The ultimate goal of the course is to provide students with a new approach for thinking about taxes which is sufficiently general to be applicable across tax jurisdictions and over time as the tax laws change. The course also aims at providing the basic tools to evaluate the effects of tax planning on economic efficiency and on the design of an efficient tax system.

Università Bocconi, A.A: Mec – Comparative public economics 5 Outline First part: describes the key features of the fiscal systems in industrialized countries Second part: evaluates the role of taxation for a wide number of business decisions Third part: provides the basic tools to evaluate the effects of tax planning on economic efficiency and on the design of an efficient tax system

Università Bocconi, A.A: Mec – Comparative public economics 6 Main topics 1. Effective tax planning requires that the tax implications of a proposed course of action be investigated from the standpoint of all parties involved. In many cases, differences in tax status across parties create tax arbitrage opportunities. 2. Effective tax planning requires considering both explicit taxes (taxes paid directly to the government) and implicit taxes (taxes paid indirectly in the form of lower before-tax rates of return on tax-favored investments). 3. Effective tax planning requires the planner to recognize that taxes represent only one among many business costs, and all costs must be considered in the planning process.

Università Bocconi, A.A: Mec – Comparative public economics 7 Main topics Identical production and investment strategies can be undertaken by taxpayers through a variety of different legal organizational forms, each of which is taxed very differently Different investments undertaken within a given organization are taxed very differently. This give rise to implicit taxes as the after-tax- returns of these differentially taxed assets are brought into closer alignment with one another When there are no costs to implementing tax planning strategies the taxpayers may eliminate all income taxes through simple arbitrage techniques. Furthermore all taxpayers will pay taxes at identical tax rates and there will be no tax clienteles.

Università Bocconi, A.A: Mec – Comparative public economics 8 Course presentation Objectives and main topics Tax law fundamentals Introduction to “Tax Planning”

Università Bocconi, A.A: Mec – Comparative public economics 9 Tax law fundamentals Fundamental differences among countries Federal vs. Unitary regimes (Switzerland vs. France) Civil Law vs. Common Law Most fiscal systems are based on 5 main taxes Personal income tax Corporate income tax Taxes on wealth and property Consumption taxes (Sales taxes and VAT)

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Università Bocconi, A.A: Mec – Comparative public economics 11 Personal income tax Mechanisms of personal income tax The tax base The tax schedule The tax unit and family taxation History and rationale of PIT

Università Bocconi, A.A: Mec – Comparative public economics 12 Mechanisms of personal income tax Gross income (sum of income from different sources: wages and salaries, dividend and interest income, sales revenue, appreciation in assets owned ect.) – tax allowances (tax deductions in U.S.) = Net income (taxable income or tax base) x tax rates = gross tax – tax credits = Net tax

Università Bocconi, A.A: Mec – Comparative public economics 13 The tax base Comprehensive income tax Expenditure tax Dual income tax

Università Bocconi, A.A: Mec – Comparative public economics 14 The tax base Comprehensive income tax Schanz-Haig-Simons and Carter Commission 1966 in Canada the tax should be levied on an individual’s potential consumption, defined as the maximum amount which a taxpayer would be able to consume without eroding his real stock of net wealth Labour income, capital income, capital gains, imputed income from owner-occupied property

Università Bocconi, A.A: Mec – Comparative public economics 15 The tax base Weaknesses of a Comprehensive tax base Taxation of capital gains Deductibility of interest payments Taxation of income from financial investment

Università Bocconi, A.A: Mec – Comparative public economics 16 The tax base Problems in taxation of capital gains Long term gains and progressive rates Inflation Deduction for capital losses? Taxation on realization: lock-in effect and tax deferral (step-up in basis) Accrual taxation: high compliance costs

Università Bocconi, A.A: Mec – Comparative public economics 17 The tax base Capital gains taxation Separate tax on capital gains: Ireland, Italy, UK Taxed within the income tax: –comprehensively, including long-term gains: Australia, Canada, France, Japan, Spain, Sweden, U.S. –special provision mainly confined to short-term gains: Germany –no or almost no special provisions: Netherlands and New Zealand

Università Bocconi, A.A: Mec – Comparative public economics 18 The tax base Deductibility of interest payments Mortage interest payments Interest related to consumer credit expenditure Tax avoidance strategies if combined with Preferential treatment of imputed income from owner-occupied property Deductibility of contributions to private pension schemes and a favorable treatment of the income of the pension fund and/or the pension payment Deductibility of premiums on life assurance policies combined with a partial exemption of the proceeds Exemption of interest payments received on post office savings, bank deposits, government bonds

Università Bocconi, A.A: Mec – Comparative public economics 19 The tax base Progressive Expenditure tax The base would be consumer expenditures, represented by labour and capital income plus gifts and bequests received, minus savings made

Università Bocconi, A.A: Mec – Comparative public economics 20 The tax base Weaknesses of an Expenditure tax Cash flow tax on corporate income Transitional adjustments Pro-cyclical Avoidance of bequest tax Renegotiation of tax treaties

Università Bocconi, A.A: Mec – Comparative public economics 21 The tax schedule Global systems Schedular systems each source of income is subject to different rates of tax

Università Bocconi, A.A: Mec – Comparative public economics 22 The tax schedule Global taxation How progressive should the rate schedule be? At what level should the threshold be set? How should inflationary fiscal drag be handled? Should there be a local PIT and if so, what should be its relation to the central PIT?

Università Bocconi, A.A: Mec – Comparative public economics 23 The tax schedule Schedular systems Alternative minimum tax higher income taxpayer are obliged to pay whichever is the greater of 21% of their gross income or the normal rate schedule applied to their taxable income Dual income tax capital income is taxed at the same rate as corporate income and at (around) the lowest marginal rate applied to earned income

Università Bocconi, A.A: Mec – Comparative public economics 24 The tax unit – family taxation Motivations for taxing family vs individual income Married couples enjoy economies of scales but they bear additional costs Artificial splitting of unearned income

Università Bocconi, A.A: Mec – Comparative public economics 25 The tax unit – family taxation Difficulties in taxing family income under a progressive tax Non-neutrality with respect to marriage Disincentive to women participation to labour force

Università Bocconi, A.A: Mec – Comparative public economics 26 The tax unit – family taxation Alternative methods Individual taxation with allowance and credits for family status Income-splitting (e.g. Germany) Family quotient systems (e.g. France) Separate schedules (e.g. U.S.)

Università Bocconi, A.A: Mec – Comparative public economics 27 History and rationale of PIT First introduced in UK at the end of eighteenth century to finance the Napoleonic wars Until the II World War it remained a relatively unimportant tax In the 1970s increasing dissatisfaction due to the complexity, reduced base, inflation 1980s widening of tax base and reduction of rates 1990s several reforms towards a DIT