Throughout this year’s US presidential election campaign, the question of Republican candidate Mitt Romney’s tax returns haunted him. He steadfastly refused to release his tax returns for twelve previous years unlike other presidential nominees in the past. There was always the sense that he had something to hide. He did eventually release his 2010 and 2011 tax returns, but the figures hardly helped his case.
Although the top rate of federal income tax in the United States is 35 percent, Romney only paid 13.9 percent in 2010 and 14.1 percent in 2011. His income was certainly large enough to be attracting the top rate. In 2010, Romney and wife declared income of US$21.7 million, well within the income bracket of “US$373,651 and above” that attracts the top rate. In 2011, the couple declared income of US$13.7 million, again within the income bracket of “US$379,151 and above” that attracts the top rate.
On average, US middle-income families — those making from US$50,000 to US$75,000 a year — pay 12.8 percent, according to congressional research (source: BBC). And according to the Center on Budget and Policy Priorities, the next-to-the bottom fifth of the US population — those with incomes between US$20,500 and US$34,300 in 2007 — paid an average of 10.6 percent of their incomes in federal taxes (source: cbpp.com).
The two chief reasons why Romney paid so little were that (1) most of his income came from capital gains and (2) the couple made huge donations to charity, mainly the Mormon Church (source: usnews.com). Over the two years, the couple donated about US$7 million. In 2011 alone, they donated more than $4 million and claimed a tax deduction of $2.25 million for it (source: CBSnews).
What is capital gains tax?
Basically, it is a tax on profits that an investor realises when he or she sells an asset at a price that is higher than the purchase price. Capital gains taxes are only triggered when an asset is realised, not while it is held by an investor. In other words, your paper gains are not taxed. An investor can own, for example, shares that appreciate every year but the investor does not incur a capital gains tax on the shares until they are sold.
In the United States, the tax is computed on the net capital gains in a year. If an investor sells two stocks in a year, one at a profit and another at a loss, the amount of capital loss incurred on the latter is netted off the gains from the former for taxation purposes. Not all countries use this principle, though.
Other assets that can easily be made subject to capital gains tax include precious metals and property. However, a person’s main home, when sold, can be exempted from capital gains tax, or, as in the United Kingdom, be set off against a predetermined relief amount.
Capital gains are taxed at 15 percent in the United States, and yet the Romneys managed to pay under that figure; I can’t explain how but I see plenty of news stories bruiting Cayman Islands (a well-known tax haven), etc.
Unsurprisingly, a major theme through the US election campaign was whether the rich should be paying more in taxes.
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In Singapore, the issue of the widening income gap has been high among people’s concerns for several years now. Add to that concerns about the thin social safety net (e.g. poor coverage of healthcare and aging needs), and the question of having to raise more taxes will inevitably surface.
Former chief economist at the Government of Singapore Investment Corporation Yeoh Lam Keong, in a talk he gave on 6 November 2012, said that to strengthen our social safety net, the state will need to spend an additional ten percent of GDP. The two largest components of the needed increase are healthcare and education. We need higher public spending of about 4 percent of GDP on healthcare and about 6 percent on education. Regarding the latter, we are currently spending on 3.7 percent of GDP, compared to the OECD average of 6 percent, he noted.
I too said in a recent article that Singapore’s public spending is currently too low and needs to go up. See In the national conversation, some kinds of talk don’t come cheap.
A simple comparison will show how pertinent the question is. Singapore’s top rate for income tax is 20 percent, compared to the US’ 35 percent. Our capital gains tax is zero percent (i.e. we don’t have any) compared to 15 percent in America. If under the tougher tax regime of the US, rich people like Mitt Romney managed to pay about 14 percent annually, what do you think he (and those like him) would have done in Singapore?
So, raising taxes may be unavoidable, but which taxes? A capital gains tax may be worth considering.
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There is also a moral angle. Wealthy people with the wherewithal to own large assets can live off buying and selling assets, enjoying capital gains as a result. Less wealthy people have to work to earn a living. We tax income from work, but not capital gains. It just feels a bit wrong.
Moreover, in times like these when, even for the middle-income group, income from work is stagnating, there is a growing temptation to look to speculative assets as an additional avenue of financial gain. The question we might want to ask is whether the absence of capital gains tax fuels speculative bubbles. Has the upward trend in property prices been exacerbated by this?
On the other hand, someone somewhere is going to argue that imposing such a tax would seriously undercut our ambition to be a financial centre. If it is as dreadful as that, then how is it that London can be the world’s leading financial centre when the United Kingdom has capital gains tax of 18 to 28 percent? Perhaps there is a difference, and Singapore is more reliant on hot money, money that is meant for evading taxes. Impose the slightest tax and the money will flee. I don’t really know if this is the case, but what I do know is that Singapore is now in the gunsights of other countries wanting to crack down on tax havens. So, maybe there’s something to the accusation, in which case the question becomes: Do we really want to be that sort of place?
A more serious objection to a capital gains tax is that it can disincentivise entrepreneurship. Someone with a bright business idea may slog at it for years, hoping that one day, he or she can either list their start-up venture on the stock exchange via a successful initial public offering or sell the company for a healthy return. Indeed, it is good for a creative economy to encourage such effort. One easy way around the problem is to exempt from capital gains tax any realised increase in value of shares if those shares are held by people actively working in the company.
In short, if we need to raise more money for public goods, Singaporeans should think about a capital gains tax.