Nova workboard

a blog from young economists at Nova SBE


No one said it better than Oliver Wendell Holmes:

“I like paying taxes. With them I buy civilization.”


As a natural consequence of the widening of inequality, income taxes are being paid by a rapidly decreasing number of people. In the UK the 1% richest people, meaning with highest income, pay about 28% of the overall tax income. In the United States the 1% highest earners pay 46% of the total tax income.

The graph below that refers to the United States shows how drastically the income tax share has changed over the last three decades. Top 1% earners have significantly increased their tax share on income; on the other hand the rest 90% is paying overall less than what it is paid by that 1%.


There are two possible explanations for this trend. First, in the last 30 years, there has been a proliferation of tax credits, people had increasing possibilities to subtract a large percentage of their tax income; typical examples of deductions are: medical expenses, interest on home mortgages, education expenditure, rents and so on. This process can be dangerous as the increasing number of possible deductions can negatively affect the progressivity of the tax system. The more complex the system is the more difficult for the government to monitor everyone’s deductions is.

Secondly, referring mostly to corporate income taxes, it is becoming increasingly common that firms transfer their profits from high-tax to law-tax jurisdictions. United States, well known for having the world’s highest corporate tax rate, is facing serious distortions on its taxation system; $30 billion to $90 billion a year were estimated to be lost by the American government for profit shifting.

All these distortions undermine the main purpose of tax systems such as the American one, but also many others across the rich world. One of the main reasons is that the tax base is becoming narrow. This means an increasingly smaller number of taxpayers with an increasingly larger percentage of the tax burden.

Governments must strive for a broad tax base. For this reason the tax burden on income, both for companies and workers, should be lowered in order to first, boost people inclination to work and second, avoid distortions. One possible solution is shifting towards a higher taxation of consumption.

What is the difference between an income and a consumption tax?

The key difference lies in the different perception of savings. The consumption tax excludes current savings from the tax base therefore people have higher incentives to save more in the present. Whereas income taxes imply that people pay their taxes on taxable income that includes new savings too.

What are the possible impacts of shifting taxes to consumption?

Research suggests that shifting to a consumption tax system would help reducing tax distortions. It also suggests that in the long run the shift would raise real GDP. Wages, prices and interest rates would however rise in the period of transition. Although potential consequences on the short run have not been extensively studied it is likely that large change in price levels and nominal wages will represent a serious issue for monetary policymakers.

Giulia Casagrande  #745


Author: studentnovasbe

Master student in Nova Sbe

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