This chapter presents the conclusions of the Taxation of Houshold Savings report and discusses potential tax policy options. It concludes that, while countries do not necessarily need to tax household savings more, there is significant scope to improve the way countries tax household savings. Most significantly, there are opportunities for countries to increase neutrality in taxation across assets and thereby improve both the efficiency and fairness of their tax systems. There may also be opportunities for many countries to increase progressivity in their taxation of savings. At the same time, there remains a case for well-designed preferential tax treatment of private pensions in order to encourage retirement savings. The chapter also highlights opportunities for improvement in tax design regarding private pensions and in a number of other areas such as residential property, in particular to improve the equity of the tax system.
Taxation of Household Savings
Chapter 6. Conclusions and policy options
Abstract
6.1. Introduction
Countries take a wide range of approaches to taxing household savings. Historically, most OECD countries tended to tax capital income on a comprehensive basis together with labour income at progressive rates. While many countries still follow this broad approach, a significant number of countries reformed their tax systems in the 1980s and 1990s to tax capital income separately from labour income, at lower flat rates. At the same time, many countries also introduced specific tax-favoured regimes for certain forms of capital income. These reforms were generally motivated by two factors: concern about low levels of savings, and difficulty in imposing high progressive tax rates on mobile capital income due to the ability of some taxpayers to hide wealth offshore.
Since this period of major reform, a number of factors have changed that make a review of the taxation of household savings timely. Inequality has continued to increase. This has been brought into particular focus as a result of the 2008 global financial and economic crisis, and has led to strong calls for greater taxation of savings and wealth in many countries. Furthermore, recent changes in the international tax environment regarding the exchange of financial account information between tax administrations can be expected to significantly alter the ability of countries to tax capital income. Meanwhile, concern about low levels of retirement savings persist, particularly in light of continued population ageing.
This report has undertaken a detailed review of the taxation of household savings in OECD and key partner countries in light of these and other developments. It has examined the different approaches that countries take to tax savings and quantified the incentives created by these approaches; examined the distribution of asset holdings in a range of OECD countries; and examined the ground-breaking changes in the international tax environment. This final chapter brings together the insights from this analysis and discusses their implications for savings tax policy.
The chapter is structured as follows: 6.2 6.3 summarise the key messages from the preceding chapters of the report; 6.4 then presents the resulting conclusions and discusses policy options. Finally, 6.5 points towards future research.
6.2. The taxation of household savings
The focus of this study has been on assessing the efficiency and equity consequences of savings taxation in OECD and key partner countries. There are a wide variety of approaches taken by countries to the taxation of household savings. Details of these approaches have been outlined in Chapter 2.
Most countries tax the majority of savings vehicles broadly following either a comprehensive income tax or flat rate capital income tax approach. Under these approaches, no tax relief is provided on acquisition of the asset, income is taxed as it is earned at either progressive or flat rates, and distributions are untaxed (see Box 6.1 for a summary of various stylised tax systems). However, even within these two broad approaches there can be significant differences in taxation, particularly in relation to the size of statutory tax rates on income and regarding the tax treatment of capital gains. Meanwhile, some assets – e.g. private pensions – are typically taxed on an entirely different basis. The addition of transaction, wealth and recurrent property taxes on some, but not all, assets adds further complexity to any comparative analysis.
Box 6.1. Stylised approaches to taxing savings
Based on the approaches currently taken by countries (as summarised in Chapter 2), it is possible to distinguish several “stylised approaches” to how OECD countries tax savings: a comprehensive income tax, a flat rate capital income tax; an expenditure tax, a tax exempt savings approach; a tax deferral approach; a rate of return allowance approach; and a deemed return approach. Most countries implement a combination of these approaches.
Under a comprehensive income tax (CT) approach, labour and capital income are taxed together at progressive rates. No tax relief is provided when the saving is made. A pure CT approach is based on the Schanz-Haig-Simons comprehensive definition of income, and would require all income and gains to be taxed on an accrual basis. However, in practise this is extremely rare with capital gains being taxed instead on realisation. As such we refer to such systems, where they are in place, as “broadly comprehensive”.
Under a flat rate capital income tax approach, labour and capital income are taxed separately, with capital income taxed at a flat statutory rate. Like a CT approach, no tax relief is provided when the saving is made. Two subsets of this system are a dual income tax system and a final withholding tax system.
Under an expenditure tax approach, taxes are levied only when income is spent. An expenditure tax approach is often taken in relation to private pension savings. In such cases, upfront relief against income tax is given for amounts saved, returns from savings are untaxed as they accrue, but both savings and returns are taxed when a pension is paid.
Under a tax exempt savings approach, no relief is provided when savings are made. However, returns are untaxed as they accrue, and both savings and accrued returns are untaxed on distribution.
Under a tax deferral approach, no tax relief is provided when the saving is made, returns from savings are untaxed as they accrue, but the accrued returns are taxed on distribution (either at flat rates, or together with labour income at progressive rates). This approach is typically applied when intermediaries manage the household savings on behalf of the individual.
Under a rate of return allowance (RRA) approach, taxation occurs as with a CT approach or a flat rate capital income tax approach except that an allowance is provided for the normal return on savings. As such only economic rents from savings are taxed at the individual level. Any unutilised allowance amount would be carried forward to future years.
Under a deemed return approach, the actual return on savings is not taxed but a presumptive return is taxed instead. No tax relief is provided when the saving is made, and there is also no taxation on distribution or when capital gains are realised. A single or multiple deemed return can be applied and can be taxed at a flat or progressive rates.
Given the variation in approaches, an assessment of the magnitude of the taxes on capital income at the individual level and their impact on the incentives individuals face to save in different forms requires a methodology which goes beyond a mere focus on statutory tax rates. A focus on statutory tax rates, for example, would not capture the impact of multiple taxes on a particular savings vehicle, of deductions and variations in the tax base, of different holding periods and the potential build-up of untaxed or tax-deferred returns, and of variation in the type of return generated (e.g. interest, dividends, or capital gains). In addition, statutory tax rates do not take account of inflation which can result in a significant increase in the effective tax burden on the return to savings.
Consideration of all aspects of taxation is therefore crucial to properly assess the overall coherence of savings tax systems. Chapter 3 achieves this by calculating marginal effective tax rates (METRs) which enable the impact of a wide range of taxes and tax design features to be incorporated into the one indicator. The METR methodology applied in this report builds on and extends the methodology applied in OECD (1994). The results for the 40 countries examined in Chapter 3 highlight significant variation in METRs across savings vehicles. Tax systems create significant incentives to alter portfolio allocation away from that which would be optimal in the absence of taxes, with some assets tending to be particularly tax-favoured as compared to others.
The variation in the taxation of savings has efficiency and equity consequences. Chapter 4 provided an evidential base for examining the distributional effects of the taxation of household savings by analysing patterns of asset holdings in selected OECD countries across both income and wealth distributions. The analysis draws on income and asset-holdings microdata for 18 countries from the Eurosystem Household Finance and Consumption Survey (HFCS).
General trends
The METR results from Chapter 3 are broadly summarised in Figure 6.1 which presents the distribution of METRs across the 40 countries considered for a range of savings vehicles for an average-income, average-wealth taxpayer. Pension funds tend to be the most tax-favoured asset class, with owner-occupied residential property, and tax-favoured savings accounts also significantly tax-favoured. Perhaps surprisingly, rental property is often subject to relatively high METRs due to the application of progressive marginal personal income tax (PIT) rates, capital gains taxes and significant property taxes.
Figure 6.1. Distribution of marginal effective tax rates across countries for each asset type: average income and wealth taxpayer case, 2016
Explanatory note: The bold horizontal line within each “box” represents the median METR for that asset type, while the box itself reflects the inter-quartile range. The extreme points of each “whisker” show the minimum and maximum METR values for each asset type, excluding outliers. An outlier is defined as a result more than 1.5 times the inter-quartile range below the first quartile or above the third quartile.
Variation in the progressivity of savings taxation is not observed in Figure 6.1, but stems from different aspects of the tax system. For example, the distinction already highlighted between progressive rates in some countries and flat rate approaches in others is clearly seen in the METR results presented in Chapter 3, with countries either applying constant METRs across income levels or progressive METRs. Variation in progressivity can also stem from deductions and exemptions. Countries providing deductions for contributions to pension funds provide greater support to higher income taxpayers than lower income taxpayers. Similarly, countries allowing mortgage interest deductibility provide greater support to higher income than lower income households.
Bank accounts, bonds and equities
The majority of countries broadly follow either a comprehensive income tax or flat rate capital income tax approach to the taxation of bank accounts, bonds, and equities. Eleven countries apply broadly comprehensive approaches, with progressive rates applying to capital income, though not necessarily to capital gains – which are often taxed at lower or even flat rates. Capital gains are also taxed on a realisation rather than accrual basis, which tends to significantly lower METRs on equity when income is retained within the company and to a lesser extent for bonds when issued below par.
In 21 countries, flat rates are applied to all capital income either as part of a dual income tax or a final withholding tax system. Rates are almost always at a significantly lower level than the top marginal rates on labour income. Capital gains are again taxed on a realisation rather than accrual basis.
In the remaining countries, a mixed approach is common – with low income taxpayers subject to withholding rates, and higher income taxpayers subject to progressive rates. Finally, there are a range of less common approaches, such as the deemed return approach in the Netherlands, and the rate of return allowance approach applied on equities in Norway.
As outlined in Chapter 4, bank deposits are the most common form of financial asset held by those with low levels of income and net wealth. By contrast, equities and bonds are much more likely to be held by those with higher levels of income and wealth.
Private pension funds
There is broad consistency across countries in the tax treatment of private pension funds, which are taxed on an expenditure basis in 32 out of 40 countries. That is, tax relief is provided for contributions made to an approved private pension scheme (though all countries have some limitation on the amount of eligible contributions); there is no taxation of the income accrued within the pension fund, but distributions are taxed (though to differing degrees). Countries that follow a comprehensive income tax approach for other assets generally apply progressive rates to distributions, though often at concessionary rates as compared to labour income. Other countries tend to tax distributions at flat rates.
A small number of countries tax pensions on a comprehensive income tax basis, while a few adopt other variants (such as taxing income accrued within a pension fund). Tax relief for contributions is provided as a deduction in many countries, but via a tax credit in a smaller number. Several countries with flat rate PIT systems provide deductions that are effectively equivalent to applying a tax credit.
As will be discussed below, pension funds are a key source of household savings, and encouraging pension saving is a key policy goal in the context of ageing societies. However, the taxation of pensions also has distributional consequences. Chapter 4 has shown that pension wealth, on average, rises with income and net wealth as a share gross financial wealth (though there is substantial between-country variation). Thus, the concessionary treatment of pensions generally favours richer households more.
Investment funds
There is considerable variation in the taxation of investment funds across countries, with the approaches applied in each country not necessarily consistent with the broad approach taken to most other assets. In some countries, a broadly comprehensive income tax approach is taken with income taxed as it accrues in the fund, but in many others tax is deferred until distribution of the income occurs. Countries that apply progressive rates on other assets typically do the same for investment funds, and likewise with flat rate countries. In some cases, potentially depending on the form of the return, income from an investment fund can effectively be tax exempt.
Chapter 4 highlights that investment funds are generally held by those with higher levels of income and wealth, so preferential tax treatment of these funds can be regressive.
Tax-favoured savings accounts
A number of countries have tax-favoured savings accounts, typically following a tax exempt pure labour tax approach, but with a limit on contributions. In some cases a comprehensive income tax approach is applied but at concessionary tax rates. Unfortunately, no distributional information is available on tax-favoured savings accounts in the HFCS data.
Residential property
The tax treatment of residential property varies depending on whether the property is rented or owner-occupied. Residential rental property is typically taxed on a comprehensive basis, in a similar way to interest income. No tax relief is provided upfront and returns are taxed as they are earned, but no further taxation is due on disposal. Both interest and capital gains tend to be taxed, and capital gains are taxed upon realisation. Recurrent property taxes are almost always applicable and often transaction taxes. The combination of taxes often leads to considerable METRs relative to other assets.
Unlike rental property, income from owner-occupied property, whether in the form of the imputed rental income or capital gains, is typically untaxed. That said, recurrent property taxes, and in many cases transaction taxes, are applied. Nevertheless METRs tend to be low for owner-occupied property.
The taxation of residential property raises complex distributional questions. The main residence makes up a larger share of household assets of poorer households in most of the countries discussed in Chapter 4. That said, the very poorest of households tend not to own a home. This means that concessionary taxation of owner-occupied property relative to other forms of assets could provide a greater tax benefit to those in the middle and top of the income distribution compared to those at the very bottom.
Providing tax relief for mortgage interest is common and also raises challenging distributional questions. Chapter 4 has shown that housing debt levels rise with income in absolute terms, so deductions for mortgage interest provide a greater benefit to those with higher incomes in absolute terms. However, deductions for mortgage interest also provide higher proportional benefits to those with low levels of net wealth. This is because housing forms a greater part of their gross wealth, and because housing debt is also more substantial relative to their gross wealth.
Second homes (which are often, but not always, rented) make up a greater proportion of gross wealth of higher income and wealth households, suggesting higher METRs on rental property aid progressivity. However, it should be borne in mind that debt financing can often enable tax planning opportunities that lower METRs on debt financed rental property.
6.3. The changing international tax environment
Chapter 5 highlighted the substantial changes in the international tax environment in the period since the 2008 global financial and economic crisis. Historically, a key barrier to the effective and efficient taxation of savings has been the ability of taxpayers to hide wealth offshore. In the absence of effective exchange of information (EOI) between tax authorities, it has been possible for some taxpayers to fail to declare their foreign-sourced income or assets and, through a lack of information in the hands of the tax authorities, avoid detection. Estimates of the size of offshore holdings have varied from USD 6-7 trillion to USD 22 trillion (Alstadsaeter, Johannesen and Zucman, 2017).
However, as a result of the work of the Global Forum on Transparency and Exchange of Information for Tax Purposes (Global Forum), the coverage of the network of exchange of information agreements has expanded substantially, both in relation to the exchange of information on request (EOIR) and the automatic exchange of information (AEOI). Furthermore, the promulgation of the Common Reporting Standard (CRS) means that AEOI will be standardised across a wider variety of countries. More than 100 countries have committed to automatically exchange financial account information by 2018. More than 110 jurisdictions have signed the Multilateral Convention on Mutual Administrative Assistance in Tax Matters – one of the key instruments promoted by the Global Forum to facilitate information exchange.
These various initiatives suggest that in the future it will be more difficult for taxpayers to engage in tax evasion by hiding their wealth offshore, and as a result these developments will make it easier for countries to levy taxes on capital with a much reduced risk that taxpayers will shift their income and assets offshore in response. Additionally, individuals who have been hiding financial assets offshore now have greater incentives than ever before to come forward and start reporting their financial assets to tax authorities. Indeed, there is evidence that the expansion of EOI has caused a substantial increase in the disclosure of offshore assets, and thus an expansion in the capital tax base.
Continued work will be needed to ensure that exchange of information is effective in reducing tax evasion. Chapter 5 has highlighted statistical evidence that the effectiveness of information exchange is increasing in the number of countries participating in EOI. The coverage of the EOI network, which has grown rapidly over recent years, has been a key ingredient of this success.
Beyond ensuring the effectiveness of EOI, continued efforts and constant vigilance will be needed to ensure that capital income can be effectively taxed internationally. The risk remains that some taxpayers will seek to use elaborate structures and mechanisms to frustrate the effectiveness of the EOI. Equally, some taxpayers may also attempt to shift their wealth into assets not covered by the most common EOI agreements or to jurisdictions not participating in the EOI.
6.4. Policy challenges for the taxation of household savings
Capital taxation is an issue that is high on the policy agenda for governments and citizens. There are widespread calls for higher levels of capital taxation both domestically and internationally in response to increasing levels of income and wealth inequality. This has been brought into particular focus as a result of the 2008 global financial and economic crisis. Meanwhile, continued population ageing is placing significant pressure on public pension systems, with many countries therefore looking to further encourage private pension savings.
While countries do not necessarily need to tax savings more, the analysis in this study shows that there is significant scope to improve the way countries tax savings. Most significantly, there are opportunities for countries to increase coherency and consistency in taxation across assets and thereby improve both the efficiency and fairness of their tax systems. There may also be opportunities for many countries to increase progressivity in their taxation of savings. At the same time, there remains a case for preferential tax treatment of private pensions in order to encourage retirement savings. However, there are also opportunities for improvement in tax design regarding private pensions and in a number of other areas such as residential property. This section discusses these policy challenges in more detail.
Increasing coherency in the taxation of savings
How a country taxes household savings can have significant effects on both the efficiency and fairness of the tax system. However, economic theory does not provide a definitive picture of how savings should optimally be taxed.1 In the absence of such guidance, the concept of tax neutrality is generally relied on, at least as a starting point, in assessing how savings should be taxed (OECD, 1994; Mirrlees et al., 2011).
There are two main aspects of tax neutrality relevant from a savings perspective: neutrality regarding the allocation of savings over the lifecycle; and neutrality regarding the allocation of savings across different assets. To achieve neutrality regarding savings over the lifecycle, a tax should not distort the decision between consumption tomorrow as compared to consumption today. Theoretically, this suggests that the ‘normal’ return to savings – defined as the return required to make a taxpayer ambivalent between consuming today and consuming in the next period – should not to be taxed.2 Meanwhile, to achieve neutrality across different assets, the tax system should impose the same effective tax rate on all assets.
Almost all tax systems breach these neutrality principles in some way, and so create incentives to consume now rather than later and to save in certain assets over others. However, these tax-induced incentives are only of concern if taxpayers actually alter their behaviour in response to them. As highlighted in Chapter 1, empirical evidence is mixed regarding the former, but clear regarding the latter: while taxes may affect consumption choices over the lifecycle (and hence the total level of savings in an economy), they clearly do affect decisions regarding which assets to save in. Tax differentials across assets are therefore likely to result in significant distortions to the allocation of savings. This suggests that, at least as a starting point, ensuring neutrality as regards the allocation of savings should be of primary concern in tax policy development.
There are also arguments in favour of taxing the normal return to savings, despite its potential distortion of lifecycle savings. For example, recent papers in capital taxation have highlighted the extent to which the absence of taxation of even normal returns on capital investment may distort the mix of assets between physical and human capital (Golosov, Kocherlakota and Tsyvinski, 2003; Stantcheva, 2017). This is particularly the case given that returns to human capital may be taxed at higher rates than physical capital – i.e. at labour income tax rates (OECD, 2017).
Neutrality in the allocation of savings
To assess the degree of neutrality in the allocation of savings in countries’ tax systems, a major focus of this study has been on the calculation of marginal effective tax rates (METRs) on different assets / savings vehicles. The METR results presented in Chapter 3 clearly highlight the lack of neutrality across assets in almost all 40 countries examined. METRs vary significantly across assets, creating strong incentives at the margin for taxpayers to save in some assets over others, thereby distorting the allocation of savings. There is consequently a clear case for countries to look to adjust their tax systems to increase the consistency of METRs across assets.
Not only will enhanced neutrality in the taxation of savings increase efficiency, it will also increase the fairness of the system. A key finding from Chapter 4 of this report is that the allocation of asset holdings varies across the income and wealth distributions. In particular:
Poorer households hold a significantly greater proportion of their wealth in typically highly-taxed bank accounts than richer households;
Richer households hold a greater proportion of their wealth in investment funds, pension funds and shares, which are all often taxed relatively lightly, than poorer households.
The very poorest households do not own residential property, which at least in the owner-occupied case is significantly tax favoured.
Where they are able to own their own home, poorer households hold a greater share of their wealth in owner-occupied property than richer households. Richer households tend to hold a greater amount of aggregate wealth in owner-occupied property.
Richer households hold a far greater share of their wealth in second properties than poorer households. While these tend to be taxed relatively heavily when equity financed, when debt financed there are significant tax planning opportunities that can reduce the effective tax burden to concessionary levels.
These distributions of asset holdings mean that tax systems often favour the savings of households that are financially better-off, thereby strengthening the case for a move towards neutrality.
Neutrality will also limit other tax planning incentives to structure savings in a way that lowers taxation, such as by retaining income within a corporate structure to defer taxation.
Achieving neutrality across assets
Part of the reason for the lack of neutrality across assets exhibited in many tax systems is the inherent difficulty in achieving it. Most countries adopt a broadly comprehensive or flat rate capital tax approach to taxing savings which involve taxing returns as they are earned. However, part of the return from many assets comes in the form of capital gains. To achieve neutrality, capital gains should be taxed identically to interest, dividends and other forms of income – i.e. as they accrue. However, gains are almost always taxed on a realisation basis due to the difficulty, particularly in thin markets, of determining and taxing gains as they accrue, as well as liquidity concerns. This deferral reduces the net present value of the tax as compared to accrual taxation so that an asset earning interest or dividends at the same rate will face a higher METR than an asset producing the same return as a capital gain.
Furthermore, the deferral benefit actually creates incentives for taxpayers not to sell assets (a ‘lock-in’ effect), discouraging the efficient sale of assets that would have occurred in the absence of taxation. Concern over potential lock-in effects has led many countries to apply reduced rates on capital gains or to even exempt, for example, long-term capital gains. However, this pushes tax systems even further from achieving neutrality. Additionally, some countries do not impose a capital gains tax at all on the basis that these gains are different in nature to ‘ordinary’ income.
Fundamental reform to the tax system – such as moving to a pure expenditure tax system (with no taxation of savings) – could eliminate the difficulty created by realisation-based capital gains taxation in achieving neutrality. However, an alternative option compatible with the broadly comprehensive and flat rate capital tax approaches adopted by most countries currently is to apply an interest adjustment to capital gains. Taxation would still occur on a realisation basis alleviating asset pricing difficulties and liquidity concerns, but interest would also be charged on realisation to approximate the net present value of accrual taxation. This would reduce deferral benefits and consequent lock-in effects, and move systems closer to neutrality.
Practical implementation issues would need to be considered further regarding the introduction of an interest charge. For example, while the timing of gains across the total holding period is likely to be variable, it may be most practical to assume a smooth increase in asset value – resulting in some inaccuracy in net present value calculations. Additional issues, such as how to prevent incentives to defer dividend payments, would also need to be considered.
Beyond the taxation of capital gains, there are other aspects of tax design highlighted in Chapter 3 that impede neutrality. In particular, some countries will apply additional taxes to some assets but not others. For example, a transaction tax may be applied to the purchase of some assets (e.g. bonds, shares, residential property) but not others. This differential treatment unsurprisingly exacerbates the variation in METRs across assets. It also creates variation across holding periods, so that distortions across briefly held assets will be greater than across longer held assets as the one-off transaction tax can effectively be spread over a longer time period.
Transaction taxes are historically popular due to the easily identifiable base, but in addition to the impact of their sporadic application on neutrality, they are highly inefficient in another way as they discourage transactions. For example, a property transaction tax will discourage efficient labour mobility as they increase the costs associated with relocation.
Net wealth taxes are applied in a small number of countries, but often with a number of exclusions and exemptions that potentially also exacerbate differences in METRs across assets. Caution also needs to be taken with wealth taxes more generally as when combined with already high personal tax rates on capital income they can result in extremely high METRs being imposed on certain assets. In general, there is a weaker case for implementing a net wealth tax where a country already has a broad-based capital income tax, including a tax on capital gains, and a well-designed inheritance tax (OECD, 2018a).
Recurrent property taxes are often also levied on residential property, but not on other bases. However, there is more justification here. In particular, these taxes can partially make up for the non-taxation of imputed rental income and capital gains on owner-occupied property. As land is in fixed supply, they are also likely to be amongst the least distortionary of taxes (Johansson et al., 2008), although their distributional effects are less clear.
The impact of inflation may also prevent tax neutrality. As nominal rather than real returns are typically taxed, assets that produce higher real returns will face lower effective tax rates than those producing lower real returns (as the inflationary component makes up a smaller part of the total tax base). Not only can this prevent neutrality, it may also have a regressive impact as wealthier individuals tend to invest in assets that generate higher returns.3 A small number of countries provide tax relief for the inflationary components of some, but not all, income or capital gains but such non-uniform treatment could further exacerbate non-neutrality. Instead, adjustments should be provided uniformly if full neutrality across assets is to be achieved.
Neutrality across the lifecycle
In addition to neutrality across assets, there is merit in countries also considering options to achieve neutrality across the lifecycle. Fundamental reform such as a pure expenditure tax will achieve this, as will non-taxation of savings. However, the provision of an allowance for the normal return on savings (a “rate of return allowance” or “RRA”) is an option worth consideration that fits within the broadly comprehensive and flat rate approaches currently taken by most OECD countries in relation to the taxation of savings. Although only one country (Norway) currently adopts such an approach, it has received significant recent support in the academic literature (see, in particular, Mirrlees et al., 2011).
While increasing compliance and administrative costs, there are a number of factors in favour of the adoption of an RRA. In addition to mitigating potential distortions to lifecycle savings decisions, an RRA will also help mitigate distortions with respect to the allocation of savings across assets by partly removing the deferral advantage attached to capital gains (as any unutilised allowance would be carried forward until realisation of the capital gain). Furthermore, it is likely to be consistent with equity goals as economic rents are still taxed. Indeed, there is no clear equity case for taxing the normal return as this simply taxes more heavily those who prefer consumption in the future over those that prefer consumption today.
An important point to note though is that concern from an efficiency perspective only relates to the distortion of lifecycle savings decisions. There is consequently no clear case to exempt the normal return from inherited wealth. Taxing the total return (normal return plus rents) on non-lifecycle savings can effectively be achieved by the combination of an estate tax (or approximated by an inheritance tax) and an RRA. In the absence of an estate or inheritance tax, a net wealth tax levied on the part of the wealth which will not be consumed across the lifecycle might be an alternative (OECD, 2018a).
In practice, an RRA could be approximated by providing a fixed basic allowance or exempt amount of savings (or preferably a tax credit in order to fix the tax benefit) – as currently provided in a number of countries. If restricted to assets such as bank accounts and bonds – that are unlikely to return significantly more than the normal return – this approach will have largely the same effect as an RRA, but with less compliance and administrative costs. An RRA could then be applied to assets expected to produce economic rents.
There are also arguments in favour of taxing the normal return to savings, despite its potential distortion of lifecycle savings. Recent papers in capital taxation have highlighted the extent to which the absence of taxation of even normal returns on capital investment may distort the mix of assets between physical and human capital (Golosov, Kocherlakota and Tsyvinski, 2003; Stantcheva, 2017). This is particularly the case given that the returns to human capital are taxed at higher rates than physical capital (i.e. at labour income tax rates). (OECD, 2017). Such concerns may be particularly relevant given the increases in capital share of national income in many OECD countries.
Increasing progressivity in the taxation of savings
While a significant number of the countries considered in this report tax savings progressively, a large number of countries tax most savings at flat rates. In relation to this latter group, two factors highlight the case for these countries to reassess the merits of applying a degree of progressivity to their taxation of savings:
First, inequality has continued to increase in most OECD countries since the late 1980s/early 1990s when most flat rate reforms took place. This has been brought into particular focus as a result of the 2008 global financial and economic crisis, and has led to strong calls for greater taxation of savings and wealth in many countries (see, e.g., Piketty, 2014).
Second, the ground-breaking changes in the international tax environment regarding the move to the automatic exchange of taxpayer information (AEOI) should decrease the ability of many taxpayers to hide income and wealth offshore.
The ability to implement such reform and the degree to which progressivity should be increased will depend on a range of country-specific factors, including existing levels of inequality and preferences for redistribution. Whilst the reform could involve a shift back to the comprehensive taxation of labour and capital income together at progressive rates, it could also involve implementing a schedular system with progressive rates applied to capital income. Such a “dual progressive income tax” approach could increase progressivity while taking into account that capital income has been taxed already at the corporate level with the corporate income tax rate.
Increased progressivity does not necessarily require increased tax revenue from savings. Although, doing so may provide an opportunity to raise additional revenues where necessary or to fund reductions in other tax bases likely to be more damaging to growth such as labour and corporate income (Johansson et al., 2008).
The introduction of an RRA would also introduce some capital income tax progressivity given that, as already noted, wealthier individuals tend to invest in assets that generate higher returns (Fagereng et al., 2016). Nevertheless, richer households would gain a lot more than poorer households from an RRA.
As noted above, an RRA could be approximated for certain assets – e.g. bank accounts – by a basic allowance, exempt amount or tax credit. Given the evidence from Chapter 4 that bank accounts are predominantly held by poorer households, a basic tax credit for bank accounts can further aid overall progressivity.
The analysis in the report also highlights that distributional objectives can also be achieved by removing certain provisions that favour the rich. As discussed further below, tax deductions provided for pension contributions and mortgage interest could be turned into tax credits so that richer taxpayers do not benefit disproportionately from these concessions as compared to poorer taxpayers.
As already noted, moving towards neutrality in tax treatment across assets will also aid distributional goals by eliminating any regressivity arising from variation in asset holdings between rich and poor.
Additionally, more progressive taxation of savings will reduce incentives for taxpayers to re-characterise labour income as capital income to reduce their marginal rate. This may occur through incorporation by the self-employed. Such re-characterisation is often available to those with higher levels of income and wealth and consequently may have a regressive effect.
In any reform, policymakers also need to bear in mind the mobility of high-income and high-skilled labour in response to increased taxation. This can be the case with respect to both labour and capital income. Recent studies have suggested that high-income and high-wealth individuals will respond by shifting location in response to both personal and corporate income taxes (Kleven, Landais, and Saez, 2013; Kleven, Landais, Saez and Schultz, 2013; Moretti and Wilson, 2017). Some countries are putting in place schemes to target highly-mobile taxpayers, signalling growing competition not just for capital, but also for highly-skilled labour (OECD, 2017). To some extent, this may limit the scope for higher income taxes on those with high levels of income and wealth, even in the context of expanded information exchange on tax matters.
Encouraging retirement savings
While the main conclusion of this report is the need for greater consistency and neutrality in the tax treatment of savings, there are some notable exceptions. Encouraging retirement savings is the clearest example. Most countries attempt to encourage retirement savings by providing highly concessionary expenditure tax regimes for private pensions that often result in negative METRs.
As noted in Chapter 1, there is clear evidence that incentives to save for retirement do increase the overall level of retirement savings, and there is some evidence that this does not entirely crowd out other savings. However, even if they do not increase total savings, there might remain merit in encouraging a shift of some household savings into long-term retirement focused savings vehicles over shorter term vehicles. As societies in most OECD countries continue to age, public pension systems are coming under increasing strain. This means that it might be important to provide sufficient incentives for private savings, and hence the case to continue with these incentives, in breach of tax neutrality, is strong.
That said, the particular tax treatment of voluntary private pension savings in each country should be considered in a coordinated way with the financial advantages and generosity of public pension systems. For example, where public pension provision is substantial, there may be less need to incentivise the use of private pensions. However, where public pension provision is less expansive, it may be increasingly important to provide larger incentives for private savings.
As noted above, the design of pension systems can be improved in many countries by replacing tax deductions for private pension contributions with tax credits so that richer taxpayers do not benefit disproportionately from these concessions. Ideally tax credits would be refundable to ensure that low-income taxpayers without sufficient tax liability in a particular year still receive the full benefit of the tax credit. Alternatively, pension contributions could be matched by government contributions to ensure that the support is provided immediately rather than at year end – which may potentially increase pension savings (OECD, 2018b). Limits on the size of the tax incentive available should also be utilised to manage both fiscal cost and the distributional effects.
A number of countries have also attempted to encourage savings through the introduction of tax-favoured savings accounts that often provide exemptions for the income earned. Where the policy goal is to encourage long-term savings, there may be merit in imposing minimum holding period requirements on these accounts (as some countries do).
Improving the taxation of residential property
Owner-occupied property
After private pensions, this report has highlighted that owner-occupied residential property is typically the next most tax favoured savings option for households. This stems chiefly from the absence of a capital income tax on the imputed rental income and of a capital gains tax. However, the presence of recurrent property taxes and, in many cases, transaction taxes ensure some positive degree of taxation.
In addition to the non-taxation of imputed rental income and capital gains, many countries have other tax policies that result in favourable treatment of home ownership over other forms of saving. As discussed in Chapter 2, 19 out of 40 countries allow tax relief for mortgage interest paid on owner-occupied properties, either as a tax credit or a deduction against labour and/or other income.
While, from a neutrality perspective, this tax relief is difficult to justify – especially in light of the non-taxation of the income generated, this position reflects the fact that a large number of countries place considerable importance on the policy objective of supporting home ownership. There are various reasons why governments may wish to support home ownership. For example, home ownership may be seen as a way to encourage long-term savings similar to tax relief for private pensions. There may also be a range of perceived social benefits from increased home ownership (see, for example, Engelhardt et al., 2010).
Tax support for home ownership may also be seen as a means to support middle income households who – as shown in Chapter 4 – hold a large proportion of their wealth in housing. However, it will not support the poorest of households as these households do not own residential property; meanwhile higher income households are likely to purchase more expensive homes and thereby benefit even more with greater deductions in aggregate terms (Fatica and Prammer, 2017). A number of countries provide caps on relief for mortgage interest which may ameliorate these negative distributional consequences.
Furthermore, when mortgage interest relief is provided as a deduction against income taxed at progressive rates it will have a regressive impact. As noted previously, this is because it allows those paying tax at higher marginal rates to deduct their mortgage at a higher rate than those paying tax at lower marginal rates. Consequently, countries should consider providing tax credits rather than deductions.
Reform of housing tax policy and reform of mortgage interest deductibility in particular, is complicated by the fact that those households that have very low or negative levels of net wealth often have substantial housing debt. While these low net wealth households may not have low incomes, reducing support for mortgage debt in a sudden way may place substantial burdens on highly indebted households. Furthermore, the tax advantage from mortgage interest deductibility may be capitalised into the value of a property, so that its removal would act as an implicit tax on current homeowners.
One approach worth consideration in addressing the non-taxation of imputed income and capital gains is through increases in recurrent property taxes beyond the level that reflects the benefits received from local public series (such as waste disposal, fire brigade, etc.). There is also a broader case for increasing recurrent property taxes as they are likely to be less damaging to economic growth than most other taxes (Johansson et al., 2008), although the distributional effects are less clear.
However, political economy issues once again arise. Local property taxes are one of the least popular taxes of all major tax categories according to some studies (OECD, 2010). Property taxes also require regular property valuations to maximise their efficiency and fairness, which can be administratively burdensome. Recurrent property taxes may also be considered a payment for local government services, so that the tax liability might have to be presented as a payment for government services and the pure tax component which is levied on the imputed income. Further complexity arises as this would also require property tax rates to vary between owner-occupied property and rental property where actual rental income is subject to income taxation.
Another potential policy reform option would involve imposing a limit on the value of owner-occupied housing that benefits from an exemption from taxation on capital gains. Given that higher income households are likely to purchase more expensive homes and have more of their savings directed towards owner-occupied housing, one way of mitigating the adverse distributional effects of an open-ended exemption would be to cap this benefit. This cap could be imposed at a relatively high level to ensure that only those properties and the high end of the residential housing market are affected.
Rental property
Chapter 3 of this report has shown that rental property is generally taxed far more significantly than owner-occupied property. Nevertheless, there may be opportunities to improve tax design in many countries.
In almost all countries rental income is taxed, and in all but seven countries capital gains on rental properties are taxed – although sometimes at concessionary rates. From a political economy perspective it should be significantly easier to justify taxing the capital gains from residential rental property and hence efforts could be made by countries to increase the taxation of capital gains where concessionary rates, or exemptions for long-term gains, are currently applied. As noted earlier, countries could consider implementing an interest charge to minimise lock-in effects and allow increased taxation of capital gains.
The case for allowing mortgage interest deductibility is stronger for rental property than owner-occupied property given that income is generally subject to comparable levels of taxation as alternative savings options. Even in this case, mortgage interest deductibility for rental property might still distort saving decisions if interest paid on debt which is incurred to buy other assets is not deductible from taxable income. Moreover, the same distributional concerns arise as with owner-occupied property and should be addressed accordingly.
As noted in Chapter 3, debt financing can create opportunities for tax planning when mortgage interest is deductible and capital gains are taxed at concessionary rates, or there are other means of reducing tax on sale of a property (e.g. age-based exemptions). In such countries, the importance of removing concessionary treatment of capital gains becomes even more pertinent. Again, lock-in concerns can be mitigated by applying an interest charge. Alternatively, if concessionary rates continue for capital gains then there is merit in considering removing the deductibility of mortgage interest, as a number of countries do. In contrast, when rental income and capital gains are fully taxed, removing mortgage interest deductibility would be more difficult to justify.
As noted earlier, there is a strong case to remove transaction taxes on at least owner-occupied residential property. These discourage efficient relocation reducing labour mobility. That said, there may be a case to retain transaction taxes where there are concerns about asset bubbles. Finally, consideration should be given to the merits of imposing wealth taxes where significant taxation of rental income and capital gains already applies.
6.5. Further research
This study has highlighted many patterns in the taxation of household savings across OECD countries. It has highlighted areas where the taxation of savings is distortive, particularly between different asset classes. It has also placed the taxation of household savings within the context of continuing changes in OECD and other countries, including: rising inequality, increasing globalisation, and increasing global co-operation on tax. However, there remains considerable scope for further research. Some possibilities are highlighted below.
Chapter 5 has highlighted the changing nature of the international tax environment. The network of EOI agreements continues to expand in scope, and the various standards promulgated by the OECD and other actors continue to be strengthened and enforced. However, more needs to be done to improve our understanding of the impact of these standards on tax evasion and the nature of taxpayer responses to the increased risk of evasion being detected.
This study has also discussed the taxation of residential property and has noted that a wide variety of taxes impact on the overall tax burden on housing. The taxation of residential property in particular often interacts with house prices in complex ways – and has been subject to strong assumptions in the METRs presented in Chapter 3. Further analysis is warranted. In addition, Chapter 4 has highlighted the centrality of residential property and debt in determining the interaction of the net wealth and income distributions. Further analysis of the taxation of residential property from an inclusive growth perspective is therefore warranted.
A key issue, which has not been the focus of this study, is the taxation of inherited wealth. Taxation of this form of asset acquisition may have different consequences for the distribution of wealth and the effectiveness of capital use in the economy than the taxation of non-inherited capital. However, the distributional consequences – and economic incidence of the taxation of estates and inheritances are so far relatively poorly understood.
This study has considered the taxation of capital income at the personal level. However, capital income is also often subject to corporate income tax. As discussed in Chapter 5, globalisation and increased international mobility of international capital raise the challenges of effectively taxing corporate income at source. For this reason, many countries shift the taxation of this income to the personal level. Thus the interaction of the personal and corporate income tax systems is of key concern for capital taxation overall. The METR modelling presented in Chapter 3 in particular could be expanded to incorporate effective corporate tax rates.
Consideration of the taxation of capital income from a life-cycle perspective also warrants further attention. Tax systems are typically designed from a static perspective which may lead to unfair outcomes as taxpayers whose incomes vary considerably over time may pay considerably more taxes than taxpayers who have a more constant stream of earnings.
The case for fundamental reform to the taxation of savings has also been briefly raised in this Chapter. In particular, the case for shifting from comprehensive to pure expenditure taxation merits further consideration. Expenditure taxation is often criticised for its inability to achieve distributional goals, however, the merits of an expenditure tax in a lifecycle context may be very different from a single-year perspective and warrant further investigation. The possibility of pure comprehensive taxation on an accrual basis also warrants consideration. In particular, the increased digitalisation of the economy and new technology and improved tax administration tools may make accrual taxation more feasible than has previously been the case.
This Chapter has also discussed the provision of a rate of return allowance. Further work assessing the merits of such an allowance, including its impacts on efficiency and equity and practical implementation issues is warranted, as well as its interactions with inheritance and net wealth taxes.
Chapter 4 has used data on wealth to examine distributional aspects of the taxation of household savings. The potential use of information on household wealth to aid tax design warrants much greater attention. In particular, wealth information may be able to be used to more accurately target support to certain taxpayer groups to achieve distributional objectives. In the past, targeting of support has had a much greater focus on incomes rather than wealth, although it is clear that better policy outcomes should involve consideration of the position of the taxpayer across both of these dimensions.
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Notes
← 1. Early papers on optimal capital taxation (e.g. Chamley,1986; Judd, 1985; Atkinson and Stiglitz, 1976), concluded that the optimal tax rate on capital income was zero. However, recent papers (e.g. Golosov, Kocherlakota and Tsyvinski, 2003; Piketty and Saez, 2012; Gordon and Kopczuk, 2014; Stantcheva, 2017) do find a role for capital income taxation. See, e.g., Broadway (2012) or Banks and Diamond (2010) for detailed reviews of the optimal capital taxation literature.
← 2. The ‘normal’ return to savings may vary across taxpayers as preferences vary, but is typically approximated by the risk free return (which itself is typically approximated by the return on a short-term government bond).
← 3. This is potentially explained by wealthy investors’ lower risk aversion and better access to financial education, financial expertise and more lucrative investment opportunities (Fagereng et al., 2016).