Saturday, September 22, 2012

Is Mancur Olson Right About Tax Rates?

I read Mancur Olson's “Dictatorship, Democracy, and Development” for a class last semester. In the paper is a prediction that autocratic regimes  will have tax rates higher than democratic regimes. This, Olson said, would be especially true when the current dictator felt their time was drawing to an end. He explained that leaders would press the population for as much money as they could. This didn’t seem intuitive to me, so I decided to look at some of the effective personal income tax rates from around the world and compare the results to the prediction Olson made.

The countries below are not randomly chosen. They are picked to represent various types of regimes existing around the world today. This blog post is only a toe dipped in the pool of data and not an attempt at finding empirical evidence.

Each of the regime examples includes a reason why it was picked. Some general information about the country is also provided. I chose the effective personal income tax rate because the mobility of people is very different than the mobility of a corporation. I feel it is also more in the spirit of Olson’s research, beginning with roving bandits and soon the settling of warlords in an area providing stability to the people (Olson, 1993).

The effective tax rate data comes from KPMG; Klynveld, Peat, Marwick, and Goerdeler. KPMG is one of the “Big Four” international auditing companies. They release the results of “The Corporate and Indirect Tax Rate Survey”. The survey is given to people all around the world and finds, among a number of tax rates inside countries, the effective individual income tax rates. The tax data used in this paper is from the most recent survey in 2011. All dollar amounts are in US dollars unless otherwise noted (KPMG, 2011).

So here they are: eight types of regimes currently in power. Two countries are examined under each regime type, when possible.

Parliamentary republic: India, Greece

India: The highest personal income tax rate is 30% and has remained at that level for the past nine years. The effective personal income tax rate of $100,000 of income is 27.4%. The highest rates for taxable income begin at $17,592. India has the highest personal income tax rate in southern Asia. Married couples file individual returns, except in certain circumstances of clubbed income.

Greece: The highest personal income tax rate is 45%. This was increased in 2010 and was previously 40%. The effective tax rate on $100,000 is 27.5%. Greece's personal income tax rate is not remarkable for the OECD countries. The highest rate for taxable income begins at $142,776. Married couples are taxed separately, but a joint return is filed.

Presidential republic: United States, Brazil

United States: The highest personal income tax rate is 35%. In has remained at that level for the past nine years. The effective tax rate on $100,000 is 18.6%. The personal income tax rate in the United States is not remarkable for an OECD country. The highest rates for taxable income begin at $379,150. This is the largest income amount for a highest tax bracket of all the samples. Married couples may choose to file jointly or separately, but the tax law provides some benefits for couples filing jointly.

Brazil: The highest personal income tax rate is 27.5%. This has remained the tax rate for the past nine years. The effective tax rate on $100,000 is 27.5%. The personal income tax rate is not remarkable for South America or the rest of Latin America. The highest rates for taxable income begin at $28,015. Married couples may choose to file jointly or separately.

Constitutional monarch: Kuwait, Monaco

Kuwait: There are no personal income taxes in Kuwait. Kuwait is one of five western Asian countries that do not have personal income taxes.

Monaco: There are no personal income taxes in Monaco unless the person is a French national. Even then there are three exceptions that can exclude a French national from income tax in Monaco.

Democratic parliament, constitutional monarch: Japan, United Kingdom

Japan:  The highest personal income tax rate is 50%. This has remained the tax rate for the past nine years. The effective tax rate on $100,000 is 16.1%. This is the lowest non-zero rate in the sample. Japan's nominal personal income tax rate is the highest in eastern Asia. But again, the effective tax rate on $100,000 is lower than any other country (with personal income taxes) listed in this paper. The highest taxable income begins at $221,400. Married couples, and even children, file separately in Japan.

United Kingdom: The highest personal income tax rate is 50%. This is an increase from 40% the previous eight years. The effective tax rate on $100,000 is 23.3%. The rate is not remarkable for OECD or European countries. The highest taxable income begins at $245,667. Married couples file tax returns separately.

Absolute monarch: Saudi Arabia

Saudi Arabia: In tradition with Islam, a Zakat “tax” on income and property is paid instead of an income tax. The money collected from Zakat is given to the poor. There is no other personal income tax in Saudi Arabia.

Military junta: Egypt, Fiji

Egypt (prior to revolution): The highest personal income tax rate was 20%. Prior to 2006 the highest personal income tax rate was 35%. The effective personal income tax rate on $100,000 was 20%. The rate was in line with other North African countries. The highest taxable income begins at $6,739. This is the second lowest top tax bracket in the sample. Only Vietnam is lower. Tax filing was the responsibility of the employer. Currently the country of Egypt is in transition. The data here is from before the recent fall of the regime.

Fiji: The highest personal income tax rate is 31%. This has been the rate for the past nine years. The effective personal income tax rate for $100,000 is 28.3%. The nominal tax rate is low for Oceana. The highest taxable income begins at $8,838. This is the third lowest of the countries listed in this paper

Single political movement state: China, Vietnam

China: The highest personal income tax rate is 45%. This rate has been unchanged in the past nine years. The effective personal income tax rate on $100,000 is 22.1%. The nominal tax rate is not remarkable for eastern Asia. The highest taxable income begins at $185,748. Married couples file taxes separately.

Vietnam: The highest personal income tax rate is 35%. This has steadily declined since being a rate of 50% in 2003. Even 35% is high for Southeast Asia. The effective personal income tax rate on $100,000 is 28.5%. The highest taxable income begins at $3,877. This is the lowest of the sample.

Directorial system: Switzerland

Switzerland: The highest personal income tax rate is 40%. It has been this rate since 2008 and prior to that the rate was 40.4%. The effective personal income tax rate on $100,000 is 11.4%. Locations inside Switzerland alter tax brackets and rates. No simple amount can be given for the beginning of the highest taxable income bracket. Married couples file jointly.

Putting the Information Together:

Highest Top Nominal Personal Income Tax Rate Bracket:

The four countries with the highest nominal personal income tax rates in the sample are: Japan and United Kingdom at 50%, China and Greece are at 45%. It's interesting that both Japan and the UK share the highest nominal rate and they are both Ceremonial Monarchies. Greece, a Parliamentary Republic is similar enough to fall into the same observations of the UK and Japan. Olson predicted regimes such as an Absolute Monarchy and other autocratic regime types would have these high tax rates. One thing to consider when seeing these high nominal rates is these three countries also have high incomes for their top tax bracket and the fact that all three countries have married couples file separately. This lowers the number of people inside the country that actually pay the high nominal rate on personal income. China, too, has a high income for the highest tax bracket and separate filing for couples. This would be expected with the collective goals of the Chinese government and in line with Olson's observations.

Lowest Top Nominal Personal Income Tax Rate Bracket:

Of the countries with personal income taxes, the three with the lowest top nominal personal income tax bracket on this list are Egypt (prior to collapse of the government), India and Fiji. India has a top nominal tax bracket rate of 30% and is a Parliamentary Republic. Olson’s prediction would hold because the government of India would not want to raise taxes in such a way that the people could become dissatisfied and vote elected officials out of office. However, Egypt and Fiji are the two Military Junta governments on the list and instead of the expected high nominal tax rates Olson might imagine, we see them having two of the lowest.

Highest Effective Personal Income Tax Rates (on $100,000 of income):

Three of the four countries with the highest effective tax rates are countries that put importance on social services of citizens. Vietnam is at 28.5%, Brazil and Greece are both at 27.5% for an effective tax rate on $100,000 of income. These high tax rates are to be expected due to the cost of distributing goods and services to others with less. Fiji is second only to India for its high effective tax rate of 28.3%. Olson’s prediction holds here because Fiji has a Military Junta regime.

Lowest Effective Personal Income Tax Rates (on $100,000 of income):

Switzerland, Japan and the United States have the lowest effective personal income tax rates on $100,000 of income. But the Military Junta of Egypt is fourth with a 20% effective tax rate. So the low rates of 11.4% in Switzerland’s Directorial System and the 16.1% rate in Japan’s Ceremonial Monarch system, and 18.6% in the United States’ Presidential Republic support Olson’s thoughts that citizens being able to vote politicians out of office keep the tax rates low. Yet Egypt is fourth on the list and this goes against the prediction. Note, though, that Egypt has the second lowest dollar amount for their highest tax bracket. There are a broad section of people in Egypt paying this top tax amount.

Zero Personal Income Tax:

There are three countries in this group. The two constitutional monarchs, Kuwait and Monaco have no personal income taxes. Monaco does have a tax provision for French nationals inside the country, but even that comes with three wide exceptions. The third country is the absolute monarch of Saudi Arabia. Instead of a personal income tax, Saudi Arabia uses a traditional Islamic tax law called Zakat. Zakat is not a personal income tax and the payments made with Zakat are a very small percentage of a person’s money and are given to the poor.

These are three governments Olson would expect to tax citizens at very high rates. Instead they are the lowest in the survey. While Kuwait and Saudi Arabia are both large producers of oil and see huge incomes from its sale, Monaco does not export oil, it has tourism and gambling. These three examples of regimes that could dominate the citizens, but instead charge no personal income taxes, are evidence of Olson’s prediction being wrong for countries existing today. Seeing these as outliers because of their large profits from oil or casinos, I began to search for other autocratic countries. But what current countries with this type of regime don’t have some odd trait that sets them as an outlier? If there was a correlation between a country’s main streams of income and its regime type, would these examples still be outliers?

The Future:

I'd be interested in collecting data from ALL countries, instead of these few, and see what patterns are found. Especially worth researching would be the tax rates of certain regimes prior to “unplanned” changes in leadership (seems like a great time since the Arab Spring and continuing unrest in other spots around the globe).

For Olson to be right we should see modern autocrats taxing at elevated rates and then increasing the rates even higher when they suspect their time is drawing to an end. The beginning of the end for Egypt is shown in the above data and instead of seeing taxing going up, we see tax rates in 2011 lower than they were prior to 2006. This could be evidence against Olson or it could be a regime trying to keep the citizens from uprising. One data point is much too little to make any arguments, but it is interesting to note.

Olson does seem to be correct that governments with democratic elections do not have the highest effective tax rates. His theory that politicians fear taxing too high will cost them reelection does have merit when looking at the small sample set in this paper.

A pattern that is found in the sample is countries that put importance on equity and redistribution have some of the highest effective tax rates. This makes perfect sense because it is in line with their goals and social services are expensive to fund.

A better prediction than Olson’s might be that elected officials in democratic governments tend not to raise taxes so high they will not get reelected and countries with a taste for social justice have to tax at levels to meet their goals. Still, when it comes to the modern autocrats in the post, it’s not clear if they still tax like the warlords of the past.

 

Dictatorship, Democracy, and Development, Mancur Olson, The American Political Science Review , Vol. 87, No. 3 (Sep., 1993), pp. 567-576 Published by: American Political Science Association

KPMG’s individual income tax and social security rate survey 2011. (2011). KPMG INTERNATIONAL.

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