Taxation And Finance

Archive for November, 2009

Some work has also been done on incentives to lock in capital gains for very long periods of time. Assets held until death or contributed to charity escape capital gains taxation under the income tax. In the case of death, capital gains are taxed by the estate tax since estates are subject to estate taxes on the full fair market value of the assets they contain. Bailey (1969) and David (1968) have argued that eliminating these provisions would be an efficient means of reducing the lock-in effect by eliminating the possibility of escaping capital gains tax.

The objective of the present paper is to examine the relationship among capital gains tax rates, the level of realizations of long-term gains subject to tax, and revenues from capital gains taxation over an extended period of time. The Tax Reform Act of 1969 began an era of high variability in the capital gains tax rate which had been relatively constant for the preceding 15 years. Further changes in the tax reform bills of 1976, 1978, and 1981 continued this variability.

The changes in the effective capital gains tax rate which resulted from these laws were quite complex and often involved the interaction of several provisions. This paper makes careful estimates of the effective marginal tax rate on capital gains for various income groups over the period 1965-82. These detailed estimates suggest smaller variability in rates than suggested by the maximum effective rates cited in other studies. The first section describes the computation of the effective capital gains tax rates and describes the impact of the various provisions on the capital gains tax rate. The effect of these provisions is combined using detailed tabulation data from Statistics of Income to estimate average marginal effective tax rates for various income groups.

The effect of the capital gains tax on the sale of capital assets and the realization of gains on these assets have been a matter of substantial academic and political controversy. Capital gains are only taxed when an asset is sold, and so inclusion of gains in taxable income is largely discretionary from the point of view of the taxpayer. As a result, sensitivity to tax rates is probably greater for capital gains income than for other kinds of income.

This sensitivity may take a number of forms. Capital gains and losses on assets held for less than a specified time period, currently 6 months, are taxed as ordinary income while gains and losses on assets held for longer periods of time are taxed at lower rates. Within limits specified by the tax law, taxpayers have an incentive to realize losses in the short term and gains in the long term. Planning of sales around this capital gains holding period was studied by Kaplan (1981), who concluded that eliminating the distinction between long-term and short-term gains, and taxing all assets under current long-term rules, would enhance capital gains tax revenue. Fredland, Gray, and Sunley (1968) also found that the length of the holding period had a significant effect on the timing of asset sales.

The current transfer pricing regime produces inequitable results. Because the
existing transfer pricing laws and regulations are not based on defensible economic principles, or on transparent rules that all countries apply uniformly, they produce arbitrary results. Arbitrary apportionments of multinational firms’ income across the countries in which they operate are inherently inequitable.

Multinational and domestic firms are not treated uniformly for tax purposes. In the abstract, the arm’s length principle appears to ensure that domestic and multinational firms will be treated uniformly for tax purposes, essentially by definition. However, individual standalone competitors in a given market often report markedly different operating results in the same reporting period. By requiring individual members of a multinational group to report gross margins, markups or accounting rates of return that are contained in the interquartile range of third parties’ results (a U.S. regulatory provision that the OECD Guidelines do not endorse), multinational firms are treated more favorably for tax purposes than a subset of their domestic counterparts, and less favorably than others.

Inequity is inherently problematic, and uncertainty is costly, both for tax authorities and individual corporations and from an economy-wide perspective. Explicit costs, from tax authorities’ perspectives, include costs incurred in conducting audits and analyzing transfer pricing issues, and in resolving conflicts over income allocations with their opposite numbers in other tax jurisdictions.