Where the US leads in the tax debate, others will follow

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The Independent Online

Tax cuts are the new global big idea. No, not here in Britain and certainly not after the boost to spending announced by the Chancellor last week. But in Germany, the most resistant to the idea, the mountain is moving at last. And in the US, the forthcoming election will be, in some measure, a debate about the nature and size of tax cuts under the new president.

Tax cuts are the new global big idea. No, not here in Britain and certainly not after the boost to spending announced by the Chancellor last week. But in Germany, the most resistant to the idea, the mountain is moving at last. And in the US, the forthcoming election will be, in some measure, a debate about the nature and size of tax cuts under the new president.

Tax cuts, like other big ideas in governance, move in waves around the world. One country starts the chase, others pick up the ideas, modify and maybe amplify them, so that finally the whole developed world has moved to a new norm.

In a way the German move, cutting the top rate of income tax and cutting corporation taxes, marks the end of the last cycle. Those two taxes were targeted by both the US and the UK in the 1980s as areas where taxation was becoming damaging to the economy. The new norm for former seems to be somewhere between 40 per cent and 45 per cent as opposed to 55-60 per cent of the early 1980s. And the new ceiling for the latter seems to be about 30 per cent, against 50 per cent - though of course these are nominal rates and the actual tax paid by corporations is lower thanks to the various investment and other allowances.

Not all developed countries have yet reaches these norms. For example Sweden still has a top rate of tax, adding local taxation to that of central government, of around 60 per cent. But even that is a long way below the 100-plus per cent top rate that Swedish taxpayers once had to pay when a one-off wealth tax was added. If Germany marks the end of the last cycle, the US looks like starting a new one. Both would-be presidents have tax-cutting plans, and whoever wins the election seems likely to have a profound influence on the rest of the world.

Governor Bush's proposed cuts are simpler and deeper than Vice-President Gore's. There are three main elements. First, income tax: Governor Bush would reduce the present five bands which run from 15 per cent to 39.6 per cent to four, running from 10 per cent to 33 per cent. Second, he would rebalance income taxation so that married couples would not be some severely punished vis-a-vis unmarried ones. And third he would repeal inheritance tax.

Commenting on these, Goldman Sachs notes that the simplicity is to be applauded but that from a macro-economic point of view, the level of the cuts is too large. The boost to the economy that would result would force the Federal Reserve to tighten monetary policy: Goldman calculates that short-term interest rates would have, on average, to be half a percentage point higher than they would other be over the five years during which the tax cuts were introduced.

The Vice-President's plans are harder to summarise because they consist of a long list of proposals from tax breaks for health premiums for employees in small businesses, through the creation of special accounts for education and training, to tax breaks on special savings accounts for retirement. The cost of this plan is seen as more affordable, but the disadvantage is that it complicates an already complicated tax system still further. The impact on interest rates might be an extra quarter percentage point.

But what about the impact on the world? If the Gore plan is the one that is adopted do not expect much to happen elsewhere as a result. Fiddling around with a tax system to fit local needs and aspiration is all very well if you like that sort of thing - our own Chancellor does a lot of it - but it is not a big idea with applications elsewhere.

If, as seems more likely at the moment, it is the Bush plan that is put to work, then there are at least two aspects that seem likely to resonate around the world: lower top rates of income tax and the ending of inheritance tax.

True top rates of tax in the US were down in the low 30s during the 1980s, only to be put back up by President Clinton. But since then the market for skilled people - particularly IT specialists - has become much more global. All countries are now competing to attract them and income tax is a key element in the package that has to be offered. High tax countries are finding that they have a choice: either they cut their top rates, or they introduce a special tax break for immigrants.

The advantage of the former is that not only that discriminating against your own citizens does not go down too well. It may also increase the general tax yield, particularly if rate-cutting is coupled with closing of loopholes.

If the US does go to the 33 per cent mark, expect the UK to be among the first to follow, with this being adopted by a Tory government in, say, 2005. And if the UK does so, the balance of probability is that the other large European countries would be pushed in the same direction, as Germany has now.

But it is the other Bush idea, the ending of inheritance taxation, that seems the more sure-fire candidate for imitation. The reasons are threefold.

First, the ageing of electorates makes this an immensely attractive option. You might argue that since people only pay death duties, as they used to be called here, after their death, they never pay them at all. It ought in theory to be the heirs who are upset. But all the evidence seems to suggest that people feel it is unfair to make them pay to die. So as the proportion of older voters increases, expect there to be more and more pressure to abolish death duties.

Second, these are cheap taxes to abolish, at least in both the US and the UK. This is because there are many legal methods of reducing inheritance tax - trusts, settlements on children, gifts while alive, etc. Arguably these taxes cause more annoyance than they are worth.

And third, the long boom in both the US and the UK and the rise in asset prices means that inheritance taxation liabilities are faced by a much higher proportion of the population. More and more people find they are having to resort to complicated measures to cut their liability. That means more votes against.

At any rate if the US does kill death taxes expect there to be enormous pressure for the rest of us to follow. If they are bright enough to spot this, maybe the Tories will have the end of IHT in their next manifesto. We will see.

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