Monday, October 22, 2012

Quick review of capital gain taxes in United States and around the world

As Mitt Romney stated in his economic plan, he proposed to cutting on capital gain tax. Many economists agree on that cutting capital gain will encourage investment in capital and continue to fund future growth. However, cutting capital gain also raises the concern that it may widen income gap between the rich and the poor.
Before rush into a quick conclusion, let's take a look at how capital gains are taxed in the US and other main countries and regions.

United States: In the United States, with certain exceptions, individuals and corporations pay income tax on the net total of all their capital gains. Short-term capital gains are taxed at a higher rate: the ordinary income tax rate. The tax rate for individuals on "long-term capital gains", which are gains on assets that have been held for over one year before being sold, is lower than the ordinary income tax rate, and in some tax brackets there is no tax due on such gains. The tax rate on long-term gains was reduced in 1997 via the Taxpayer Relief Act of 1997 from 28% to 20% and again in 2003, via the Jobs and Growth Tax Relief Reconciliation Act of 2003, from 20% to 15% (for individuals, whose highest tax bracket is 15% or more), or from 10% to 5% for individuals in the lowest two income tax brackets (whose highest tax bracket is less than 15%).
United Kingdom: Individuals who are residents or ordinarily residents in the United Kingdom (and trustees of various trusts) are subject to an 18% capital gains tax. For people paying more than the basic rate of income tax, this increased to 28% from midnight on June 23, 2010. There are exceptions such as for principal private residences, holdings in ISAs or gilts. Certain other gains are allowed to be rolled over upon re-investment. Investments in some start up enterprises are also exempt from CGT. Entrepreneurs' Relief allows a lower rate of CGT (10%) to be paid by people who have been involved for a year with a company and have a 5% or more shareholding. Every individual has an annual capital gains tax allowance: gains below the allowance are exempt from tax, and capital losses can be set against capital gains in other holdings before taxation. All individuals are exempt from tax up to a specified amount of capital gains per year. For the 2011/12 tax year this "annual exemption" is £10,600.
Russia: There is no separate tax on capital gains; rather, gains or gross receipt from sale of assets are absorbed into income tax base. Capital gains of individual taxpayers are tax free if the taxpayer owned the asset for at least three years. If not, gains on sales of real estate and securities are absorbed into their personal income tax base and taxed at 13% (residents) and 30% (non-residents). A tax resident is any individual residing in the Russian Federation for more than 183 days in the past year.
South Korea: For individuals holding less than 3% of listed company, there is only 0.3% trade tax for sales of shares. Exchange traded funds are exempt from any trade tax. For larger than 3% shareholders of listed companies or for sales of shares in any unlisted company, capital gains tax in South Korea is 11% for tax residents for sales of shares in small- and medium-sized companies. Rates of 22% and 33% apply in certain other situations. Those who have been resident in Korea for less than five years are exempt from capital gains tax on foreign assets.
Mexico: Capital gains are taxed at 30% in Mexico during 2012 (29% in 2013 and 28% in 2014 and on).
Japan: In Japan, there were two options for paying tax on capital gains from the sale of listed stocks. The first, Withholding Tax, taxed all proceeds (regardless of profit or loss) at 1.05%. The second method, declaring proceeds as "taxable income", required individuals to declare 26% of proceeds on their income tax statement. Many traders in Japan used both systems, declaring profits on the Withholding Tax system and losses as taxable income, minimizing the amount of income tax paid.
In 2003, Japan scrapped the system above in favor of a flat 20% tax on gains, though the rate was temporarily halved at 10% and after being postponed a few times the return to the normal rate of 20% is now set for 2014. Losses can be carried forward for 3 years. Starting in 2009, losses can alternatively be deducted from dividend income declared as "Separate Income" since the tax rate on both categories is equal (i.e., 20% temporarily halved to 10%). Aggregating profits and dividends to reach a single figure taxed at the same rate is fairly innovative.
Germany: In January 2009, Germany introduced a very strict capital gains tax (called Abgeltungsteuer in German) for shares, funds, certificates etc. Capital gains tax only applies to financial instruments (shares, bonds etc.) that have been bought after 31 December 2008. Real estate continues to be exempt from capital gains tax if it has been held for more than ten years. The German capital gains tax is 25% plus Solidarit├Ątszuschlag (add-on tax initially introduced to finance the 5 eastern states of Germany - Mecklenburg-Western Pomerania, Saxony, Saxony-Anhalt, Thuringia and Brandenburg - and the cost of the reunification, but later kept in order to finance all kind of public funded projects in whole Germany), plus Kirchensteuer (church tax), resulting in an effective tax rate of about 28%. Deductions of expenses such as custodian fees, travel to annual shareholder meetings, legal and tax advice, interest paid on loans to buy shares, etc., are no longer permitted starting in 2009.
China: The applicable tax rate for capital gains in China depends upon the nature of the taxpayer (i.e. whether the taxpayer is a person or company) and whether the taxpayer is resident or non-resident for tax purposes. It should however be noted that, unlike common law tax systems, Chinese income tax legislation does not provide a distinction between income and capital. What commonly referred by taxpayers and practitioners as capital gain tax is actually within the income tax framework, rather than a separate regime.
Hong Kong: In general Hong Kong has no capital gains tax. However, employees who receive shares or options as part of their remuneration are taxed at the normal Hong Kong income tax rate on the value of the shares or options at the end of any vesting period less any amount that the individual paid for the grant.
Singapore: There is no capital gains tax in Singapore.
(information from Wikipedia)
From above information we can see most countries have capital gain taxes in various forms. Usually the rate is between 10% and 30%. The few countries or region that do not tax capital gain are usually financial center like Singapore, Hong Kong and Swiss. However, they suffer from the problem that many rich company executives split their income with large portion of company shares and option and small portion of salary, in which way they can get away from income tax.
When we look at other countries policies. We can find following similarities.
1. Most countries try to make rich people pay more capital gain tax and normal people pay less. Some countries use different tax rate like the US, South Korea. Some countries use annual exemption such as United Kingdom, which means capital gain are tax free within the limit - ₤10600 for fiscal 2011/2012.
2. They try to make long-term capital holders pay more and short-term holders pay less. Countries like United States, United Kingdom, Germany and Canada all have such policy to encourage long-term investment, either in equity or property.
So it seems that the capital gain tax is well designed in United States. First, it tries to tax more on rich people, which helps prevent widening income gap. Second, it encourages long-term investment with lower rate, which creates jobs and helps the economy grow, even providing more revenue than a higher rate.
In the Fiscal Year 2012, the lower tax rate of long term capital gains meant $38 billion less in taxes was paid to the federal government. The 2007 capital gains tax revenue of $123 billion was equal to 75% of the Fiscal Year 2007 budget deficit. So it seems that cutting too much capital gain tax will make government budget in trouble.
From my point of view, the new government should further tailor the tax policy to fit the country's economy. For example, they can provide annual exemption for low income people, further lower long-term capital gain tax rates and increase tax rates on speculative investment and securities. And increasing top tax rates for specific people and circumstances will not affect economic growth, which have been proved by study conducted by Burman, Leonard, Tax Reform and the Tax Treatment of Capital Gains

- Tian Tan


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