I had a bit of an intellectual crisis this evening as I
pondered the conventional wisdom in economics regarding the choice between
reducing consumption taxes or income taxes. Briefly put, the simple conventional wisdom is that taxes on
consumption are preferred to income taxes because they encourage saving and
long-term capital formation and economic growth. Income taxes, on the other hand, distort the labour-leisure
choice and can reduce labour supply and therefore reduce economic growth.
Yet, as I thought about the Canadian economy and how well it
seems to have weathered the global economic downturn, one thing that stuck out
in my mind is that the federal government reduced the GST rate just prior to
the Great Recession. In 2006, the
rate was reduced from 7% to 6% while in 2008 it went down to 5%. Could the reduction in the GST rate
have stimulated consumer spending in Canada just enough to help offset some of
the effects of the economic downturn?
After all, a reduction in the GST can be interpreted as economic
stimulus. If spending increases are
economic stimulus, so are tax decreases.
I’m afraid I don’t have an answer to that specific question for
Canada. However, it should be
possible to see if countries with greater reliance on consumption taxation have
better growth rates than those that were less reliant. What I did do was quickly collect data from
OECD Statistics for the 34 OECD countries on the annual average growth of per capita GDP in US PPP dollars over the period 2007 to 2009, the share of GDP accounted
for by taxes on goods and services in 2008 and the share of GDP accounted for
by taxes on income and profits in 2008.
I then proceeded to plot the tax to GDP shares against the growth rates as
shown in Figures 1 and 2 with a linear trend. The results show a positive correlation between growth in
per capita GDP and the share of GDP accounted for by consumption taxation and a
negative correlation between growth and the share of GDP accounted for by taxes
on income and profits. Well, I’m
glad I sorted that out. Good
night.
Related articles
Worthwhile Canadian Initiative 
Determinant – I would like to like the NDP federally. As you well know, several provinces have a long history of electing provincial NDP gov’ts. It hasn’t helped much at the national level, and I don’t think it’s relevant and I don’t want to get bogged down.
More importantly, I think my assertion stands. The NDP lacks the courage of it’s convictions.
I had a look at the policy book. It’s actually a good example of what I’m complaining about. It’s the same old same old we get from the other parties.
There are four vague bullet points on taxation, which neglect transfers entirely. On poverty there are four points (with D being expanded with many sub-points), and all but A are are so vague as to be meaningless.
Now, picking on one of my own hobby horses, specifically climate change, I see nothing inspiring. Three vague bullet points about what the NDP believes. I don’t care what they ‘believe’, I want to know what they intend to do. Specifically. Carbon market? Fine … gonna auction the permits? How’s it’s going to functions? How’s it to be governed and regulated? Why a market and not a carbon tax? Polluted pay you say? What about pricing power – they’ll just pass it on. Etc … The details matter. No mention of replacing coal fired power plants (the single biggest emitters). And no specifics for reducing emissions from cars (#2 after coal fired electricity). It’s hopelessly inadequate.
Furthermore, climate change – arguably the single largest threat to continued ease and comfort for modern human civilization – merits three bullet points, while Supporting Canadian Creativity merits … seven? C’mon.
For me, this is the same old drivel. It’s a lot of pandering to various factions within the base, a bunch of stuff to try to keep QC, and lots, and lots of hand waving.
Meet the new boss. Same as the old boss.
First, thanks for even looking at the Policy Book 🙂
Second, the Policy Writing Guide issued to Riding Associations said that Resolutions had to be general. It IS all about what we believe; implementation comes later and is the responsibility of the Federal Caucus and the Campaign Committee. The Policy Book stands from election to election, so it has to be general to have a lifespan.
No mention of replacing coal fired power plants (the single biggest emitters).
That’s a provincial responsibility. The provinces own/regulate specific plants. It’s always been that way.
You’ll have to wait for the Election Platform to see how we intend to implement things.
Oh my, I turn off for the weekend and look what I miss.
Determiant: “It’s also a false contention that our income-tax system is a progressive-consumption tax system. Those RRSP contributions are taxable in full on withdrawal, so you can’t armwave the investment deduction away. And we’re generous to RRSP’s so that people will acquire a decent retirement income, which is taxable on withdrawal. That is a conscious policy decision.”
shakes head sadly Right, RRSPs are taxable when they are withdrawn and used to… consume. If people consume their lifetime income (i.e., save when young, dissave when old) all income is taxable, because all income is consumed. But in an income tax system, investments are subject to double taxation, first when they’re saved, and again when they generate returns. Or, put differently, an income tax system is a consumption tax system which taxes future consumption more onerously than current consumption.
Determinant: “Before you cite Sweden again, it has high income taxes* too, so do as proper analysis, you have to analyze income taxes and sales taxes simultaneously, they are not independent which is what Livio assumed above.”
Good lord, how often do we have to hear this nonsense? Sweden has high income taxes on LABOUR income, investment income is taxed at a substantially lower rate (like, half).
“The Left in Canada is still committed to the Beveridge model which features higher tax rates and uses government as the delivery agent.”
Instead of higher tax rates, wouldn’t it be better to have higher tax REVENUES? You can’t spent tax rates.
See, that’s the problem. The Canadian (and American and pre-Blair British) left fixates using inefficient taxes with high notional rates (namely income taxes), which never generate meaningful revenue at the margin, instead of using efficient taxes (VAT or payroll taxes) to generate high revenues. You want high tax revenues and government spending, hey, go for it. All we’re saying is that if you want to do that you have to use SMART taxes, not stupid ones. The NDP’s rejection of consumption taxes puts it in an odd alliance with conservative small government types (for a Canadian example, witness the baptist-bootlegger coalition of Bill Van der Zamm and the NDP in the BC HST debacle). For conservatives, opposition to consumption taxes has a certain practical and ideological appeal. Consumption taxes are an efficient way to raise vast sums of money, while income taxes are an inefficient way to raise revenue. So long as income tax is seen as the principal tax policy pool available, government revenue (and spending) will remain relatively small (at least compared to EU countries), because they simply cannot raise enough money to fund the spending ambitions of the left (at least not in a sustainable way, i.e., without crippling the economy). That’s a position which, while cynical, at least is rational, if you’re a believer in small government. But it is inexplicable why the NDP shares that view. Indeed, the NDP is complicit in maintaining that conservative position because it presents high, inefficient, income taxes as the only way to fund its spending ambitions – feeding into the conservative message.
“You, sir, have carried on about Sweden while patently ignoring exactly how it finances its welfare programmes”
It finances them principally with taxes on labour (payroll taxes and labour income) and VAT – http://www.skatteverket.se/download/18.616b78ca12d1247a4b2800025728/10411.pdf
And according to the Swedish tax authorities – who might know a think or two about the subject – 60% of the “social contributions” are properly regarded as taxes.
“Not sure why this needs to be conflated with a policy of subsidizing investment at the expense of consumption, or why a the wealthy, who consume a smaller share of their income, should contribute a smaller proportion of their income to be redistributed than the middle class.”
Whoa, let’s be careful there. We’re not talking about “subsidizing” investment, we’re talking about not double-taxing it. That’s a huge difference. We’re talking about treating future consumption (i.e., today’s savings) the same as today’s consumption. To characterize that as a subisdy for future consumption does a great deal of violence to the concept of a “subsidy”.
And let’s also separate the tax instruments we use with a discusstion of redistribution. The wealthy may well consume a smaller share of their income, but that doesn’t mean you can’t design a consumption tax that is sharply progressive (using different tax rates, higher exemptions, etc.). Again, one could consider Canada’s income tax system (at least at incomes below ~$130,000 to be a defacto consumption tax regime, and yet there’s not doubt that, even over that range, it is sharply progressive. You want the rich to contribute to public goods and transfers, great, all I’m suggesting is that we should use an efficient instrument to achieve that goal.
Livio, I think the spam filter ate one of my comments.
Determinant: “Explanation: There is only one NDP with a federal section and thirteen provincial sections (the Quebec Section only competes federally) and a common membership roll. There aren’t 13 different NDP’s.”
Formally, no, but there’s a world of difference between the NDP in Manitoba and Saskatchewan, who regularly govern, and their federal cousins who have never seen the inside of a Cabinet room (BC political parties, of all political stripes, are in a world all their own).
Consider Kevin Milligan’s timely piece in today’s Macleans highlighting the decision of Manitoba’s NDP government to buck the trend of raising taxes on the “rich” (which taxes raise little or no revenue) in favour of raising the PST by 1 percentage point – http://www2.macleans.ca/2013/04/29/manitobas-choice/#.UX59_XeW-9o.twitter. The PST is a sub-optimal tax (Manitoba should convert to the HST), but it’s probably less inefficient than the alternative income tax increase that would generate the same revenue.
That’s how responsible social democratic governments operate, and it’s a world of difference from the rhetoric that has formed the basis of NDP tax policy for the last 40+ years.
So there’s a NDP government that’s
Livio,
nearly totally off topic, but your old post about NBER w18315 paper from Robert Gordon “Is U.S. Economic Growth Over? is closed, and I think, you might be interested in this:
I wondered at that time, whether I believe the factor of 2 drop, from 1450 to 1650.
And I stumbled yesterday upon the Herengracht index, 350 years of house / rent prices in Amsterdam,
e.g.http://www.personal.psu.edu/bwa10/House%20Prices%20and%20Fundamentals%20On-line%20Appendices.pdf
a) growth rates just dominated by inflation index
There are some folks, who say we gained a factor of 100 in GDP over the last 200 – 250 years (2 % growth, as a stylized fact)
The paper from Robert Gordon looks more like a factor of 13,
and the Herengracht data say: basically constant
b) long term expectations
Rent price ratio is historically at 1:16, pretty much the same as the PE ratio for the S&P500
And if we now have services at 80% of the GDP, we are basically consuming just each others time, and this can not grow at all.
I ran a slightly different version of this analysis, comparing proportion of sales revenue to sales + income revenue as it correlates with growth and found some slightly different results.
Click to access sales_tax_v_income_tax.pdf
2008 is roughly in line with what you found. But 2009, when the recovery was really starting, shows a significant, in fact the only significant result in the lot, negative correlation of having a high sales tax:income tax ratio and economic growth.
Between 2005-2009, where the tax data was available, this method of predicting growth doesn’t seem to useful. 2009 really stood out to me though because it was the first test I ran and seemed like the most obvious choice.
That’s a huge difference. We’re talking about treating future consumption (i.e., today’s savings) the same as today’s consumption. To characterize that as a subisdy for future consumption does a great deal of violence to the concept of a “subsidy”.
“Future consumption” is not taxed. Only present activities occuring in the time period in question are taxed. You cannot say that because A is necessary for B, then a tax on A is a tax on future B. I mean, you can say it, but that type of argument is capricious and meaningless. I need to eat today in order to have strength to supply labor tomorrow. Does that mean that a tax on consumption is a tax on “future labor supply”? It is absurd to be making these types of claims. And if you look at what most people spend their consumption basket on — transportation, education, shelter, food, health care — that is also critical for the future production of goods and services, nevertheless a tax on these expenditures is not a tax on future production anymore than a tax on investment.
In terms of “double taxation” — that is an equally meaningless statement. When a worker pays a portion of their wages for FICA taxes, then another portion for income taxes is that “double taxation”, or is the total tax burden just applied in two levies? What is important is not the number of levies but the total levy. There is nothing “unfair” about applying X levies instead of a single levy.
I was also going to say that the assertion that today’s savings is tomorrow’s consumption is meaningless. Today’s savings MAY (and often is) tomorrow’s income, a percentage of which may be saved and the rest consumed; there is a fresh choice each time period. So there is no “double-taxation”.
What a VAT does is allow untaxed compounding on a very broad basis. A VAT is an excise tax and whenever a country relies on excise taxes it faces Pitt’s Dilemma if they are relied upon too much. William Pitt the Younger tried to finance the Napoleonic Wars based on excise taxes; he taxed hair powder (which was de rigeur at the time) and powdered hair and wigs promptly fell out of fashion. So Pitt instituted the First Income Tax in 1798.
Any time a tax allows a choice to escape it (investment, in the case of VATs) it risks narrowing the tax base. An income tax is not so easy to escape, that’s why it’s such a “burden”, all taxes are a burden if they are to be actually paid.
Formally, no, but there’s a world of difference between the NDP in Manitoba and Saskatchewan, who regularly govern, and their federal cousins who have never seen the inside of a Cabinet room (BC political parties, of all political stripes, are in a world all their own).
No, there isn’t. Been to Convention, seen it all up close.
“Future consumption” is not taxed. Only present activities occuring in the time period in question are taxed”
In an income tax system, any future consumption financed with savings is taxed when the money to pay for it is earned, not when its consumed. Think otherwise? Try this thought experiement. You earn $100 and put 40$ under your bed for next year. When do you pay the tax on the $40 you saved (i) when you consume it next year, or (ii) when you earn it now? Hint, unless you want a visit from the tax authorities, I wouldn’t answer(i). It’s a simplified example, but it illustrates the point, in an income tax system, future consumption is taxed when income is earned, not when it is consumed.
“You cannot say that because A is necessary for B, then a tax on A is a tax on future B.”
Why not? It’s true.
Let’s start with a couple of simple propositions:
(1) Todays savings becomes tommorow’s consumption (i.e., people don’t save and bury money in the ground foreever): S(today) = C(tommorow)/(1+r), where r is the real return on savings.
(2) Income is the sum of todays consumption and today’s savings: Y = S(today) + C(today)
So a tax at rate t on income is the same as a tax on consumption and savings: (1-t)Y = (1-t)S(today) + (1-t)C(today)
As for double taxation, again, that’s easy to show. With an income tax, C(tommorow) = (1-t)(S(today)(1+r(1-t)).
See how the tax shows up twice in that equation? Once when the money is saved, and again when it generates a return (i.e., investment income). You can make the double taxation explicit by rewriting the equation to that C(tommorow) = (1-t)s(today) + (1-t)(1-t)r.
The brilliance of RRSPs and TFSAs is that they prevent this double taxation by ensure that savings are only taxed once, either when they are earned (in the case of TFSAs) or when they are consumed (in the case of RRSPs). In effect, they remove one of the layers of tax from r.
“Today’s savings MAY (and often is) tomorrow’s income, a percentage of which may be saved and the rest consumed; there is a fresh choice each time period. So there is no “double-taxation”.”
See my prior post. In any event, last I heard, people don’t live foreover (I’d like to be proven wrong on that point) and when they die, everything is taxed. Outside of RRSPs and TFSAs there is always double-taxation.
“What a VAT does is allow untaxed compounding on a very broad basis. A VAT is an excise tax and whenever a country relies on excise taxes it faces Pitt’s Dilemma if they are relied upon too much”
Except modern VATs, unlike Pitt’s excise taxes, are imposed on pretty much everything. You can’t avoid the tax by shifting your consumption patterns. You want to buy wigs? Taxable. Hair powder? Taxable. Ribbons? Taxable. Have the barber shave it off, or give you a mohawk? Taxable. You want to buy brandy? Taxable. Gin? Taxable. Beer? Also taxable. Granted, we have some exceptions in Canada’s GST/HST, notably basic groceries, federally regulated drugs, catheters, etc. although they tend to be for goods/services that people aren’t likely to shift consumption to (there’s only so much milk you can drink in a year and not many people voluntarily consume catheters – I hope).
True, you can avoid taxes today by saving for tommorow, but you can’t avoid the tax because the wigs, brandy, and everything else, will be taxable tommorow. Unlike the income tax, which distorts the choice between consumption today and consumption tommorow (see above), the VAT is neutral, it taxes you at the same rate regardless of when you choose to consume your income.
“No, there isn’t. Been to Convention, seen it all up close.”
And yet, when faced with tough choices the NDP government in Manitoba raises the PST, which will actually raise money, while the federal NDP runs on BS policies of taxing corporations and “the rich” – which will generate sweet f-all in revenue – and their Ontario breathren ask for tax increases that – plausibly – could cost the province revenue (See Kevin Milligan’s calculations: https://docs.google.com/spreadsheet/ccc?key=0App-Y0SS83SndDlTYlRKY01qVTBONE9sSlB5UFp0OUE#gid=0. As a proposal, it at least has the merits of creating work for tax lawyers). Same party, different realities.
“Any time a tax allows a choice to escape it (investment, in the case of VATs) it risks narrowing the tax base. An income tax is not so easy to escape, that’s why it’s such a “burden”, all taxes are a burden if they are to be actually paid.”
As I noted above, a VAT doesn’t allow people to “escape” taxes by saving (investing), since those savings (and any income they earn) will be taxed when they are ultimately consumed. A VAT does prevent such savings from being taxed twice (as does an RRSP). The income tax is a burden not because it it taxes investment, but because it double-taxes investment (or, I suppose, more accurately, the returns on investment income). If you’re worried about people having a vast store of untaxed wealth that never gets taxed, hey, adopt my consumption tax proposal of having an unlimited RRSP – when you die, your RRSP gets taxed. Once.
Bob,
Most tax codes allow for capital losses to be realized (deducted from taxable income). Hence your r is not always positive and the double taxation becomes a redistribution means – from those who incur capital gains to those who incur capital losses.
Sure, today’s consumption is tomorrow’s investment, and tomorrow’s consumption is today’s investment. You can draw these analogies if you want. If I tax consumption, that will discourage the purchase of consumption, which will discourage the production of consumption, which will discourage investment.
At least we see now that you need a general equilibrium analysis, instead of picking two random points in the circle of cause and effect and marking them special.
The advantage of taxing capital over consumption is that while no one will increase their demand for consumption if sales taxes go up, the demand for savings may well go up if capital income is taxed — this depends on whether the wealth effect outweighs the income effect. But for consumption, you have no correspondance to the wealth effect. So this is really an empirical question — how sensitive is investment to broad capital income taxes, which is equivalent to asking how sensitive are savings demands to the interest rate. The answer is not very much. But if savings demands are less responsive to changes in the interest rate than consumption demands to an increase in the price of consumption, you would want to tax capital income more than consumption.
In terms of “escaping” paying capital income taxes, investment occurs as a result of arbitrage. There is no escaping the desire for free money. If the CB sets the policy rate at 1%, and you see an investment opportunity that yields 2%, you will invest — borrowing from the CB and purchasing the asset yielding 2%, and you will make this investment regardless of whether 50% or 90% of your capital income is taxed. 50% of free money is still better than nothing. So investment will still occur — the only question is whether the CB will need to hike rates as a result of the capital income tax in order to avoid inflation due to reduced overall savings demands at the after-tax yield. And again, that depends very much on whether wealth effects outweigh the income effects, as well as depending on things like distribution of wealth, the social safety net, etc. Again, it’s an empirical question, not something to be reasoned out from pure philosophy.
In terms of your fixation on the number “1”, I am assuming that if I levy a tax of $5 on you in the morning and $5 in the evening, then you will be obsessed about being taxed twice and will therefore prefer to pay a $10 tax in the morning. I see nothing special about two levies rather than a single levy, and am genuinely amused that you seem to think the latter is always better than the former.
Bob Smith writes:
“The brilliance of RRSPs and TFSAs is that they prevent this double taxation by ensure that savings are only taxed once, either when they are earned (in the case of TFSAs) or when they are consumed (in the case of RRSPs). In effect, they remove one of the layers of tax from r.”
Disagree. The brilliance of RRSPs and TFSAs, if such exists, resides in the behavioural and distributional effects they produce by sheltering returns to household financial investment from taxation. It is not a matter of “double taxation” as such. Imagine a world in which we taxed only consumption and household investment income, but not labour income. One might still be able to make a sound efficiency/equity case for removing the investment tax, even though the investments in question had all been made out of previously untaxed labour income. On the other hand, if it turned out TFSAs did nothing to alter savings behaviour while merely providing a windfall to high-income households, then one might be able to make a case for a little more “double-taxation” by zapping TFSAs.
And by the above argument, if we are in a depressed economy, and there is consensus that the CB needs to credibly promise more inflation, then the best situation would be eliminate all consumption taxes and tax only capital. As we know from arbitrage that every investment earning a return in excess of the policy return will continue to be funded, whatever the capital income tax rate happens to be, we also know that if we raise taxes high enough on capital income, at some point savings demand will decrease and the (post-tax) natural rate will drift above zero.
Instead of trying to discourage aggregate demand by taxing consumption or labor, we should be encouraging aggregate demand by successively hiking capital income taxes while the CB keeps the policy rate fixed at zero.
Giovani and Bob,
I presume that capital losses on holdings of TFSA’s are not tax deductible? Meaning that selling at a loss generates no reduction in tax burden. This works well at near 0% interest rates, not so well with higher nominal interest rates.
Part of the reason for double taxation is that it allows capital losses to be deducted from taxable income. In essence it is a form of income smoothing and reduces market volatility.
I presume that capital losses on holdings of TFSA’s are not tax deductible? Meaning that selling at a loss generates no reduction in tax burden. This works well at near 0% interest rates, not so well with higher nominal interest rates.
Correct, capital losses in both RRSP’s and TFSA’s in non-deductible.
Frank:Most tax codes allow for capital losses to be realized (deducted from taxable income). Hence your r is not always positive and the double taxation becomes a redistribution means – from those who incur capital gains to those who incur capital losses.
Two points. First, and its a secondary point, capital gains is only one form that r can take (dividends, interest, etc. being other forms). So even if I accept your proposition, it doesn’t apply generally.
Second, and more importantly, ACTUAL r can be positive or negative. But when we’re talking about capital gains people don’t know ACTUAL r when they’re making their investment decision (outside of the odd insider trader). Rather, people are making their investments on the basis of EXPECTED r. And since people alway have the option of “investing” in a sock under their mattress, they’re not likely to invest in a risky asset where EXPECTED r is less than zero. So, directly at least, the deductibility of capital losses in the event you lose money doesn’t directly affect your investment decision.
Now, there is some literature (and its been a decade, so I can’t remember by whom, but they were prominent – diamond, saez?) which suggested that loss deductibility reduces the expected volatility of r, since the government is taking a cut of both the upside and of any loss. So to the extent that people are risk adverse, loss deductibility might increase investment. I think the caveat to that is that its unlikely (but I could be proven wrong) that that effect dominates the reduction in EXPECTED r caused by the imposition of a tax. Moreover, in practice, loss deductibility of capital losses are often sharply constrained (in Canada, for example, you can only deduct them against other capital gains, meaning that capital losses are often of limited use). So I think my general point holds.
Giovanni: “On the other hand, if it turned out TFSAs did nothing to alter savings behaviour while merely providing a windfall to high-income households, then one might be able to make a case for a little more “double-taxation” by zapping TFSAs.”
Sure, if the investment/consumption decision is entirely insentive to price (i.e., after-tax return on investment) then I don’t disagree that taxing investment would be great tax policy (for the same reason that taxing other price-insensitive commodities – cigarettes, for example, is a relatively efficient way to raise money). Taxing a perfectly inelastic good or commodity is restritributive, but not inefficient.
But that’s one hell of a proposition, and to be accepted, I think you’d have to put some evidence on the table. For a somewhat older summary of the abundant evidence to the contrary see http://www.unescap.org/drpad/publication/journal_8_1/PETER.PDF
“Correct, capital losses in both RRSP’s and TFSA’s in non-deductible”
That’s not right. RRSP losses aren’t deductible against your non-registered losses (i.e., losses ouside your RRSP – the RRSP trust is a separate taxpayer), but they are certainly deductible against gains in your RRSP. Think about it. If you realize gains and losses inside your RRSP, do you (i) pay taxes only on the gains when you collapse your RRSP, or (ii) pay taxes on the amount actually in your RRSP (the gains net of the losses)? Losses in your RRSP are deductible against gains in your RRSP, because you only pay tax on the net amount in your RRSP when you take it out.
Neither gains or losses are taxable/deductible in your TFSA, because you pre-paid your tax on the funds in your TFSA (i.e., it is paid out of after-tax funds). But the after-tax return on the TFSA is, all else being equal, the same as that for the RRSP.
Frank, note that the deductibility of losses isn’t a “benefit”, it simply involves the government treating gains and losses consistently (i.e., taxing net gain). Income smoothing and reducued volatility is one of the results of taxing gains/deducting losses (although only if the losses can be applied against other gains and/or are refundable by the government, which as discussed above, they often aren’t). But you don’t need double taxation to see those effects – the same effects would be present if investments were only taxed once (as the RRSP example makes clear). Go back to my original equation and take out the second level of taxation, think the results you identify cease to occur? Those are arguments for taxing investment income, not for double-taxing investment income.
Bob,
“But you don’t need double taxation to see those effects – the same effects would be present if investments were only taxed once (as the RRSP example makes clear).”
If you invest in an RRSP and that RRSP is sold at a loss, you never paid any taxes on the income that you used to fund that RRSP. Hence you go from double taxation to zero taxation. That creates a perverse incentive to pour money into enterprises that have no hope of ever offering a positive real return on investment. See offshore shell companies.
Frank,
First, avoiding tax by losing money isn’t much of a tax-avoidance strategy. And offshore shell companies typically have significant returns – they don’t pay taxes after-all – people just don’t report it.
Second, the example you give is no different from paying tax on the original income, then claiming an offsetting deduction for the loss. And intuitively, in the scenario, the person SHOULDN’T pay any income tax because his net income is nil.
Bob,
“First, avoiding tax by losing money isn’t much of a tax-avoidance strategy.”
That would depend on how progressive / flat the tax rate structure is and how much control or foresight you have on the amount of money you lose.
Frank, think about that for a second. At any tax rate less than 100% the cost of the loss exceeds the tax saved. Typically, the aim of tax-avoidance strategies is to save you money. At a 99% tax rate, does it make sense to lose $100 to save $99 in tax? Really? At tax rates less than 100%, losing money is NEVER a good tax-avoidance strategy. And, I’m willing to bet if investors had any control/foresight over the amount of money they lose, they wouldn’t lose it, losing money being generally a bad investment strategy.