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Farquhar

Posted by theonlinecitizen on March 21, 2008

TOC is introducing a weekly commentary on Singapore. Named after one of colonial Singapore‘s early pioneers and its first Resident, William Farquhar, the column will mix theme and personality to better (we hope) guide our readers through the opaque state of affairs in Singapore. It’s a local take on the British publication The Economist’s commentary pages. You can find the full introduction here.

Farquhar

Death and Taxes

It was Benjamin Franklin who coined that phrase about the inevitability of taxes on the living. Yet, as one of the leading lights of a republic founded on a tax revolt, he might have been quite appalled that America would emulate its ex-British overlords in taxing a rich fellow simply for dying. Indeed, the establishment of the death tax (or estate tax) in the late 19th century has remained controversial in both these countries.

Singapore‘s own estate tax was put to rest when, in a long anticipated move, Finance Minister Tharman Shanmugaratnam announced its abolition during his Budget Speech on 15 February 2008. The estate tax, levied on the estate of a deceased person’s non-residential assets exceeding $600,000 and for residential assets above $9 million, had been gradually lowered over the past decades, from a top rate of 60% in 1984 to 10% in 2001.

As is usually the case in Singapore, the tax went out without so much as an eulogy. This is a pity, because Mr Shanmugaratnam premised the abolition of the tax on three questionable arguments: that it is unfair, it is no longer relevant, and that Singapore needs to do more to encourage wealth accumulation.

Mr Shanmugaratnam argued that the current system was unfair because it affected the middle and upper-middle-income estates disproportionately compared to wealthier ones. The government rejected the option of correcting this by raising the $600,000 limit for non-residential assets because it felt that this would make the tax narrower and therefore less effective. But that is the point of an estate tax – it is meant to be narrow in scope in order to capture only rich estates.

With Singapore having some of the lowest rates for estate duty around (5% for the first $12 million of dutiable assets and 10% thereafter), there is significant room for the government to increase the top rate while raising the exemption limit. This would bring the estate tax more in line with its original purpose, which is to provide a check on large estates rather than to be a tax on middle income groups. Recent estate tax reform in both the US and Britain have moved in this direction.

Perhaps the government did not see it fit to reform the tax because of its belief that, as Mr Shanmugaratnam also argued, estate taxes are no longer relevant in the modern age. He said that wealth today is being created in many more ways and by a wider group of entrepreneurs.

Hence, the current circumstances are quite different from the late 19th century when estate taxes were first levied as a means of taxing land, which made up the bulk of wealth in those times. This is well and good, but it neglects the fact that property is still one of the prime constituents of wealth in Singapore, making up 46% of the assets of Singaporeans in 20051. If the government wants to adjust the estate tax to changing circumstances then it should levy a higher rate on non-residential assets to reflect this rather than do away with estate tax altogether.

The government’s third argument, that Singapore needs to do away with the estate tax in order to become an attractive place for wealth to be invested and built up “whether by Singaporeans or foreigners who bring their assets here”, discounts the fact that Singapore is already one of the most lightly taxed destinations anywhere in the world.

In countries such as the US and Britain where the clamour for abolishing the estate tax is the loudest, the top rate was 55% in the US on estates larger than US$675,000 in 2001 and 40% in Britain on estates exceeding £300,000 for 2007. Prior to its demise, the estate tax in Singapore was among the lowest among comparably rich economies, with Australia being a notable exception as it did not have an estate tax. In any case, Singapore is an attractive destination for foreign residents for many other reasons (such as its good record in public safety and first-world amenities) besides being a low-tax country.

The Case for Estate Tax

On the other hand, there are good grounds for retaining and reforming2 estate taxes in Singapore. In terms of the incentive to work, estate taxes were instituted precisely because, as Mr Shanmugaratnam admitted, they were “a means to a means to rebalance opportunities with each new generation and prevent wealth from being concentrated in fewer and fewer hands over time.” This is in line with what French political thinker Alexis Tocqueville had in mind when he wrote that taxes on the “estates of the rich” were necessary in order to ensure a mobile and open society. Winston Churchill backed this up in 1924 with the argument that the tax was “a certain corrective against the development of a race of idle rich”. Big bequests might make people less likely to work and discourage individual enterprise.

Benjamin Franklin had unintentionally helped to pioneer one of the favoured means of escaping the estate tax when he bequeathed a generous sum of money to the cities of Boston and Philadelphia upon his passing. Many wealthy people still do this as a means to reduce the amount that they would have to pay on death taxes.

Recognising that the elimination of the estate tax could reduce such charity, Mr Shanmugaratnam urged the wealthy to give more now that they no longer have to pay the estate tax. But such pleas are not likely to be effective in encouraging philanthropy, considering for example that so far only the Prime Minister has declared that he will be giving away any increases in his multi-million dollar salary over the next five years.

The strongest argument for retaining the estate tax is that it will help offset some of the wealth inequality that is building up rapidly in Singapore. The government said that the current tax on property serves this purpose, disingenuously arguing that it “does not affect our middle and upper-middle-income estates disproportionately compared to wealthier ones” in the same manner that estate tax does. This is true, only because property tax is a flat rate of 10% a year. Like the Goods and Services Tax, it is regressive in nature, affecting rich and poor property-owners in the same proportion. Furthermore, though estate duty revenues constituted only 0.3% of the government’s tax take, the government would still have to make up for the shortfall through taxes elsewhere, which could exacerbate inequalities.

Nevertheless, Singapore‘s estate tax could have been made fairer while strengthening the incentives for enterprise. Raising the exemption limit for non-residential assets would ensure that it affects only the rich that it is meant to target. Increasing the rate on the non-residential component, while reducing that on property, could also bring the estate more in line with the diminishing importance of property as a source of wealth.

Another idea is to tax beneficiaries rather than estates. This will help in reducing wealth inequality that is the result of large inheritances rather than big estates. It also creates an incentive for wealth to be spread among several beneficiaries, whereas the estate duty simply reduces the wealth that it taxes in a direct transfer to the state.

It therefore makes sense to retain and reform the estate tax. Yet the hurried manner in which the estate tax met its ignominious end precludes any possibility that it will be reincarnated anytime soon.

References:

1 Singapore Department of Statistics

2 The Economist, “The case for death duties”, 25th October 2007

3 In Budget 2008, the estimate revenue from the estate tax was S$98 million against an estimated total tax take of S$28 billion.

Farquhar will feature every Friday.

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10 Responses to “Farquhar”

  1. quitacet said

    1. Double taxation

    The estate of a deceased person has already been taxed when it was initially accrued. It is taxed again when spent, whether by the deceased or his intended or unintended beneficiaries.

    2. Effectiveness

    The targets of estate taxes are wealthy enough to amass an army of lawyers and accountants to minimize their tax burden already through deduction loopholes and regulatory arbitrage. All this will do is create more iron ricebowls for tax bureaucrats on the taxpayer dime, and more fees for private wealth management services.

    3. Redistribution

    You seek it for its own sake, rather than ask whether additional government revenue actually translates into higher welfare expenditure. Given what little feedback mechanisms are available to influence state expenditure patterns and hold them to account, I would suggest this is not the optimal approach to your desired end.

    4. Quoting Tocqueville

    Is simply not done! Within the three volumes in “Democracy in America” he says enough, and sometimes contradicts himself, for anyone to selectively quote whatever they want.

  2. Farquhar said

    Dear Quitacet,

    Thank you for your comments. Farquhar would like to point out the following:

    Re point 1 – If this is what you mean by double taxation, then one could say that the Goods and Services Tax is a form of double taxation – you are being charged income tax when you “accrue” your income, then it is taxed again when spent. Double taxation in this sense is not serious enough to warrant eliminating estate tax.

    Re point 2 – One cannot avoid the fact that all taxes will involve some sort of evasion. If one were to judge whether to eliminate tax on the basis of possible evasion by the wealthy then perhaps income tax would be the first to go.

    The rate of compliance with a tax depends on its simplicity and fairness – on both counts Singapore’s estate tax is pretty good, since it is among the simplest and lightest of estate taxes in the world. Farquhar does not see how the proposed reforms of the article would change this for the worse – in fact, they would actually increase the fairness of the tax.

    Re point 3 – Redistribution of the revenues is a separate issue – the point of the estate tax is to serve as a check against really large estates as argued by Farquhar.

    Re point 4 – If this is your benchmark for throwing out quotations, then we might not have too many theorists or thinkers to quote at all, since perhaps all of the ones worth studying have contradicted themselves in some small way or another!

    Perhaps you might wish to point out where in “Democracy in America” Tocqueville contradicts himself regarding the accumulation of large estates?

    In any case, one of the key themes of Tocqueville’s work was the examination of what makes a democracy vibrant, and he argued that America’s system thrived because of the open and mobile nature of its society. Read in this context, Farquhar would argue that the quote is entirely consistent with the spirit of Tocqueville’s work.

  3. cx said

    the greater source of inequality, not referred to in your column, is benefits derived from wealth during the patriarch’s lifetime. estate duties do nothing to reduce this. you say the strongest argument for retaining estate duties is that it will help redistribution, but you did not discuss the causes of inequality or the persistence of inherited advantages. it will be much more interesting to consider the broader issue of how much inequality is transmitted over generations. your column would have been a lot better if it had not ignored this important issue — i haven’t seen any study on this, nor any real discussion of it and it should be a lot more interesting than flogging a dead donkey already done to death in foreign press, as your column acknowledged.

    Also there is seldom any merit in comparing singapore with the UK or US – she does not have the many advantages both countries have built up over the years. she is a new entry into the wealth market – price and honesty are her only two selling points. International comparisons are always difficult and dangerous, something that should have but was not acknowledged. On its own, a side-by-side review of different countries means nothing.

  4. shoestring said

    It is good that TOC has initiated this series. After all, not all of us get to read what has been flogged to death in the foreign press. It would be even better if critics contributed and elaborated on what they thought was lacking to complement the offering.

    That would be extremely interesting.

  5. Farquhar said

    Dear Cx,

    Thanks for your comments. Could you clarify what you mean by “benefits derived from wealth during the patriarch’s lifetime”? Farquhar believes that the “patriarch” is also being taxed a higher rate of income tax during his lifetime, though perhaps you are arguing that this tax rate could be increased?

    The point of the article is to question the arguments made by the Minister for Finance in abolishing the estate tax, and to argue the merits of retaining it. While it will certainly be interesting to examine the causes of inequality and its persistence, it is beyond the scope of the article. What does the article does assume, is that inequality and its persistence will be somewhat mitigated through the retention and reformation of the estate tax – which is the point of the tax in the first place.

    Regarding your last point on the comparison with US and UK – perhaps your argument misses the point. First, it was useful for the article to point out the much higher tax rates in the US and UK as a basis of comparison – you would notice that the article did not argue for Singapore to raise taxes to the same level as in the US and the UK.

    Second, as noted in the article, there are many, many other advantages that Singapore has – other than low taxes – which make it an attractive destination for investments and for foreigners. The point that the article is trying to make is that abolishing the estate tax is marginal to making Singapore a more competitive destination for the foreign dollar, and that this has to be weighed against the disadvantages wrought, which includes rising inequality and the risk of perpetuating a “idle rich” class.

    If you are saying that Singapore absolutely needs to retain the lowest possible taxes in order to stay competitive, then you might actually get more mileage from abolishing or reducing the Goods and Services Tax. GST is projected to take in S$6.2 billion in FY2008, compared with S$75 million for estate tax. While there are no breakdowns to show how much rich people have to pay in GST, one might plausibly argue that they are more profoundly affected by GST than the estate tax over their lifetimes, since GST is a recurring tax compared with the one-off estate tax. The reason why the government has actually increased the GST shows that there are other considerations besides the need for Singapore to stay competitive.

  6. cx said

    a) I meant the advantages of growing up in wealthy families – do they affect equality of opportunity, upward mobility, etc. are estate taxes even going to help this at all? But clearly while we should have no interest in reducing inequality generated within a cohort (unless you believe equality for its own sake is good), we do have an interest in reducing unfairly generated inequality e.g. by shifting starting posts etc. the impact of inherited wealth on this should be discussed, and also considered is the wealth the child enjoys before he/she inherits it.

    b) I believe, I could be wrong, that you were arguing that retaining, even increasing, the estate tax would help redress inequalities. Two issues: first taxing inherited wealth doesn’t necessarily reduce income inequality (at least, income from work, which the government uses in its inequality statistics). Second, it’s useless to make this argument without assuming that estate duties are at least somewhat useful in addressing the issue. My point is that this should not be assumed offhand – it is not obvious that taxing wealth will help. At the very least there should have been some discussion.

    c) You said in the article that the tax rate in UK?US is the highest and that recent reforms have raised the ceilings. you imply that this is what we should do, without considering if it is, in the first place, a sound thing. that was what i meant by unreflecting comparisons with other countries.

    d) i don’t mean anything you mention in the final two paragraphs – merely that a greater case should have been made for the harmful effects of a low/non existent estate tax.

  7. Farquhar said

    Dear Cx,

    Thanks for your reply. While you are right in pointing out that estate tax might not necessarily reduce “income” inequality, you would notice that the article referred to “wealth” inequality rather than “income” inequality.

    This is because the whole point of the estate tax is to provide a check against large estates (which are characterised as “wealth” rather than “income”). On the other hand, the tools that governments have to check against income inequality will be the progressive income tax or the redistribution of tax revenues to give more benefits to poorer folk. Farquhar would argue that to truly combat inequality, a government needs to employ all of these tools rather than just one or two, but that is another story.

    You are also right in pointing out that estate tax does not do much to reduce the advantages that wealthy kids have, including the money to attend expensive schools or inheriting the networks of contacts that their parents have. But for the estate tax to substantially reduce these advantages, it would have to be quite considerable, and this would compromise on the fairness of the tax and the incentive to work, both of which would reduce the rate of compliance. Hence, rather than trying too hard to bring down the rich, it would be better to use the income derived from the tax to lift the poorer folk up.

    Re point (c), perhaps you are referring to the following extract from the article:

    “With Singapore having some of the lowest rates for estate duty around (5% for the first $12 million of dutiable assets and 10% thereafter), there is significant room for the government to increase the top rate while raising the exemption limit. This would bring the estate tax more in line with its original purpose, which is to provide a check on large estates rather than to be a tax on middle income groups. Recent estate tax reform in both the US and Britain have moved in this direction.”

    Rather than making “unthinking comparisons” as you have alleged, this paragraph argues that it would be desirable to look at the reform taken in the US and Britain (which had raised the exemption limit while increasing the top rate of tax) because it would move Singapore’s estate tax towards becoming more in line with its original premise of targeting rich estates.

  8. cx said

    i don’t really see how, or why, reducing wealth disparities on its own would be at all important or useful, unless you believe in egalitarianism for its own sake. an estate tax is only good if it is instrumentally useful to reducing greater ills – like an entrenched wealthy class of idle rich, or conversely, a perpetual underclass. As i pointed out, estate taxes on their own do very little to stop this. they reduce some wealth disparities, but do not target the greater reasons for inequalities persisting through generations.

    if your strongest argument for the tax is that it reduces wealth inequality, i would ask – so what if it does? What does that achieve? Remember that it should not be presumed that money raised from estate taxes is automatically ploughed back into redistributive expenditures – it could be used to pay higher salaries, buy more prison guards, build more gold plated taps etc. so it is worth a fight to preserve what is only doubtfully useful?

    in short, you would increase (or retain) estate taxes because they reduce wealth inequality, which is true – but they do not help prevent the more pernicious forms of inequality. as you rightly pointed out again, the amount raised (75m) is so small as to be insignificant; doubling, even tripling it would still be of little help. and if the sum to be raised is to go higher, that can be done only a) taxing fewer people more, b) taxing more people more, or c) taxing more people less. Clearly you would have a), but these people are precisely those who would have greatest access to tax dodging accountants, and precisely those targeted by the fleets of private bankers.

  9. Farquhar said

    Dear Cx,

    Thanks for your comments. You are right in pointing out that the estate tax reduces some wealth disparities but do not target the greater reasons for the persistence of such inequalities, but as pointed out in Farquhar’s earlier reply to you, such persistence is impossible to eliminate without draconian rates of taxation that will compromise both fairness and work incentive in highly detrimental ways. But it is illogical to get rid of Singapore’s estate taxes simply because it cannot eliminate this persistence, since at least it does go some way towards mitigating wealth inequalities. (You would notice that the original article admitted as much and did not make the outrageous claim that estate tax will eliminate such inequalities once and for all.)

    Re your second paragraph, as stated before, a discussion about the causes of inequality and its persistence, as well as the merits of egalitarianism or even the redistribution of revenues, is out of the scope of an article that focuses on the case for retaining the estate tax. The article more or less takes it as a given that too much inequality is undesirable. Farquhar will certainly consider these points in a future article on the issue of inequality itself.

    Re your third paragraph – just because there is the possibility of evasion does not justify the elimination of the tax, since getting rid of the tax could compromise other things such as the principle of fairness. As stated in an earlier reply to Quitacet, the rate of compliance with a tax depends on its simplicity and fairness – on both counts Singapore’s estate tax is pretty good, since it is among the simplest and lightest of estate taxes in the world. Furthermore, the proposed reforms in the article would actually increase the fairness of the tax.

  10. shoestring said

    May I suggest that issue of estate taxes be viewed as only one of many other solutions to wealth distribution. It should not be the only magic pill and it may not solve the entire problem. But still, having it in place would help to alleviate the situation to a certain extent.

    If we take the myopic view that since it does not solve the problem entirely, it is not worth administering, then I am afraid we won’t be able to solve any problems at all because the ills in a society are not individually one-dimensional or mutually exclusive.

    Unless removing estate taxes will bring about a more equitable distribution of wealth, there is little case in removing it. Because the argument that its removal will attract more foreign wealth does not address the issue of disproportionate wealth distribution. So what if the economy is thriving but only a minority benefits?

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