Taxes affect the degree and efficiency of financial intermediation by imposing a “wedge” between the return to an individual who saves and the return on the investment that is ultimately financed by that saving. This wedge is created by particular taxes (or tax reliefs) that are associated with the acquisition of financial assets, the holding of those assets, the income and capital gains that are generated by them, and their disposal. The paper shows that the effect of these tax provisions varies widely in OECD countries according to whether the saving is done directly or through financial intermediaries, such as banks, pension funds, and insurance companies--and also according to whether the savings are channeled to companies (in the form of debt or equity finance) or to the government. The international playing field for financial assets is thus very uneven.
A number of studies have been conducted since the mid-1980s of the overall ex ante “effective tax rate” on different types of saving in different countries. The paper finds that the results of these studies have, however, been very sensitive to the assumptions that they make (for instance, about inflation) and to their treatment of particular details in the tax laws. In addition, the impact of taxes ex post may differ substantially from ex ante tax rates as a result of market responses that lead to capitalization of tax burdens and tax arbitrage.
The paper describes how tax regimes for financial assets may be assessed according to different standards, such as the “comprehensive income tax” ideal, specific theories of optimal taxation, or more eclectic criteria (including the traditional criteria of fairness, simplicity and transparency, economic efficiency, and administrative feasibility). These different standards often imply different answers to some of the central questions that arise in designing a tax regime for financial assets, such as, what should be the overall tax rate on income from those assets? how should capital gains be treated? and how should tax regimes be adjusted in the presence of significant inflation?
Tax reforms in OECD countries since the mid-1980s have generally tended to broaden tax bases and tax rates. With regard to the tax treatment of financial assets, the clearest common trends have been the further spread of taxes on capital gains, the imposition of restrictions on deductions for interest expense, and the extension of final withholding; in other areas, trends are more difficult to discern. A relatively new development has been the removal (particularly in the Nordic countries) of capital income from the scope of progressive personal taxes and the substitution of flat-rate taxes. The paper concludes that, as the trend toward globalization in financial markets makes it increasingly difficult for individual countries to tax capital income effectively, this approach may offer important advantages.