Globalización

COMENTARIOS DE FRANCISCO GIL DÍAZ AL LIBRO “GLOBALIZACIÓN, DESARROLLO Y POBREZA DE GUILLERMO DE LA DEHESA

México

Febrero 18, 2004

·     Es un verdadero gusto participar en la presentación del libro titulado Globalización, Desarrollo y Pobreza de Guillermo de la Dehesa. Se trata de una obra que lleva a cabo una difícil combinación: es a la vez rigurosa en sus fuentes, en su acopio de evidencia empírica, en el peinado de la bibliografía pertinente y en su sencillez de exposición. Este logro permite que cualquier interesado en el tema, sin necesidad de dominar la teoría económica, pueda beneficiarse de las lecciones contenidas en un valioso libro en el que el autor blande con elegancia su cimitarra para descabezar un buen número de mitos construidos alrededor de los supuestos males de la globalización

·     El comercio internacional nace con la aparición misma de los Estados, pero quizás nunca como ahora brindó las oportunidad de aumentar rápidamente el empleo y los salarios de los más necesitados

·     El nuevo ingrediente en la organización económica mundial son las telecomunicaciones. La red de fibra óptica que envuelve al planeta transmite datos a la velocidad de la luz y permite así la comunicación en tiempo real

·     Comunicación confiable, en casi todo el mundo barata, hace posible el diálogo entre las computadoras del corporativo de una empresa en Irlanda con su almacén de datos en Canadá, su centro de diseño en Italia, su fábrica de programas en la India, sus plantas de producción en China, México y Tailandia, simultáneamente con la interacción de la empresa con sus proveedores, sus clientes y sus medios de transporte en el mundo entero

·     Este fenómeno, único en la historia, permite que sin necesidad de emigrar, fenómeno doloroso para quienes lo emprenden y cada vez más políticamente controvertido para las poblaciones receptoras, puedan emplearse y mejorar su condición económica centenares de millones de personas dentro de países que empiezan a salir aceleradamente de su atraso 

·     Al poblado Alsmeer en Holanda concurren diariamente vendedores con flores provenientes de Colombia, Kenya y Zimbabwe, entre otros, a ofrecer 7 millones de rosas, 3 millones de tulipanes, 2 millones de crisantemos más 8 millones de plantas y macetas de diversas variedades. Las flores se colocan a lo largo del equivalente a 125 campos de fútbol[1]

·     La organización de este centro comercial es tan eficiente que las flores viajan a Holanda, son objeto de pujas de parte de 2 mil compradores y  en un lapso asombrosamente corto alcanzan a llegar frescas a sus destinos, muchos en ultramar. En menos de un día un embarque sale de Nairobi, se comercializa en Alsmeer y está en las manos de una enternecida novia en Seúl[2]

·     2 mil compradores acuden simultáneamente a este mercado ofreciendo sus posturas a través de medios electrónicos dentro de la famosa “subasta holandesa”

·     El ejemplo anterior es elocuente porque la subasta holandesa de flores tiene cientos de años, pero su alcance internacional y los medios para realizarla han experimentado recientemente una revolución. Esta revolución es a la que se refiere Guillermo de la Dehesa en su estupendo libro

·     El trabajo de Guillermo aborda varios de los aspectos que se han controvertido alrededor de este fenómeno explosivo que se ha bautizado con el nombre de Globalización. Lo hace con un manejo diestro de la teoría y mediante una recopilación de trabajos empíricos que interpreta

·     Su obra es de una enorme trascendencia porque se ha difundido un gran número de nociones falsas acerca de los resultados de este fenómeno mundial que le han permitido a algunos gobernantes justificar políticas empobrecedoras de sus poblaciones pero con atractivos populistas que, frente a ciudadanos mal informados, sirven, al menos en el corto plazo, para atraer votos

·     Las conclusiones principales  de De la Dehesa sobre los efectos de la globalización se pueden resumir en lo siguiente:

-Al mismo tiempo que se ha acelerado la globalización durante las últimas 2 décadas, se ha dado una muy significativa reducción mundial de la pobreza absoluta

-No obstante el “enorme crecimiento de la población en los últimos 20 años, la reducción de la pobreza en términos relativos ha sido espectacular”

-Es interesante notar la diversidad geográfica de estos efectos: donde no se aprecian disminuciones en la pobreza absoluta y relativa es en África, y con efectos leves, Latinoamérica. La primera sin reformas estructurales en su conjunto y la segunda con pocas reformas, algunas mal instrumentadas y en todo caso, con gran lentitud en su andar

-Por lo que respecta a la desigualdad, la conclusión es que ha tenido una ligera disminución y que, en los países en los que ha aumentado, como en China e India, se debe a que ha subido relativamente más el ingreso de las personas de mayor capacidad económica y no porque se haya empobrecido el resto de la población

-Otro argumento es que la globalización ha creado emporios empresariales con un poder superior al de los Estados. Los hechos ciertamente no se compadecen con esa opinión: la Comunidad Económica Europea ha impedido fusiones y dictado medidas de competencia que han afectado a corporaciones internacionales de las de mayor tamaño, lo mismo ha sucedido tratándose de autoridades reguladoras de los Estados Unidos, en ambos casos con efectos incluso extraterritoriales. La regulación o soberanía de otros Estados tampoco se ha visto impedida para dictarle normas a la inversión extranjera 

-También aborda Dehesa la acusación relativa a la explotación de la fuerza trabajadora de los países emergentes. Sin duda que la inversión ha fluido hacia lugares en donde, además de otras condiciones, es competitivo el costo de la mano de obra. La pregunta pertinente no es sin embargo si se está aprovechando el bajo costo de la mano de obra, sino qué ha sucedido con el bienestar económico y los salarios de esos trabajadores. La evidencia empírica recopilada por Dehesa muestra que las empresas extranjeras “pagan salarios más elevados que los de las empresas nacionales y sus condiciones de trabajo son siempre mejores que las generales de los países donde se ubican, además de darles a sus empleados más formación y mejores condiciones de retiro”

-Sin embargo, no todo es color de rosa en el entorno del comercio internacional y de la globalización. Los gobiernos de los países desarrollados perjudican a los trabajadores más pobres del resto del mundo a través de barreras al comercio en productos agrícolas y de los subsidios a sus agricultores y de la reducción que ha tenido la ayuda oficial a los países más necesitados. Pero el autor hace ver que estas políticas de los países desarrollados no tienen que ver con la globalización, sino con la falta de la misma

-¿Qué advertencias o recomendaciones contiene la obra?

§  Una sobre los peligros de una rápida apertura de la cuenta de capitales. Quizás este sea el único aspecto en el que tendría una diferencia de matiz con el autor. Me parece que la multitud de crisis que hemos presenciado durante los últimos años, digamos a partir de las de Chile y México en 1982, tienen que ver con el mantenimiento de tipos de cambio fijo combinados con uno o dos de los siguientes elementos: a) pobre supervisión de la banca y/o déficit presupuestarios. Dadas estas 2 condiciones las crisis hubieran aparecido aun sin apertura al movimiento de capitales

§  Otro señalamiento del autor tiene que ver con las privatizaciones. El autor critica el uso del producto de la venta de activos públicos para financiar gasto y no para retirar deuda pública, así como la creación o mantenimiento de monopolios a partir de las nuevas empresas privadas

§  Otra de las lecciones de este trabajo es que las barreras a la globalización, tales como aranceles, controles cuantitativos, reglamentación asfixiante, límites a la inversión extranjera, etc., equivalen a la acción de  los Luditas del S XIX que destruían maquinaria moderna con el objeto de mantener los empleos

En suma, por la riqueza de material informativo y su inteligente argumentación, así como por su trascendencia, sin duda la obra de Guillermo de la Dehesa es lectura obligada para todos aquellos interesados en políticas públicas

Felicidades a Guillermo

Francisco Gil Díaz

---

[1] “Reinventing the Bazaar , a Natural History of Markets” de John Macmillan. 2002. Editorial W.W. Norton& Co.

Capital gains taxation in Mexico

Capital gains taxation in Mexico and the integration of corporate and personal taxes

FRANCISCO GIL-DÍAZ

Within the economics profession and in journalistic pieces, the tax- ation of capital gains has been the subject of continuous debate. On one extreme is the Henry-Simons1 camp that insists on taxing in- come defined comprehensively, however impracticable, choice dis- torting, lifecycle inequitable and unrealistic it may be. On the other side is the consumption-based tax camp that includes most modern economists. In the middle is the camp that serves up all kinds of sal- ads depending on the tastes of the proponents (or, to put it more elegantly, social engineers).

This paper will deal first with the tax-base issue to show how far removed from a practical reality is the ideal of so-called compre- hensive income taxation. From this conclusion, the jump to con- sumption-based taxation is natural. But even then, because of the need to recognize the inevitability of the corporate income tax, there is a need to find a solution to the treatment of capital gains on corporate shares if individual consumption (or even income) taxa- tion is to coexist with the corporate income tax. The conclusion is paradoxical and to some it may be somewhat surprising: the only way to avoid the double taxation of gains on corporate shares is to tax them, but to do so in a particular way. The method for treating the taxation of capital gains properly in this context is an old Cana- dian contribution. It is tax neutral and, therefore, avoids the type of tax arbitrage that concerned The Fraser Institute when it convened the 2000 Symposium on Capital Gains Taxation. But, before dis- cussing this idea, it will be convenient to go into more detail con- cerning the real-life problems involved with the Simons definition.

Henry Simons ́ global income approach
Echoing philosophers’ equity ideals, economists have generally favoured progressive taxation as well as an income-tax base with a broad global definition. The required reference to a comprehensive tax base is Henry Simons’ Personal Income Taxation, where he defines the ingredients required to measure the individual’s increase in net worth. Such a concept includes wages, interest, rents, dividends, fringe benefits, subsidies, debt reductions, imputed rent to owner- occupied housing, inheritances, unrealized capital gains, scholar- ships, gifts, and perhaps even the imputed income of household work. Even while striving towards the attainment of this ideal, pol- icy-makers who claim to have established a global-progressive sys- tem of taxation do not realize, or do not confess, how far they are from it, nor how inequitable and random the true incidence of actu- al income taxation really is.

Theoretical considerations are involved in optimal tax design but the most elaborate and dazzling theoretical construct has to recognize the reality upon which it will be applied. In an interconnect- ed and global environment, policy-makers and politicians should become aware of nasty secrets widely known to taxpayers.

• A substantial portion of top salaries in high-tax countries is deposited in tax havens—just ask high salaried executives in European-based companies about compensation deposits in bank accounts abroad.
  
• Ingenious and forward-looking tax planning also avoids the fragmentation of large estates and all kinds of complicated ruses disguise substantial capital gains.
  

Capital gains taxation in Mexico 91

• Political lobbying converts income taxes into veritable gruyère cheeses through myriad deductions, concessions, and favourable treatments.
  
• Fringe benefits often cannot be individualized and taxed or are, because of political considerations, never fully included in the taxable income of individuals.
  
• In many countries, corporations and non-incorporated firms are taxed differently, with the income of the first frequently subject to double taxation.
  
• Dividend income is often double taxed or subject to diverse discriminations because of the “evils of distributed earnings.”
  
• Across countries, the individual global income tax, the al- leged great equalizer, often accounts for no more than 20% of total fiscal revenues.
  
• Global corporations readily relocate profits internationally ac- cording to tax minimizing strategies.
  
• A substantial portion of personal income, which stems from the implicit stream of services from owner-occupied housing, is usually not taxed.
  

Because of the high mobility of financial capital, interest in- come is generally not taxed or, when taxed, its burden is shift- ed to the consumer. 

Because of the practical and political reasons given above, the at- tainment of equity, based on the income tax, is a delusion, a Holy Grail that only serves to inspire the matins of the apostles of global income taxation. So much for the practicality of a comprehensive in- come tax and the attainability of horizontal and vertical equity. 

But how about efficiency considerations? There is a broad consensus in the economics profession that taxes generally distort the choice between labour and leisure but that the income tax also distorts the choice between consumption and savings. A tax that generates equal revenue and comparable equity effects, based on consumption, would be preferable on this account. 

The other attribute generally examined in taxes is their inci- dence and their effect on comparable net of tax incomes. From this perspective, another defect of the income-tax approach is that it views equity from a static point of view. It considers the ideal base for taxation to be all sources of income and the increase in the net wealth of the individual over a given period of time. It is fitting that this approach was perfected in the 1940s, together with the linear- static Keynesian consumption function, which considered current income as the explanatory variable of consumption and totally ig- nored life-cycle income. With some exceptions, economists tend to ignore the tax design and equity implications of a life-cycle or permanent-income approach to consumption behaviour.

If income is the vehicle towards achieving consumption and if consumption is the quintessential ingredient of a utility function, it is not clear from a theoretical standpoint why income should be the object of taxation instead of consumption. The indirect attain- ment of an objective, through the taxation of the means instead of the objective itself, might be justified when the objective is hard to define, to administer, or both. But in the case at hand it seems that the opposite is true. Consumption is much easier to tax, unless one wishes to tax consumption directly at the individual level. I return to this issue below.

Intertemporal or life-cycle considerations imply that if con- sumption is programmed throughout a lifetime in an effort to max- imize an individual’s utility, it makes sense to target it, instead of global income, as the object of taxation. Beyond practical consider- ations, income taxation will result in, at best, the equivalent to con- sumption taxation and, generally, in an inferior outcome. Savings and returns on savings are the tools used by individuals to average out consumption through time. Thus, the life-cycle approach sug- gests that, if the measure of an individual’s utility wealth is consumption, it is the latter that ought to be taxed.

There are practical considerations as well. It is well known that consumption follows a more regular pattern through time than income. Individuals whose income is bunched up, frequently in the early stages of life, as is the case of entertainers, traders, athletes, and so on, face a more progressive income taxation and heavier av- erage taxes than those whose income is more equally distributed through their life-times. The excess tax burden faced by such indi- viduals cannot be eliminated except through extremely complicated lifetime-averaging techniques. The same will usually be true of highly variable incomes derived from such activities as farming, fishing, cattle raising and mining.

The inequities just discussed can be avoided in principle if the tax base and the tax rates are set up so that the present value of tax revenues is the same. Under these conditions, the lifetime inci- dence of both income and consumption base taxation will be the same and there is no a-priori reason to choose, on equity consider- ations alone, one tax over the other.


Collection costs are not the determinant of the appropriate choice between consumption and income tax bases. As Hall and Rabushka (1985) point out, consumption taxes can be designed to tax directly an individual or income-based taxes can be designed to be “indirect.” On the other hand, collection costs should rather be a decisive factor in the choice between indirect and direct taxation since the collection and compliance costs associated with direct tax- es can be considerable. Hall and Rabushka (1985) report a figure of 10% of revenue for the American income tax. However, a tax on wages is one simple direct tax that over the life-cycle is equivalent to taxing consumption.

Given the considerations above, an “income” tax that excludes imputed rents from owner-occupied housing, capital gains and in- terest income, does not appear to be inequitable but it will be unnec- essarily distortive unless it also excludes rental income. Within such a framework, the next section will explore how not to tax capital gains when a corporate tax is in existence.

In summary, efficiency and equity considerations counsel consumption-based taxation because a consumption tax involves a lower number of distorted individual choices and because intertem- poral equity is better served. If, on efficiency and intertemporal eq- uity grounds, consumption is to be the preferred mode of taxation, it is evident that capital gains and other sources of capital income ought not to be taxed. One solution to the debate would then be to base taxes on consumption and be done with capital gains taxes.

But, despite all the ink spilt in discussing the theory and the persuasive arguments in favour of consumption taxation, it is a fact of life that a form of income taxation will prevail for a long time to come. Furthermore, and also on practical grounds, imperfect, inef- ficient, and inequitable taxation of personal income will also prevail to be an extended form of taxation. Under these rules of the game, an important issue to resolve before dealing with the appropriate way to tax corporate capital gains is: should corporate income be taxed twice by having both dividends and capital gains income sub- ject to the income tax

If the answer is negative, the method of avoiding the double taxation of profits is to integrate individual income taxation with corporate income taxation. The exemption of capital gains from the income tax would not be sufficient to avoid double taxation be- cause, under an integrated setup, individuals are entitled to a tax re- fund if their tax bracket is below that of the corporation. Integration encompasses more than the treatment of dividends. It requires a treatment of gains obtained through the realization of corporate shares symmetrical to the one given to dividends.

The interaction between dividend and capital gains income and its implication for the taxation of capital gains will be the subject of this paper. It will be seen that, to understand the treatment that ought to be given to capital gains income, the two income sources have to be considered jointly. The discussion will deal solely with equity shares and will not include other wealth accretions, such as real estate, art works, or in general the appreciation of any other asset. A succinct presentation of Mexico’s perhaps singular experience in this regard will conclude the paper.

Integration of corporate and personal income taxation = disappearance of capital gains
It will be argued that, when dividends are taxed, it is inequitable and inefficient to exempt capital gains. However, it is well known that, if the personal and the corporate income tax are integrated, the tax on dividends will vanish. Under these circumstances, a symmet- rical treatment of capital gains requires adjustments to provoke the virtual disappearance of capital gains taxation, as it should under an appropriately balanced non-distorting design. It will be shown that a simple exemption of capital gains will not do and that, paradoxi- cally, a scheme to tax capital gains will, in fact, encourage people to avoid their taxation.

The concern about the taxation of capital gains has at least two origins: the technical, public-finance outlook from which many analysts point out that capital gains are generally overtaxed;2 and the notion that capital gains are the ultimate manifestation of market, technological, or organizational efforts. As such, these rewards to entrepreneurship ought not even be taxed, lest the motor of eco- nomic growth is impaired and welfare reduced.

Digression on inflationary accounting
Before discussing the merits of the diverse modes that capital gains taxation can take, it will be convenient to deal with, and leave aside, the other significant source of double taxation and sometimes even confiscation of capital gains. Over taxation frequently occurs when the purchase price of an asset is not corrected for inflation to calculate its taxable gain. It may even turn into confiscation given a sufficiently high increase in the general price level. A creeping low inflation over a long period is all that is required for this effect to take place.

But, although the remedy for this misfortune seems obvious, beware of individual indexations to correct partial distortions. The reason for these distortions is that general price-level increases will tug at a corporation’s balance sheet from different directions and the net result will differ from firm to firm, depending on the relative importance of monetary assets and liabilities. Depending on how several factors combine, corporate profits may be understated or overstated as the result of inflation. If a firm is a net debtor, it gains from inflation on this account, or loses from a net creditor position. 

The firm also loses from depreciation charges that, being based on the original (nominal) purchase price of capital assets, fall in real terms with inflation. Thus, profits and dividends are, because of in- flation, distorted reflections of a firm’s true results. This argument is also applicable to any accrued capital gain. While the latter may seem to have ended up being overtaxed in real terms, the gain may be due to inflation that lowered the corporate income tax and re- sulted in more untaxed reinvested profits. The converse argument also applies, of course: nominal taxation may account for the double taxation of losses!

Could it be that the general impression of over-taxation orig- inates in the isolated perception of taxes? These taxes fall dispro- portionately on the sale of shares when it would be more appropriate to consider all the inflationary effects on the balance sheet of the firm whose shares were sold.

To conclude this section, it seems wiser to either not index at all or to index comprehensively, that is, to index the whole balance sheet and to carry its adjustments into the taxable profit and losses statement. Partial indexation will introduce an additional source of random variation in end results.

The dilemma—to tax or not to tax capital gains
Excessive capital gains taxation should not be viewed singling out capital gains as a special entity. This is the position of many propo- nents of capital gains tax reform, especially some vocal contemporary American advocates for the exemption of capital gains from the in- come tax. Abstracting from the unpredictable effects of inflation, over taxation of capital gains is a result of separate corporate and in- dividual income taxes; it originates in the overall design of the in- come tax itself. Except for some European countries and Mexico,3 among others, where the two taxes are integrated, corporate profits are taxed at the firm level and again when they are distributed. In this context, it must be understood that realized capital gains on shares are a form of profit distribution: if an investor decides to sell a corpo- rate share, the proceeds of the sale are equivalent to a “home-made dividend” (Fama and Miller 1972). Therefore, if profits are taxed once at the firm level and again when distributed, symmetry requires that the same base and tax rate be applicable to capital gains.

If distributed profits and capital gains are taxed differently, people will tend to engage in tax arbitrage and to choose the lower taxed vehicle. Therefore, the correct, neutral and equitable goal is not a favoured treatment for capital gains but rather a symmetrical treatment of distributed profits and of capital gains. If the first are taxed twice, so should the other and, if the first are not adjusted for inflation, it is not clear why the other should.

On the other hand, there are no efficiency or equity grounds to double-tax corporate profits, if dividend and corporate profit tax- ation were integrated; that is, if only the individual shareholder were considered the unit of taxation, capital gains taxation would virtually disappear.

Under such a scheme, a corporate income tax is solely an in- dividual income tax withheld at the source, just as is frequently done with wage or interest income. In this vein, individuals add up their various sources of income, including dividends, albeit grossed-up to determine the profit before corporate income tax, but then the cor- porate income tax would be creditable as a withheld tax in order to arrive at the individual income tax.

The end result of this procedure is that corporate profits would be taxed only once at the individual’s level. Such a design requires parallel corrections in the way capital gains are taxed. The seller of a share would be allowed to modify its purchase price when calculating the difference between the sale and purchase prices to arrive at the taxable capital gain. The required adjustment would be to allow for taxed reinvested profits to be added to the purchase price of the share and to deduct corporate losses. When the individ- ual and the corporation’s marginal tax rates differ, a grossing-up and tax-credit procedure similar to the dividend method is required. This method is discussed below.

To simplify the first example, the two rates will be assumed to be equal. In this case, since most capital gains originate in the ap- preciation of share values derived from the reinvestment of profits, the deduction of these investments from the capital gain should cancel out the capital gains’ tax base.

There is a caveat to the last assertion because, beyond the mere reinvestment of profits, a share’s value may appreciate be- cause of the market’s appraisal of the growth potential of a particu- lar firm, an appreciation beyond the average expected marginal return on other investments. Examples abound, such as Wal-Mart, Microsoft and, until recently, the “dotcoms.”
Even in this case, the adjusted purchase-cost procedure out- lined above should generate neutrality; that is, no taxation of capital gains or, equivalently, no double taxation of profits. Consider for simplicity (a) no corporate income tax; (b) a firm whose profits are reinvested; (c) a 10% annual discount factor; (c) a riskless environ- ment; and (d) a change of market sentiment so that a share that had been expected to yield the same 10% as the rest of the market is sud- denly expected to appreciate 20% the following year. Assume also a $100 purchase price for the share and that, after the 20% apprecia- tion, the share is expected to continue yielding 10% per year. The original purchaser of that share, who paid $100 for it, can now sell it for $109.1 and pay a tax of 91 cents, if we assume a proportional income tax of 10%. If the original holder sells the share immediately after its higher expected return is known to the market and if the new owner sells it at the end of a year for $120, the tax adjusted cost of the share for the latter will be $129.1, since the firm generated and reinvested $20 in profits. The second seller of the share will be able to deduct from his global tax bill losses equal to $9.1, for a tax saving of 91 cents. The capital gains tax paid by the first individual is thus offset, except for the difference in present value, by the tax saving of the second individual, who obtained a 10% return on the purchase plus the tax-saving on a capital-gains deduction.

However, the numbers above cannot be the outcome under a perfect capital market, while the original asset holder 
obtained an extraordinary return. The unexpected and sudden appreciation of the share also brings the buyer a return higher than 10% if this tax savings is added to the return on the asset. In a competitive capital market, the original holder will ask somewhat more than $109.1 for the shares in order to let the second holder earn a return just equal to 10%. The sale price in this case will be $110. At this price, the second holder will get a $10 return when selling the share after one year, plus a tax saving equal to a 10% tax rate on the difference between the fiscal cost $110 + $20 = $130 and the $120 sale price, or a savings of $1. A return of $11 on a $110 investment is just equal to the market discount rate of 10%. (The method for arriving at this number with this simple set of assumptions is presented in the Appendix.)

What is of interest here is that, even though the original shareholder pays a tax on the capital gain, the net after-tax income will be the same as if there had been no tax. Since the discount rate is 10% and the net increase in the wealth of this individual is $9.1, the return is the same that would obtain if a capital gains tax did not exist. The original shareholder recovers the tax saving of the second asset holder because the sale price of the share is bid up exactly in the amount necessary to recover the tax. In a competitive market, the original shareholder will be able to capture the tax saving that will eventually be realized by the second holder.

Since for simplicity the numerical example assumed away the corporate income tax, it did not illustrate the important point of how to adjust at the individual level for the tax paid by the firm. An- other numerical example will take care of this omission. Assume a share valued at $100, a profit of $10, a corporate income tax of $5, and a dividend of $5 to an individual in a 30% tax bracket. The in- dividual will add to other income the grossed-up dividend ($10), calculate the tax ($3), and credit the corporate income tax formerly paid on that dividend ($5) to arrive to a claim of $2 on the Treasury for a total net income from the dividend of $5 + $2 = $7, that amounts to the disappearance of the corporate income tax.

If the corporation does not pay out a dividend and the individ- ual wishes to obtain the same cash income, the procedure is analo- gous to the mechanism described above. The share will be sold for $105 and its adjusted cost will also be $105. 

But, this would be the end of the story only if the shareholder pays a marginal tax rate equal to that paid by the corporation. If the rates are different, the individ- ual will be allowed to credit the $5 tax paid by the corporation to a total taxable income augmented by the grossed-up, unadjusted cap- ital gain ($10), in order to generate the same $2 tax refund.

Therefore, even in a case of extraordinary gains, the taxation method proposed ensures that there is no capital-gains tax. This ar- gument is not new: it has simply been forgotten, since it was pre- sented, in a different fashion, in the report by the Royal Canadian Commission on Taxation (known also as the Carter Commission) in the 1950s.

I hope the discussion above helps to clarify some issues on the important and delicate matter of capital gains taxation reform. A change that simply eliminates the taxation of capital gains will contribute to the disappearance of the tax on dividends and of dou- ble taxation as well, at least on the shares of those firms with stock- listed shares. But if this is the desired output, why do it through the back door? And, why not adjust the burden of the tax to the lower rate that should be borne by individuals in the lower brackets?

The arguments presented here suggest that the proper solu- tion is to eliminate both income-tax sources simultaneously. Alter- natively, if one wishes to benefit lower-income tax payers, one should apply the integration recipe outlined above regarding capital gains and dividend taxation to transform the corporate income tax into a tax on the individual’s income. This solution is much prefer- able to simply abolishing the capital gains tax because its elimina- tion would turn individuals into tax planners engaged in the elimination of the tax on dividends through tax arbitrage. However,

100 International evidence on capital gains taxes

the owners of medium-sized and small-sized firms, for which there is not a ready and liquid stock market, would have trouble selling their shares and would, thereby, be stuck with the tax on dividends. Therefore, whoever claims that reduced or zero capital gains taxa- tion is a benefit for the small entrepreneur should concentrate such intellectual efforts elsewhere.

Zero capital gains taxation would also allow the total avoid- ance of taxation on those firms where, because of differences be- tween their accounting and fiscal accounting rules, capital gains are realized despite no apparent gain. To close this loophole completely it also has to be established, as was done in Mexico, that realized profits, through dividends or capital gains, will be taxed even if they are generally exempt, when they are derived from profits that did not previously pay the corporate profits tax.

However transparent and non-distorting, the integration so- lution has serious drawbacks. The accounting requirements are complex and many years of information and documentation are needed. Besides, in countries where the estate tax has contributed to place large amounts of corporate shares in the hands of non-prof- it institutions, the revenue loss from an integration scheme could be large. This latter problem might be dealt with by not having the corporate tax be definitive in the case of shares held by non-profits, and a partial solution to the accounting and computing complexi- ties might be sought in a rate structure low enough for both taxes with equal proportional rates.


The evolution of the capital gains tax in Mexico
The treatment above was not incorporated into Mexican tax legisla- tion in one fell swoop nor were all its ingredients fully implement- ed. Given the sharp general price increases of the 1970s and an expectation that inflation would continue, it was deemed conve- nient at the time to correct in real terms the purchase cost of assets. The solution was to include in the legislation a table constructed with the price levels of the former 50 years.

Another reform had to do with the need to correct for the bunching in time of capital gains, since they are not recurrent for most individuals and may, therefore, be taxed at an extremely high marginal rate simply by adding overall gains to the rest of taxable income. Therefore, a simple averaging procedure was introduced to ease the impact of accumulation.

The other important reform was to add reinvested profits— corrected for inflation—to the adjusted purchase cost of a share, af- ter having deducted any losses and distributed profits. The adjust- ment does not include the credit for taxes paid in excess by the corporation but, as long as the personal and corporate maximum tax rates coincided, the effect of this omission was probably negli- gible. The top individual rate is reached at relatively low income thresholds so that most shareholders’ marginal tax rate was the same as that of the issuing corporations. This is no longer true since 1994, when the corporate rate was brought below the top personal tax rate. Since then, the corporate rate has slid to 30% and the per- sonal rate rose to 40% in January 1999.

The procedures described above apply to assets held by both individuals and firms, except that capital gains in stock-listed shares owned by individuals continue to be exempt in order to avoid administrative complications. The exemption of individually held stock-listed shares from the capital gains tax has been in force for several years with probably no major fiscal consequences, spe- cially given that, up to 1999, the personal dividend tax was fully in- tegrated into the corporate income tax. This is because, if corrections are made for inflation and reinvested profits, the result- ing consolidated tax base for the shares of listed corporations turns out to be either minimum or negative, although there are times when sharp increases in the stock-market index suggest otherwise.

When corporate tax rates are below the top individual mar- ginal income tax rates, this exemption allows the tax consequences of the spread between the personal income tax rate and the corpo- rate tax to be either avoided or deferred. This is done through lim- iting dividend distribution and letting shareholders obtain their income through exempt capital gains. However, as the top personal marginal income tax rate came to equal the corporate income rate, the incentive to switch the gain into the shares of unlisted compa- nies disappeared. But, the distortion has reappeared under the re- cent Zedillo reforms that lowered the corporate tax to 34%, reintroduced double taxation through a dividend tax, and raised the top individual marginal tax to 40%.

Before the recent Zedillo reforms, the changes performed on the capital gains tax were intended to improve fairness and to “lu- bricate” the capital market. An efficient capital market is of utmost importance for sound resource allocation. The former tax on nomi- nal gains led to the strangling of asset transactions because individ- uals and firms preferred to hold on to their assets rather than incur a tax on gains that were merely nominal. By showing their portfolio valuations at current market prices and excluding potential liabili- ties stemming from the tax due on the sale of the assets, firms could also better leverage their balance sheets.

As explained above, the capital gains mode of taxation is sim- ply a reflection of an integration procedure adopted between the in- dividual and corporate income taxes, a reform that was aimed at improving both fairness and efficiency.
Initially, the procedure allowed firms to deduct paid divi- dends just like any other deductible item or cost. It also required a withholding tax at the maximum marginal rates on individual in- come, creditable by the recipients. The same procedure was applied to interest paid to individuals.

Transfers of dividends among firms were also deductible and cumulative, which allowed interrelated firms to offset losses instan- taneously from one side of their operation against gains on the oth- er. This possibility was deemed particularly important within an inflationary environment.

Another reason to adopt an integration formula using a divi- dend deduction is that, in the first stage of the reform effort, an in- tegration scheme based on an imputation method was introduced. This proved complicated for taxpayers and was later abandoned. Subsequently, when corporate and top personal income tax rates were aligned, the dividend deduction was replaced by a dividend ex- emption.

With the enactment of these reforms and price stability, the distortion that encouraged debt financing over equity financing was virtually corrected. With inflation, however, the deductibility of real-debt amortization through interest payments created an enor- mous attraction to issue corporate debt until the tax treatment of both interest income and expense was corrected for inflation.

Appendix
Assumptions and Definitions

• Let V0 be the purchase price paid by the original owner of the share.
  
• Let V01 be the sale price after a new higher return is an- nounced. The new return higher ( g per year) than previously expected is known by the market seconds after V0 was paid for the share.
  
• Let r be the discount rate and “normal” rate of return in the market.
  
• t is the average and marginal tax rate equal for everybody.
  
• The sale price V1 of the share after one year will be
  V1 =V0 (1+g)
  V 1 – t [ V 1 – ( V 01 + g V 0 ) ] —————————— = 1 + r
  V01
  V1 –tV1 +tV01 +tgV0 ————————— = 1 + r
  V01
  V1 –tV1 +tV01 +tgV0 =(1+r)V01
  V1(1–t)+tgV0 =(1+r)V0 –tV01 V1(1–t)+tgV0 =(1+r–t)V01
  V1(1 – t) + tgV0 V0(1 + g)(1 – t) + tgV0
  

V01 = ——————— = ——————————–
1+r–t 1+r–t
V0(1 + g)(1 – t) + tg V01 = —————————
1+r–t

Notes

1. 1  The classic reference for a comprehensive income taxation defini- tion is Simons 1938.
   
2. 2  The postponement of the gain does not lower the present value of the tax. See Gil Díaz 1982.
   
3. 3  This comment is no longer fully applicable to Mexico where recent reforms have destroyed the former symmetry and neutrality of its combined personal and corporate income-tax structure.
   

References
Carter Commision (1966). Report of the Royal Commission on Taxation (Vol- ume 3): Taxation of Income. Ottawa: Queen’s Printer.
Fama, Eugene, and Merton Miller (1972). The Theory of a Finance. New York: Holt, Richard & Winston.
Gil Díaz, Francisco (1982). Three Essays on the Taxation of Capital. Ph.D. dis- sertation, Faculty of the Division of the Social Sciences, University of Chicago (December, 1982).
——— (1993). Política Fiscal y Administración Tributaria: La Experiencia de México. Subsecretaría de Ingresos.
——— (1996). To Tax or Not Tax: That Is Not the Question, But How to Tax Best. Unpublished paper given at Conference at the Internation- al Tax Program, Harvard University (June 3, 1996).
Gil Díaz, Francisco, and Wayne Thrisk (2000). Mexico’s Protracted Tax Reform. Gaceta de Economía-ITAM (January).
Hall, Robert, and Alvin Rabushka (1985). The Flat Tax. Stanford, CA: Hoover Institution Press.
Simons, Henry (1938). Personal Income Taxation. Chicago: University of Chicago Press.