Question asks: "You are advising the government of a country on how to set up a tax system. The chief minister wants to tax investment income at a higher rate than earned income, and to exempt capital gains from tax. His aims are to encourage entrepreneurial activity and investment and to redistribute wealth from the rich to the poor. Explain the flaws and unintended consequences of his proposed approach." Solution states: "By exempting capital gains from tax and taxing investment income at a higher rate than earned income, capital gains will become the most tax efficient method of wealth creation and investment income will become the least tax efficient method of gaining wealth. Potentially this will encourage companies to retain profits rather than distribute them, leading to higher levels of corporate investment but it may also reduce the average rate of return for new investment opportunities as opportunities that would previously have been ignored will now be developed. The higher level of corporate investment will not necessarily increase the overall growth rate of the economy as there will be less distributed income reinvested by companies and individuals." I think this is bullsh*t. The effect of making capital gains tax free and taxing investment income heavily won't be to encourage firms to retain profits etc etc and there won't be less distributed income reinvested ... etc. In reality, firms will just either: a) issue heavily discounted zero coupon bonds or b) issues shares, don't pay dividends and do regular share buybacks (the increased level of share buybacks in the UK since the removal of tax credits on dividends for pension schemes supports this) I am getting the feeling that the key to passing these exams is to lose the ability to think freely and believe the only thing there is to know, is what's written in the core reading.
it turns out that the asset has a more sensible solution that agrees with the points above. i hope the markers have more sense than to blindly follow the official solution...
