Welcome back to the deep dive. This is where
we grab that overwhelming stack of information
on a really complex topic. And while we distill
it down, we give you the essential nuggets of
insight, making you the most informed person
in the room quickly and thoroughly. And today
we are undertaking a deep dive into something
that. I mean, it literally defines the relationship
between citizens and their governments. Yeah.
Income tax. Right. It's an essential, almost
universal mechanism. But the history behind it,
the, you know, the complex mechanics and the
economic consequences are just profoundly misunderstood.
Exactly. We all interact with it. I mean, you
see it on your pay stub. You file a return. But
how many of us genuinely understand why the systems
are built the way they are? Right. Why are my
wages taxed differently than, say, my investment
returns? Why would a country even try to chase
income all over the globe? Our source material
for this is pretty ambitious. It gives us a really
structured, comprehensive overview. It traces
income tax from its earliest and sometimes shockingly
modern sounding precursors right up to the policy
dilemmas we face today. Things like international
tax competition or bracket creep. Bracket creep,
the never ending battle against avoidance, all
of it. So our mission today is to give you the
framework to understand not just your own tax
situation, but the whole global architecture
that governs how governments finance pretty much
everything they do. Let's start with the basics.
What are we actually talking about here? At the
highest level, income tax is just a levy. It's
imposed on a taxpayer. That could be an individual
or an entity based on their specific calculated
income or profits. And we call that taxable income.
We call that taxable income. And the fundamental
calculation is, you know, it's very simple. The
tax rate multiplied by that taxable income. That
equals the amount you owe. That sounds deceptively
elegant. It is. And yet that simple equation
somehow generates tax codes that are thousands
of pages long. Because the devil is entirely
in the definitions. It all comes down to the
complex, sometimes, frankly, arbitrary determination
of what counts as taxable income, how you apply
the right rate. And those definitions. They determine
everything. Everything. From how a billion -dollar
company structures its global supply chain to
how a new parent decides whether it's even worth
it to go back to work. OK, let's start with those
rates, because this is where you can instantly
see the policy philosophy of a nation. And globally,
there are really only two main ways to structure
them. That's right. First, you have the progressive
or graduated tax rate system. This is what most
people think of when they hear individual income
tax. So talk to us about the philosophy behind
that. Why not just a single, simple rate for
everybody? What's the point of progression? Well,
a progressive system is built on this core principle
of ability to pay. It's a mechanism that's specifically
designed to distribute the tax burden. How? By
increasing the marginal rate as taxable income
goes up. So it's not just about collecting revenue?
No, not at all. It's an explicitly social policy
tool. We hear about tax brackets all the time.
Can you just nail down what that looks like in
practice for us? Sure. In practice, it means
your income is divided up into tranches or brackets.
So, for instance, the first, say, $10 ,000 of
income might be taxed at 0 % or maybe 1%. That's
designed to protect low -income earners. But
the highest tranche of income, let's say everything
you earn over half a million dollars, that might
be taxed at 35 % or even more. This structure
ensures that, on average, a high -income earner
pays a much higher proportion of their total
income to the government. And this progressive
design, it's almost universal for individuals.
But when we look at businesses, at corporations,
we see a totally different philosophy. Yeah,
we shift almost entirely to a flat rate system
for corporations in most places around the world.
Here, the tax rate just stays constant. It doesn't
matter if the corporation earns a million or
a billion dollars in profit. Why do governments
just throw out that ability to pay? principle
when it comes to companies. What is the rationale
for a flat corporate rate? There are a few arguments.
The main one is the need for stability and predictability
for business planning. I see. Corporations have
to forecast their tax liabilities years in advance
to make huge investment decisions. A constantly
shifting progressive rate schedule, well, that
introduces a lot of volatility. So that's one
reason. The second big argument is that corporations
don't really bear the tax burden themselves.
They just pass it on. To who? To consumers in
the form of higher prices or to their employees
with lower wages or to shareholders through lower
dividends. So the argument goes applying a progressive
system to an entity that's just a collection
mechanism is, well, philosophically kind of pointless.
That is a fascinating tradeoff. You're basically
sacrificing that social equity goal at the corporate
level for the sake of economic stability and
encouraging investment. Precisely. And that leads
us right into defining who exactly is paying
the tax. We've mentioned individuals and corporations,
but the world of taxable entities is a lot more
nuanced than that. And I know the U .S. is a
huge outlier here, right, when it comes to defining
what a business even is for tax purposes. It
really is. Globally, most systems tax an entity
based on its legal formation. A corporation is
a corporation. End of story. Simple enough. But
the U .S. system stands out because many entities
can actually elect their tax identity. They might
be legally organized as an LLC, but they can
choose, they literally check the box, to be treated
as a corporation or as a partnership for tax
purposes. And that flexibility, that choice,
must be a huge lever for tax planners. Oh, it's
a massive planning opportunity. And that brings
us to the other major structure, partnerships.
How are they treated? Partnerships are generally
treated as pass -through entities. The income,
the deductions, the credits, they don't stop
at the business level. They pass through? They
pass directly through to the individual partners
who own the business. Those partners then report
their share on their personal tax returns, where
the progressive rates apply. And the goal there
is to avoid what they call double taxation. Exactly.
You want to avoid taxing the business and then
taxing the owners again when they take the money
out. Okay, so we've covered the structure of
the payer. Is it an individual, a corporation,
a pass -through? But what about the source of
the income? Are my wages treated the same as
my dividends? In most systems, the source of
income absolutely matters. And this gets us into
income variances and exemptions. Income from
investments, things like dividends, capital gains,
interest, is very often taxed at different and
usually lower rates than your active wage income.
And what's the policy driver behind giving investment
income a break? Again, it's mostly an economic
incentive. It's aimed at capital formation. Governments
want people to save, to invest, to risk their
capital because that's what drives economic growth.
So if you tax it too heavily. If the return on
that investment is heavily taxed, people are
just more likely to spend their money rather
than save or invest it. And, you know, there's
all that double taxation idea again. The corporate
profit was already taxed once at the flat corporate
rate. So taxing the dividend that comes from
it at the full individual rate is seen by many
as excessive. And speaking of not taxing things,
certain organizations are just taken out of the
system entirely. Yes. Almost every jurisdiction
in the world. recognizes the public good that's
provided by schools, hospitals, social welfare
groups. So local charitable organizations are
almost universally exempted from income tax.
It's a deliberate policy choice to encourage
private funding for things that benefit the public.
Okay, last thing before we leave these building
blocks, we have to talk about the most powerful
tool in the toolbox, the tax credit. What makes
a credit so different from a deduction? This
is a really crucial distinction. A deduction
only reduces your taxable income base. So if
you're in a 20 % bracket, a $100 deduction saves
you $20 in actual tax. Okay. But a credit is
a dollar -for -dollar reduction of your final
tax liability. So a credit hits the final bill
directly. Precisely. If you have a $500 tax bill
and you get a $100 credit, your bill immediately
drops to $400. Credits are a much more potent
and therefore more expensive for the government
policy tool. But their function is uniform everywhere.
All right, now we get to jump back through time
and see how this incredibly complex system actually
came to be. When we think of tax, you know, we
often think of simple things, levies on land
or sales. But a modern income tax requires some
serious administrative sophistication. Oh, absolutely.
For a government to even attempt a modern income
tax system, you need a few key things. You need
a functioning money economy, not barter. You
need systems for accurate accounting. A common
understanding of what profit even means. Exactly.
A common legal understanding of receipts, expenses,
profit, this whole idea of net income. Right.
And crucially, you need reliable records and
a bureaucracy strong enough to enforce it all.
And that structural requirement is why those
older systems like tithing, which focused on
a piece of your gross output, were so fundamentally
different from what we have today. Right. Tithing
and ancient property taxes, they were assessments
on gross items or on wealth ownership. They didn't
have the precision you need to calculate true
profit or the net increase in your wealth over
a specific period. But there's one really surprising
detail in our sources that shows this idea of
taxing net income isn't new at all. It's not.
The history books take us way out of Europe,
all the way to 9 CE China. To the Xin Dynasty?
Yes, to the very short -lived Xin Dynasty under
Emperor Wang Meng. Our sources pinpoint this
as the very first documented income tax that
was based on the principle of net earnings. This
is just fascinating. What prompted this massive
administrative leap 2 ,000 years ago? Wang Meng
was a really ambitious reformer. He established
a 10 % tax, but not on everything. It was on
the net earnings from specific activities, non
-agricultural trading, fishing, wild herb and
fruit collection, shepherding. The sheer administrative
complexity of trying to define net earnings for,
say, a rural trader in 9CE China is just astonishing.
It is. And the compliance mechanism they developed
sounds frighteningly familiar to what we do today.
How so? People were required to self -report
their income. And just like today, the government
didn't just take their word for it. Officials
would actually audit the self -reported figures
to check for compliance. And I'm guessing the
penalties for getting caught were not small.
Not at all. They were brutal. Tax evasion was
penalized with a full year of hard labor and,
this is the kicker, confiscation of all your
property. Wow. And penalties that severe, they
suggest the system was incredibly difficult to
enforce and probably met with immediate resistance,
which it was. It was abolished in 22 CE after
only 13 years because of widespread popular discontent.
So a short -lived but radical experiment. Now,
jumping forward, early Rome had taxes, but they
weren't based on annual profit, were they? No,
Rome had a wealth tax. During the early Republic,
they had these modest assessments, usually 1%,
maybe up to 3 % during a war. But it was applied
to property you owned, lands, slaves. money it
was a snapshot of what you had not a calculation
of what you earned then we hit the medieval period
with the very famous salad and tithe right the
salad and tithe in 1188 imposed by henry ii this
starts to look a lot more like a precursor to
an income tax it required one -tenth of a lay
person's personal income and their movable property
and this was in england and wales the money was
to fund the third crusade So it was an emergency
measure, but that specific link to personal income
suggests a real evolution in how they were measuring
wealth. And then finally, 17th century Portugal
gives us a truly early modern example. In 1641,
yeah, Portugal introduced the décima, which was
specifically categorized as a personal income
tax. But while you see these examples popping
up... the real inception of the modern, structured,
progressive income tax, the direct ancestor of
what we know today. That's 1799 Britain. Tell
us about that. This was William Pitt the Younger,
and the context was the French Revolutionary
Wars. Exactly. Pitt needed a huge amount of money
to fight Napoleon, and the traditional methods
just couldn't raise the kind of sums required.
So in 1799, he introduced the tax, but, and this
is important, he introduced it explicitly as
a temporary war measure. And it was progressive
from day one. Yes, although modestly. It started
at a tiny rate for lower incomes, two old pence
in the pound for incomes over 60 pounds, and
it climbed progressively to a maximum of 10 %
on incomes over 200 pounds. So that concept of
capacity to pay was baked in from the start.
But the tax was incredibly unpopular precisely
because it was supposed to be temporary and linked
only to the war. This led to that wonderful story
when it was repealed after Napoleon was finally
defeated. Right. So when it was abolished in
1816 after Waterloo, the opposition was so loud
and so angry that they demanded all the tax records
be publicly and ceremoniously destroyed. It was
a signal that this tax was dead forever. And
the government agreed. The chancellor of the
Exchequer complied. He publicly burned the records.
But the bureaucracy, as always, had the last
laugh. Exactly. We know the copies of those records
were secretly kept in the basement of the tax
court. It's just a perfect example of the enduring
administrative instinct of government. Even when
you're defeated politically, information is power
and records are never truly destroyed. And despite
all that opposition. Income tax eventually came
back to the UK as a permanent thing. It did.
That happened in 1842 under Sir Robert Peel.
And Peel was initially against the tax, but a
severe and persistent budget deficit basically
forced his hand. He reintroduced it. And despite
all the opposition, it eventually became, you
know, grudgingly accepted as an indispensable
part of government funding by the mid 19th century.
And the story in the US really mirrors that pattern.
Wartime necessity driving fiscal innovation.
Absolutely. The U .S. federal government brought
in its first personal income tax in 1861 to fund
the Civil War. It was a modest 3 % on incomes
over $800. It was quickly changed, later repealed.
The first real peacetime attempt didn't come
until 1894. And that 1894 tax, it was meant to
replace lost tariff revenue, but it ran into
a much bigger problem than political opposition.
It ran into the Constitution. That is the critical
pivot point in U .S. tax history. The Supreme
Court ruled the 1894 income tax unconstitutional.
The 10th Amendment required direct taxes to be
apportioned among the states based on population.
The court decided that a tax on income from property
like rent or interest was a direct tax and therefore
had to be apportioned, which for an income tax
is administratively impossible. So the U .S.
system was just legally stuck. They had to literally
change the foundational law of the country. Correct.
That monumental change was the 16th Amendment
in 1913. And it specifically gave Congress the
power to lay and collect taxes on incomes, quote,
from whatever source derived without apportionment
among the several states. And that amendment
was like. Opening the floodgates. It was. Revenue
soared. It passed the billion dollar mark by
1918. And the rates began this dramatic fluctuation
that you see throughout 20th century tax policy.
Wild swings. Absolutely. From a low of 1 % in
the early brackets to these staggering highest
marginal rates of over 90 % that were used to
fund World War II. It just shows the incredible
power of income tax as a lever for massive governmental
mobilization. And if you look at the global timeline,
once the U .K. and U .S. models were in place
and working, adoption just became rapid. It was
mostly driven by industrialization and the need
to fund big state projects or wars. You see it
everywhere. Switzerland in 1840, Japan in 1887,
France starts to evolve its system in 1872, Canada
in 1918. And it's important to remember this
isn't a finished story. I mean, Uruguay only
introduced a personal income tax in 2007. Wow.
So this transition from systems that rely on
tariffs or consumption to systems that rely on
income, it's a global, continuous process. So
history shows us that income tax is sticky. Once
it's implemented, it's really hard to get rid
of. Now let's transition into how this money
is actually collected today, focusing on the
shared mechanics that really bind almost all
global systems together, no matter the local
politics. The first and most important shared
principle, the one that immediately dictates
how complex your tax life is, is the system of
residency rules and worldwide taxation. OK, we
need to really clarify the fundamental difference
here. How is a tax resident treated versus a
non -resident? OK, so a resident, and that can
be a person or a company, is generally subject
to tax on their worldwide income. Worldwide.
Worldwide. So if you're a tax resident of Germany,
you have to report the income from your job in
Germany, but also from your rental property in
Spain and from your investments in Asia. All
of it. That is incredibly expansive. What about
the non -resident then? A non -resident is taxed
only on specific types of income that are sourced
within that jurisdiction. So if you live in Canada
but you own a building that generates rent in
Germany, Germany is only going to tax you on
that specific rental income from the German property.
So how do countries define residency for an individual,
especially now in a world of remote work and
global travel? For individuals, the rule is often
pretty quantitative and simple. It's a physical
presence test. If you're physically present for
more than 183 days, so roughly half the year,
you're often deemed a resident for tax purposes.
And for companies. For corporations, it's usually
based on either the place of legal organization
or, and this gets more complex, where the company's
management and control actually happens. This
dual system immediately creates the potential
for double taxation. It does. If I'm a German
resident, but my Spanish property is taxed in
Spain, I'm being taxed twice on the same money.
And that is the single biggest challenge of the
worldwide residential system. Double taxation
happens when one country claims you as a resident
and another country taxes you as a non -resident
on the income you earn there. So how do they
fix this? To mitigate this huge barrier to global
trade and movement, nearly all countries enter
into double taxation avoidance agreements, or
DTAs. DTIA sound incredibly important. How do
they actually work? A DTIA is a bilateral treaty
between two countries. It dictates which country
gets the first right to tax a specific type of
income. And maybe more importantly, it ensures
that the resident country has to offer relief
for the tax that was already paid to the source
country. And they do that with a credit? Usually
with a foreign tax credit, yes. That offsets
the tax paid somewhere else. Without these thousands
of treaties, I mean, global business would just
grind to a halt under crippling compounded tax
burdens. It's important to remember, though,
that a few jurisdictions just completely reject
this worldwide tax model. They do. Places like
Singapore and Hong Kong, for example, they operate
largely on a territorial basis, even for their
residents. They only tax residents on income.
that's earned in or actually remitted to the
jurisdiction itself. And that's a deliberate
choice. Oh, it's a very deliberate design choice,
often aimed at making the jurisdiction extremely
attractive for internationally mobile wealth.
Okay, let's move on to the second fundamental
shared principle, defining taxable income. For
residents, you said the definition is generally
broad. What are the key things we see included
everywhere? Income is broadly defined as any
receipt that enriches the taxpayer. This includes
compensation for services, wages, salary, bonuses,
but also things like the net gain from selling
property, interest, dividends, rent, royalties,
annuities, and pensions. I want to focus on that
detail. Net gain from the sale of property. Why
is that wording so important to the idea of fairness?
Well, it's the difference between taxing wealth
movement and taxing wealth generation. Explain
that. If you buy a stock for $100 and you sell
it for $100, no wealth was generated. So you
shouldn't be taxed, even though $100 passed through
your hands. Tax is only imposed on the $10 of
net gain if you sell it for $110. And that concept
applies to real estate and other assets globally.
Are there any universal exclusions from this
broad definition, things that are left out for
policy reasons? Yes. Two big ones are common
globally. First, national retirement payments
are often fully or partially excluded from current
income tax. That's a policy choice to encourage
retirement savings or maybe to just defer the
tax until retirement. And the second? The second
is employer -provided health care benefits. They
are typically excluded. And this is a subtle
but massive subsidy that governments use to encourage
employers to provide health coverage, which promotes
public health without them having to directly
fund it. So once we have our gross income, we
need to subtract the costs of generating that
income. Let's talk about allowable deductions
and business profits. The principle here is foundational.
Tax is imposed on profit, not revenue. So expenses
that you incur in the process of generating income,
running a business, renting out a property, are
generally deductible against that gross income.
That's why only the net income from a business
is taxable. What about non -residents? We said
they're taxed on source income. Is that usually
on the gross amount or the net? Non -residents
are often taxed on the gross amount of certain
passive income, like royalties. Just simpler
administratively. However, if they're earning
net business income in the jurisdiction like
operating a branch office, then they're allowed
to deduct the expenses related to that local
business activity. How do systems account for
long -term investments, like buying a huge piece
of machinery or a factory? You can't just deduct
the entire cost in one year. No, that's managed
through what's called a capital allowance or
depreciation deduction. Systems all over the
world allow businesses to recover the cost of
those long -term assets over time. But here's
where tax policy gets very interesting. The rules
often permit businesses to recover those costs
more quickly than the actual physical life of
the asset would suggest. So the government deliberately
allows accelerated depreciation. What's the point
of that mechanism? It's a huge economic incentive.
By letting businesses deduct costs sooner, you
lower their current year's tax bill, which improves
their cash flow and makes the investment more
attractive. It's essentially a government subsidy
for the decision to invest in new equipment or
facilities, and it drives capital expenditure.
Turning to individuals, aside from business costs.
What kind of personal expenses are generally
deductible across different systems? Most jurisdictions
start with a notional deduction. It's a fixed
amount of income that everyone gets to earn,
subject to zero tax, which ensures that very
low earners pay nothing. Beyond that, many systems
let you deduct certain personal costs, like most
famously home mortgage interest or medical costs.
Which is another subsidy? It's another subsidy,
yeah. Designed to encourage specific social behaviors,
like home ownership. Okay, let's look at the
administration of this. How do tax authorities
even determine a business's net profit? For major
domestic companies, many countries rely heavily
on their audited financial statements. The taxable
income is often closely tied to the profit they
report in their official books, with just a few
adjustments. But for, say, a non -resident company
operating a local branch where accounting is
tricky, some jurisdictions simplify. How? They
might just compute the taxable net income as
a fixed percentage of gross revenues and just
ignore the complexity of the local expense report
entirely. We mentioned the foreign tax credit
earlier. Let's confirm how critical that is.
It is the glue that holds the entire residential
worldwide system together. Without it, the combined
tax burden would just be prohibitive. Every system
that taxes its residents on worldwide income
has to offer this credit to stay functional and
competitive. And some countries, like the U .S.
and Switzerland, they complicate things even
more with alternative taxes. They do. They often
impose the higher of the regular complex income
tax calculation or an alternative simpler tax.
For corporations, this alternative might be based
on capital or gross receipts rather than net
income. And the goal there is just to make sure
they pay something. Exactly. It ensures that
even corporations that manage to reduce their
taxable net income to zero through deductions
and credits still contribute some minimum amount
to the Treasury. OK, now let's dive into the
two major ways the money actually gets collected.
Administration and compliance. The first method
is withholding, or what's sometimes called pay
-e -pay as you earn. This is required for payments
to employees and to non -residents. The employer
or the payer acts as the collection agent. They
deduct the expected tax amount before the money
ever even reaches the recipient. But it's so
important to understand that withholding is just
an advance payment. It is not your final bill.
Exactly. It's the government ensuring it has
a steady cash flow. The final determination of
what you owe falls to the taxpayer through the
process of self -assessment. So you have to do
the final math. You have to aggregate all your
income sources, subtract your deductions, apply
your credits, and calculate the actual final
tax you owe. If more was withheld than you owed,
you get a refund. If less, you have to pay the
rest. And this brings us to this fascinating
measure of civic cooperation, the voluntary compliance
rate, or VCR. The VCR measures the proportion
of taxes that are paid voluntarily, on time,
and without the tax authority having to intervene.
The US, for instance, has historically had a
very high VCR, often cited as being above 80%.
Why do these rates vary so much around the world?
Our source material contrasts the US with countries
like Germany or Italy. Well, compliance is heavily
influenced by a country's administrative capacity.
the public's perception of government integrity,
and the size of the informal economy. The black
market. The black market, exactly. In countries
with a sizable black market where transactions
are unrecorded and cash -based, the VCR naturally
just plummets. And enforcing tax law becomes
exponentially more difficult and expensive for
the government. And finally, we need to remember
that income tax often happens at multiple levels
of government at the same time. That is vital
to understand, particularly in federal systems
like Canada, Germany, Switzerland, and the U
.S. These systems impose income taxes separately
at the subnational level, so provinces, cantons,
or states, in addition to the national tax. And
those can be linked or completely separate. Right.
They can be integrated, where the state tax is
just a fixed percentage of the national tax,
or they can be entirely independent systems with
different forms and different rules. And we can't
forget the taxes that look and feel like income
tax but serve a totally different social purpose.
wage -based taxes. These are your Social Security,
national insurance, or national pension contributions.
While they are a levy on income, they're typically
a fixed rate, often capped at a maximum annual
earning level, and they are explicitly earmarked
for things like retirement, unemployment, or
health care systems. So it's a parallel system.
It's a parallel form of income taxation, usually
imposed on the employer, the employee, or very
often both. All right, we've built the history
and we've explained the global structure. Now
we have to look at how income tax fundamentally
changes behavior and creates these policy headaches
for every single government on the planet. The
core truth of taxation is that it introduces
friction. It changes incentives and ultimately
it changes how people decide to spend their time
and their capital. Let's start with the most
immediate effect, the effect on labor supply.
Does high income tax discourage people from working?
The research here has really evolved. Earlier
studies were a bit inconclusive. They suggested
a minimal effect on, say, the number of hours
a full -time professional might work. But more
recent, more nuanced studies, especially those
that focus on high marginal rates and secondary
earners, they indicate a large price elasticity
of supply. That sounds very academic. What does
a large price elasticity actually look like in
a household? It looks like the spouse who decides
not to enter the labor force. If that second
earner's income immediately gets hit with a high
tax bracket, say 35%, and then they have to subtract
costs like child care. The net benefit of working
might be tiny. It might be minimal or even zero.
The tax burden reduces the ultimate reward for
working and leads many people to decide that
leisure or time spent on other activities is
simply more valuable than that heavily taxed
income. And that reduction in labor force participation
is a real loss to the economy. And that reduction
in activity, that leads directly to the concept
of deadweight loss, or DWL, which sounds like
something economists invented just to make taxation
sound scary. DWL is a real and a critical concept.
It represents the loss of economic activity that
is not collected by the government as revenue.
It's just lost entirely because of the friction
of the tax. It's the higher cost that income
tax imposes on labor and capital. So if someone
decides not to work an extra 10 hours because
the tax rate on that time is too high, the economic
activity that would have been generated by those
10 hours is the dead weight loss. Exactly. And
that loss has a few components. There's the loss
from productive labor or investment that just
never happens. There's the distortion of economic
choices, people investing in tax -advantaged
areas that are maybe economically inefficient.
And then there's the time and resources that
are devoted to tax -avoiding behavior. So the
act of trying to avoid the tax is itself a loss.
Yes. Every hour, a highly paid lawyer spends
engineering some loophole instead of, say, advising
a company on a real commercial project is also
considered a component of deadweight loss. And
that fight against the tax system is constant.
It leads to this vicious cycle of tax avoidance
and complexity. This is the never -ending arms
race between the state and the taxpayer. Clever
tax avoidance strategies emerge legal methods
that exploit loopholes. Lawmakers then respond
by adding incredibly detailed, complex, and specific
legislation that's intended to close those loopholes.
And what's the result of this constant back and
forth? The entire system just becomes labyrinthine.
And the crushing consequence is that this complexity
tends to disproportionately benefit large corporations
and wealthy individuals. They are the only ones
who could afford the sophisticated accounting,
the legal advice, and the tax planning you need
to find and use the loopholes. Which fundamentally
challenges the whole progressive nature of the
system that we defined back in Section 1. It
does. While the progressive rates on paper suggest
that high income earners pay the highest proportion,
the complexity allows those same high income
earners to manipulate their taxable income downward
in ways that are just not available to a median
wage earner who only has W -2 income. And that
fuels inequality and political discontent. Let's
move to a challenge that often goes unnoticed,
working silently in the background. Bracket creep
or fiscal drag. This is a quiet, systemic way
that taxes rise without a single legislator ever
casting a vote. Bracket creep is what happens
when inflation pushes your nominal wages into
higher tax brackets or just increases your effective
average tax rate, even if your real purchasing
power hasn't increased at all. Can you give us
a concrete example of how this would work in
a system that's not indexed for inflation? Sure.
Imagine in country A. The 10 % tax bracket ends
at $30 ,000. If inflation is 5%, a worker who
earned $30 ,000 last year now has to earn $31
,500 just to buy the same stuff. Right, just
to stand still. But that extra $1 ,500 now falls
into the next tax bracket, say 20%. So the government's
now collecting tax at a higher marginal rate
on money that hasn't actually provided the worker
with any real benefit. The worker now has less
real disposable income because their tax burden
rose automatically. So the government gets an
unlegislated real tax hike and the taxpayer suffers
a silent reduction in their standard of living.
Precisely. To combat this, some countries have
chosen to index their brackets and deductions.
They're automatically adjusted upward each year
based on the inflation rate, which prevents this
fiscal drag. But a lot of countries choose not
to because bracket creep is a politically convenient,
stealthy source of additional government revenue.
Let's pivot back to the global systems and look
again at that distinction between territorial
and residential systems. This choice really dictates
how a country sees its engagement with the world.
The territorial system is focused inward. Tax
is imposed only on local income that's sourced
inside the country. France, for its corporations,
is a classic example. The policy choice here
is to attract foreign capital by making it clear
that profits you earn somewhere else won't be
taxed locally. And the residential system used
by the U .S. and Germany, that's the global model.
It looks outward. Residents are taxed on their
worldwide income. This system is philosophically
based on the idea that citizenship or residence
confers a benefit that you should pay for no
matter where you earn the income. And the U .S.
has that exceptional and highly complex rule
regarding its citizens who live abroad. It's
highly unusual. The U .S. is almost alone in
taxing its non -resident citizens on their worldwide
income based solely on citizenship. It doesn't
matter how long they've lived abroad or if they've
earned any U .S.-sourced income. That must create
a huge compliance burden. A massive burden for
Americans living overseas. And it requires specialized
exclusions and treaties just to function at all.
It's a major outlier in global tax policy. And
we noted that countries will mix and match these
systems, which shows there's no perfect universal
solution. Absolutely. You might have a country
like Brunei that taxes corporate income but not
personal income, or Singapore, which separates
its treatment. It uses a residential system for
individuals, but a territorial one for corporations.
The tapestry of global tax is determined by a
country's unique economic goals. Whether they're
trying to attract mobile wealth or fund a big
social safety net. Exactly. Or encourage local
investment. It's all a tradeoff. Finally, we
turn to a subject of just radical difference
and I think great controversy, transparency and
public disclosure. This is a policy choice that
fundamentally redefines the relationship between
the state. and the citizen in countries like
finland norway and sweden personal income tax
filings including the person's income and the
tax they paid are publicly disclosed so a citizen
could genuinely look up the tax record of their
neighbor or maybe the ceo of a major local company
That's correct. In Sweden, this practice has
been enshrined since 1905 with the annual publication
of the tax ring Skalendern. The philosophy here
is that radical transparency increases compliance,
it holds authorities accountable, and it promotes
a fairer social contract because wealth and contribution
are visible to everyone. And this is in direct
stark contrast to countries like the U .S., where
tax information is considered the ultimate private
financial detail. What are the potential downsides
of that kind of radical transparency? Well, while
it might increase compliance, it can also lead
to social friction, jealousy, potential security
issues. It's a fundamental choice. Does the public
good of transparency outweigh the individual's
right to financial privacy? And the Scandinavian
nations decided yes. They decided yes. Most of
the rest of the world, including you and our
audience, have decided no. Hashtag tag outro.
So to synthesize this huge deep dive, we can
really return to that core distinction. The global
structure of income tax is defined by the tension
between the simple, locally focused territorial
system. which is designed to attract external
capital. And the complex, globally reaching residential
system. And the complex residential system, which
requires this massive international web of DTAs
and foreign tax credits just to manage the global
movement of people and money. And what endures
through this entire history from 9CE China to
modern Washington is the persistence of the system
and the resistance to it. Whether the challenge
is external like a war that requires new funding
or internal like the constant pressure of bracket
creep silently raising the tax income tax just
adapts. It is a permanent fixture that's constantly
trying to maintain its balance against the forces
of avoidance and complexity. We saw that that
first experiment in taxing net income under Emperor
Wang Meng failed within 13 years because of popular
unrest and the seizure of property. The modern
state has solved some of those administrative
problems, but that underlying social contract,
the public's willingness to fund the government,
that remains the system's most vulnerable point.
Which leads us to our final provocative thought
for you to consider. Reflect on that Scandinavian
model of public disclosure. If you knew definitively
what your peers and your competitors earned and
paid, how would that knowledge change your personal
decisions? Your decisions about work, compensation
negotiation? your level of trust in your government?
Would that radical transparency solve the complexity
and avoidance problems we discussed? Or would
it simply create new and perhaps deeper social
frictions? It's a point of fundamental difference
in civic approach to revenue, and it's one worth
exploring on your own. A fascinating concept
to mull over indeed. Thank you for joining us
on the Deep Dive. We hope you feel thoroughly
informed and armed with insight into this universal
but very complicated mechanism.