University of Konstanz Department of Economics A Viable International Tax-Order for Cross-Border Pensions Bernd Genser & Robert Holzmann Working Paper Series 2018-02 https://ideas.repec.org/s/knz/dpteco.html A Viable International Tax-Order for Cross-Border Pensions Bernd Genser 1 and Robert Holzmann 2 (March 1, 2018) Abstract There is strong evidence that the existing pattern of cross-border pension taxation in OECD countries and beyond is extremely diverse and inconsistent and thus generates a double equity dilemma for individuals and countries alike. We argue that this dilemma cannot be solved within the current double-taxation treaty network and therefore propose a new conceptual framework for the taxation of old-age pensions in a world of high and increasing cross-border mobility of workers and pensioners. We demonstrate that a coordinated move to a front- loaded pension tax system and exclusive source taxation would pave the way for an international pension tax order which eliminates the double equity dilemma. As an additional innovative element of front-loaded pension taxation we discuss the decoupling of individual tax assessment and tax payment which may prove helpful by smoothing transitional effects when the front-loaded pension tax system is introduced. Keywords: pension taxation, international taxation, international migration, double taxation convention JEL classification numbers: H2, H20, H55, H87, F22 1 Professor of Economics, University of Konstanz (retired) 2 Professor of Economics and Fellow of the Austrian Academy of Sciences (Vienna), with honorary chairs at the Centre of Excellence in Population Ageing Research, University of New South Wales (Sydney) and the Social Security Research Centre, University of Malaya (Kuala Lumpur) 2 1 Introduction In many OECD countries the taxation of old-age income has become an issue in recent tax reforms. There are several reasons for this new focus of tax policy. First, longer pension periods due to aging and generous retirement rules have increased the number of pensioners and the share of old-age income in the national income tax base. Second, many countries implemented deferred taxation of statutory and occupational pensions, following a recommendation the EU Commission which was released as a byproduct of Commission’s initiatives to ensure the portability of old-age pensions for migrants. Finally, pension reforms and the move toward multi-pillar systems have increased the variety of old-age income sources and tax policy frequently legislated specific tax rules for these new forms of pensions. An OECD stocktaking of old-age pensions reveals a three-pillar mix of public, occupational, and personal retirement income’ provisions with expanding new components which were introduced to cope with the fiscal pressure of the mandated pension scheme (OECD 2017). Moreover, countries supported in particular new forms of occupational and personal retirement savings through tax preferences or direct subsidies. As a matter of fact the taxation of different forms of retirement savings that is more aligned with the principle of consumption-type income taxation created substantial deviations from the principle of comprehensive income taxation which is still regarded as the benchmark income tax system across OECD member countries. The blending of comprehensive income standard with selective expenditure tax elements generates inconsistencies in old-age income taxation and they are the source of inequities in pension taxation among pensioners who are enrolled in different mandatory pension schemes or use the room for strategic pension planning. Increasing international mobility of workers and retirees is another source of interpersonal inequity.3 Following the blueprint of the OECD model convention to prevent double taxation on income and wealth the existing network of bilateral double taxation treaties pays attention to cross-border pension benefits (see Annex 7.2), but these rules do not exclude interpersonal inequities between recipients of domestic and cross-border pension benefits. The international treaty network also generates international inequities among signatory states which are unable to recoup income tax revenue losses if pension savers emigrate. The paper is organized as follows. In section 2 we provide some evidence that the existing pattern of pension taxation is extremely diverse and inconsistent. In section 3 we explain why diverse forms of national pension taxation and residence taxation of cross-border pension benefits are responsible for interpersonal and international equity conflicts and why unilateral and/or bilateral approaches to solve the double equity dilemma within the current OECD double taxation model treaty framework will not prove successful. In section 4 we present a new conceptual framework of front-loaded pension taxation which can consistently be combined with exclusive source taxation to get rid of the equity dilemma for individuals and countries. As an additional innovative element of front-loaded pension taxation we discuss the 3 A pre-condition for the taxation of cross-border pensions is, of course, that pensions in disbursement and pensions rights in accumulation are in a first instance made portable between countries. The instruments to make them fully portable include agreements at bi- and multilateral level, the use of transnational providers and the redesign of benefits. See Holzmann and Koettle (2015), Holzmann (2017) and Holzmann (2018). 3 separation of individual front-loaded pension tax assessment and income tax payment as a potential cushion when the new system is introduced. In a final section we summarize our findings and raise the question, whether the “multiple instruments” approach would be a suitable vehicle to establish a consistent international tax order for cross-border pension taxation. 2 The state of taxation of cross-border pensions Income taxation in most OECD countries is codified according to the Schanz/Haig/Simons principle of comprehensive income taxation, which regards any annual increase in personal wealth as taxable income. This is uncontroversial for individual pension wealth which is accumulated in financial institutions like pension funds, insurance companies or banks and which increases an individuals’ ability to pay and should therefore be taxed as a component of comprehensive income. Economically it is also true for notional pension wealth within a statutory or mandatory occupational pension system, because individual pension claims under these systems increase ability-to-pay, although pension benefits are not capital-funded by financed on a pay-as-you basis. In fact this difference between funded and unfunded pensions has led to a different tax treatment of pension benefits. To compare national pension tax practices we distinguish three phases of capital accumulation in which income taxes can or should be levied: capital saving, returns on capital wealth, dissaving or withdrawal of wealth. Technically comprehensive income taxation of saving can be characterized by a T-T-E income tax, where T indicates that the respective income flow is taxed at the going tax rate and E indicates that it is tax exempt. With respect to old-age pensions comprehensive income taxation T-T-E would require that income used to contribute to a pension system should be taxed, growing pensions claims as returns to pension wealth should be taxed as well but withdrawals of pension wealth are tax-exempt. In contrast to the comprehensive income principle most national income tax codes tax pay-as-you-go financed pension E-E-T, which implies to exempt pension contributions and accruals in pension claims and to tax withdrawals of pension benefits. The coexistence of both forms of pension taxation reflects the long-lasting dispute among public economists to tax capital income uniformly and consistently either according to T-T-E (Schanz/Haig/Simons) or E-E-T (Fisher/Kaldor). But it is also backed by the understanding of tax practicioners and tax lawyers who deny any discrimination in pension taxation ifstatutory pensions are preferentially taxed as (deferred) labor income and funded pensions are double-taxed as capital income. In Table 1 we provide a survey on pension taxation in European and four non-European OECD countries which shows a much broader variety of tax rules for different forms of pensions. To capture the different tax rules we introduce t and s to indicate that in a certain phase of the capital cycle a lower tax rate t<T or even a subsidy rate s is applied. In our sample a majority of countries apply expenditure taxation (E-E-T) and none of them comprehensive income taxation (T-T-E) to statutory pensions. Few of them impose a slightly higher income tax burden, but many offer additional tax preferences to statutory pensions down to a complete tax exemption through all three phases of the pension cycle. Sweden is the only country for which we found a pension tax relief by not only deducting social security 4 contributions from the personal income tax base but granting a full tax credit for these contributions. The taxation of occupational and personal pensions reveals a similar pattern with a less dominating cluster of countries using E-E-T. But columns 3 and 4 also exhibit a significantly broader scope of complexity, reaching from comprehensive income taxation down to full exemption of occupational as well as personal pensions over all three phases of the pension cycle. In addition to the different forms of tax treatment which