One common argument for removing the upper band of income tax is that it will encourage investment in the economy and end up creating more wealth overall. Effectively this is supply side economics as it is a policy to try and boost supply. If rich people have more money then they will invest more. If the gains are there to be made then they will invest.
I would like to highlight one testimonial against this by someone much more experienced and far better placed than myself to talk about the thought process of a rich investor. Warren R Buffett wrote this excellent piece for the New York Times yesterday. For those who don't know who he is well there is too much to talk about, but basically he is one of the most successful investors of all time. According to Forbes he was the world's wealthiest man in 2008 and in 2011 stood third behind Carlos Slim and Bill Gates.
I think the article is a great insight into what is wrong with tax systems. I don't know the American system at all - it is notoriously complex and state specific as far as I am aware. When I worked in tax we contacted tax specialists in America if any client had any income from there.
The particular section I believe key to my point is:
"Back in the 1980s and 1990s, tax rates for the rich were far higher, and my percentage rate was in the middle of the pack. According to a theory I sometimes hear, I should have thrown a fit and refused to invest because of the elevated tax rates on capital gains and dividends.
I didn’t refuse, nor did others. I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then: lower tax rates and far lower job creation."
As far as I'm concerned the major reform that is necessary is to align Capital Gains Tax with Income Tax. I would provide a separate personal allowance (as is currently in place) so as to not penalise small investors but I would add any gains above that straight onto the income tax.
I think the best reform I've read suggested however has been to do with inheritance tax. Currently it is effectively a tax on the donor. I think a much better system would be a tax on the recipient. Yes have a decent tax free inheritance allowance, but don't make that for a period/transaction, make that over a person's lifetime. It is more than possible to receive multiple inheritances and receive the allowance each time. Two people could receive the same amount, one in one lump sum the other in a number of smaller sums, yet one will pay a lot less tax on their windfall.
I think the key thing with inheritance tax however is that is has to be deferrable - if for example someone lives in the property that they inherent, they have no other property, they can't be forced to sell it just to meet the tax on it's value. This should be deferred until the property is sold - this isn't my area of expertise so I don't know the current situation (feel free to enlighten me).