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Why the new top rate of tax is a poor idea
The problem with the increase of the highest tier of income tax is that it will not result in more revenue being raised from the wealthiest in society. Though this may sound counter-intuitive, it is true; it has been shown that by taxing the highest earners less, revenue raised from them is increased. This tax is not intended to improve the public finances, and is simply a way of punishing those in society who make more money than the rest, taxing the relatively wealthy until those pips squeak. What seems like economic common sense, that the more a government taxes this group, the more money it raises in doing so, is actually, like so much of what has been regarded as common sense, just a lot of rubbish.
To those economic flat-Earthers out there who don’t believe me, take a look at these facts. When George W Bush took office, the highest-earning 0.1% of the US population paid 16% of all income taxes raised there. By the end of his presidency, they paid 20%. This was achieved simply by cutting the top rate of income tax from 40% to 35%. In the US, despite its having a less progressive tax system than ours, the poorest in society pay a smaller percentage in tax than in the UK, and the richest 1% of Americans pay 16% more than those in the same income bracket back here across the Atlantic. To me, that actually sounds quite progressive. By contrast, when the state of California raised its top rate of income tax, the amount of revenue raised fell. The result has been likened to a “reverse Gold Rush”, as entrepreneurs and businessmen left the state; this is part of the reason why California’s finances are in such a poor state. In the 1970s, Denis Healey was prepared to try to attempt to tax the rich into the ground, even though he realised that doing so would likely cost more to collect that it would raise in revenue.
The top tax rate in a globalised world is never going to be so much about the redistribution of wealth as the redistribution of people. Put simply, when you tax the rich too much, they will go and live somewhere else, and rather than getting a little more of their money as you would like, you get none of it at all. Like it or not, the highest earners, the ones most capable of giving money to the state, will leave if they feel they are being pushed out, and rather than obtaining, say, 45% of their income above a certain figure, the state will obtain none. A substantial difference, one might say.
Oh, and you don’t just lose their money, you lose people. People who are capable of more than simply putting in hours at some sinecure set up so the unemployment figures don’t look too bad, or indeed just sitting at home. Again, put simply, we’re not going to be losing dance assistants and tourism ambassadors here, neither are we going to be losing teenage mothers on benefits; we’ll be losing the people who make the economy move, the ones putting money in, rather than just taking it out. As may be said of so much the government has done recently, We Really Can’t Afford This.
I have argued with lefty friends who point out haughtily that, well, if these rich swine would rather leave the country than pay their fair share, so be it, we shan’t miss them. Wrong, comrade. You see, the top 1% in Britain contribute 24% of all taxes. Disincentivising them from remaining here is going to create a huge hole in the budget; kissing goodbye to the rich means doing the same to the public services they fund. Independent researchers have found this new, punitive tax to be, unsurprisingly, unlikely to raise revenue, but in fact is likely to lose £5 billion which could potentially be raised by cutting taxes on the highest earners. If you make the rich hurt enough to leave the country, the poor will hurt harder for it. The only way to stop it without lowering taxes would be to forcibly stop people from leaving the country.
The real question is not what Gordon Brown thinks about this. After all, he hasn’t got long left in government, and a good thing too. The real question is what David Cameron thinks. At the moment, he has refused to commit to cutting this new tax. He is too intelligent to believe that it will raise money, so the reason for this is that he has seen the polls, and knows that there is support for the measure from the general public, who, smarting from the recession, want to see those richer than themselves hurt too. They believe too that this tax would increase the amount of money going into the public coffers, and for this we must blame the press, who peddle this dangerous delusion.
Cameron’s soundbite on this is that the “rich should pay their fair share”. One may take this to mean that the rich should be made to hurt a little bit. Well, that’s all fine, but don’t expect this approach to raise any money; it will lose it. If Cameron is prepared to throw away a great deal of money simply to hurt the rich, he is in the wrong party.
Comments in chronological order
Total: 3
Tue 22 Sep 2009 12:20am
Wed 23 Sep 2009 1:16am
I heartily take your point about the thinness of evidence, though I think it's fair to point out that there can, obviously, never be a great deal of evidence of this sort which is directly comparable with the present situation of the UK, seeing as recent governments in this country have not previously seen fit to fiddle with the top rate of income tax. Also, as you say, any evidence presented, however sparse, which one may put forward is corrupted and complicated by the fact that events do not take place in sterile bubbles; any change is affected by a number of causes, and to cite any one in particular is always to open oneself to charges of oversimplification. Finding a great deal of unassailable evidence on this issue is likely to be a pig of a job, whichever way one argues the case, and it will be impossible to know when we will hit Lasser’s T* until we exceed it (assuming that we have not already exceeded it with the present rate as it stands).
Still, I stand by my argument. This tax is a bad idea. Whether or not the country would see massive out-migration as a result of this tax to the extent that it raises less revenue than it loses is, as you say, hard to predict, but one may be certain that any who would be most likely to be put off by this tax to the extent that they leave the country would be likely to be those with the very highest incomes, and therefore the ones who pay by far the most income tax. Such people are likely to find it easiest to leave the country, not just because they have the money required to settle elsewhere but because many will work for big multinational firms such as Goldman Sachs, or indeed own their own multinational companies, which would allow them to emigrate from the UK without a great deal of disruption to their income. The very richest would be given a pretty powerful economic incentive to leave the country, and it is the very richest who not only pay the most taxes, but who are likely to have the most important roles in the creation of wealth. Whether or not the tax would raise more revenue than leaving the present rate alone (unlikely as that perhaps seems), it would still be likely to edge out some of the highest-earning people in the country, people who would be beneficial to have around to boost the economy in other ways. This would not be a good result for the country either, though it is one which is much harder to quantify than simply the amount of tax revenue collected.
There are other issues with this tax. It is not just the case that it will lose the country money and lose those capable of making money, but it will worsen the problem of our aging population. When people are earning at their highest level, they tend to be at or nearly at retirement age. If these people are being taxed at exorbitant rates, they are less likely to bother to continue to work, being at the age when retirement is looking attractive and within grasp, and so will probably stop earlier than they otherwise would. From contributing a lot of revenue, suddenly they are a drain, and at an earlier age than we or indeed they would like. We need people to carry on working as long as possible; we should certainly not disincentivise people from doing so, as the increased top tax rate surely does. The country is soon to have a larger elderly dependent population than ever before, and this tax would be likely to exacerbate that already pressing issue.
Sam Sims
Tue 22 Sep 2009 12:19am
Although I appreciate the authors emphasis of a counter intuitive point often missed by populist comment and his rightful ridiculing of "we'd rather not have them" leftist ideas I disagree with his argument. The general claim that "it has been shown by taxing the highest less, revenue raised from them is increased" is a very strong claim - and not one that is supported by economic theory or the evidence presented here. The Laffer curve is simple A-level economics and makes the basic point that increased tax rates increase revenue up to the point at which the disincentive effects they create start making the total pie to be divided smaller at such a rate that the larger portion of that pie taken by the government is no longer larger in absolute terms. The scant evidence produced for the authors claims is all from the USA - a country which differs in many relevant economic parameters from the UK - violating the basic conditions for a fair test. Further, the cursory statistics provided are insufficient to establish the point being made. Bush came to power in 2001 at which point US unemployment was around 4% (http://northshorejournal.org/unemployment-for-september-2008) by the time he was ejected from power in 2008 unemployment was 5-6% meaning that even if the top 1% were earning exactly the same amount (ie, the tax cuts had no incentivizing effect) they would have automatically been contributing a larger slice of the revenue pie [all other things equal]. Further, at the height of the credit boom income accumulated disproportionately to those in the top 1% meaning, again, that even if they were working the same amount (and the tax cuts in themselves achieved nothing) they would be contributing more. In other words this was not achieved "simply by cutting the top rate of income tax" - there were myriad factors at work.
The debate about the returns on raising tax rates will rumble on precisely because it is very hard if not impossible (for some of the reasons pointed out above) to know whether we have yet reached Laffer's magical T* ( the optimal point at which the pie size reducing effects are perfectly balanced with the government slice increasing effects). While I agree whole heartedly that counter intuitive points need to be rammed home in public debate making the claim that we shouldn't "expect this approach to raise money; it will loose it." can only be made with a great deal of argumentative arrogance, fudged evidence, and bodging of economic theory.