Memo to 50p tax trashers: Laffer Curve peaks at over 75 per cent


 

500 “business leaders” have written a letter to the Telegraph today, encouraging George Osborne to drop the 50p tax rate. The letter is short – dwarfed by the list of names – and doesn’t really attempt to make much of an argument.

Their main claim is that:

The 50p tax is set to reduce government income, and damages the economy, the public services and charitable giving.

This claim is hard to back up with empirical evidence. As we reported last month, the HMRC’s best estimate is that :

The first year of [the tax rate's] introduction led to a “surge” in revenues of hundreds of millions of pounds.

Without data to support it, the signatories have had to resort to trotting out discredited economic theories when they have defended their letter on TV and radio. The phrase of the day is “Laffer Curve”.

The Laffer Curve is a concept coined by the economist Andrew Laffer which adds one and one and one and makes three million. It begins with three ‘common sense’ claims:

• At an income tax rate of 0 per cent, the income tax revenue will be £0, because no tax will be taken in.

• At an income tax rate of 100 per cent, the income tax revenue will be £0, because no one would do any work if they didn’t get paid.

Somewhere between 0 per cent and 100 per cent is a tax rate which maximises income tax revenue.

From this, Andrew Arthur Laffer and the signatories of todays letter draw the conclusion that cutting income tax will encourage people to work harder, and increase revenue.

Unfortunately for them, we now know where on the curve revenue is maximised – and it’s pretty far away from 50 per cent.

As Matt Yglesias writes:

Christina Romer and David Romer have a new paper looking at evidence from the 1920s and 1930s and find that the revenue-maximizing rate on the highest earners is extremely high—over eighty percent.

Among the top 0.05 percent of the income distribution they find an elasticity of taxable income of 0.19 percent which implies “that tax revenues would be maximized with a tax rate of 84 percent; that is, you could raise taxes up to 84 percent before people’s reduced incentives to make money would compensate for the higher tax rates.”

Other economists put the peak closer to 76 per cent.

Either way, if you want to maximise revenue, the 50p tax rate is about 25p too low. The Institute of Directors may want to think twice before bringing up the Laffer Curve in support of tax cuts any time soon.

See also:

It’s official: the 50p tax rate raises revenueAlex Hern, January 9th 2012

50p tax: Still a Tory obsession, still not that exceptionalAlex Hern, November 24th 2011

The 50p tax debate: Are we taxing off our nose to spite our face?Luke Bozier, September 16th 2011

Only quarter of voters want to scrap 50p taxWill Straw, August 1st 2011

Fraser Nelson is wrong on the 50p tax rateDuncan Weldon, February 24th 2011

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  • http://twitter.com/Shinsei1967 Nick Reid

    Your Laffer Curve arguments are as misconceived as the DT letter.

    You can’t just say that the Curve peaks at 76% or 84% without also saying at what salary level these peak rates apply.

    76% on £1million salaries is different from 76% on £100,000 salaries.

  • Carlpackman

    Communist!

  • Anonymous

    “Unfortunately for them, we now know where on the curve revenue is maximised – and it’s pretty far away from 50 per cent.”

    No, we don’t *know*.

    The rather childish nature of your presentation weakens may reduce its effectiveness. If your point is valid, that would be unfortunate.

  • http://twitter.com/Shinsei1967 Nick Reid

    The other issue that you would need to take into consideration when determining the shape of the Laffer Curve is the ease of moving overseas to avoid tax.

    Back in the 70s it was unusual and difficult to move overseas. These days tens of thousands of Brits work in low tax places like Singapore, Hong Kong and Dubai.

    Therefore one would expect the peak of the LC to be lower today than it was thirty years ago.

    And, of course, people don’t just move to Singapore or HK for tax reasons. It’s also fun to live overseas. But it does make calculating the LC extraordinarily difficult.

  • http://twitter.com/notayesmansecon Shaun Richards

    Alex in your rush to give us examples from the 1920s and 30s (could you not find anything more out of date?) you have missed some important points out.

    Firstly we in the UK have a 60% income tax rate just above £100,000 a year which logically the business leaders should have argued against first.

    Secondly I wrote a blog post back on September 13th 2011 which pointed out that there are much higher effective tax rates in the UK.

    “Furthermore there is a group where the gross tax rate may be 90% or more. According to the DWP some 600,000 people are in a situation where a combination of taxes and benefit withdrawal means that they lose 90% or more of all their total income. As these are likely to be close to the bottom of the income scale we are making it incredibly unlikely that it will ever be financially viable for the people affected to ever find work. In my opinion social and economic mobility is important to an economy and its flexibility and we are failing here.

    Even if they were not important we should be ashamed of the situation which we have allowed to build up here.”

    My view has not changed and it is that if we have any scope for tax cuts we should start at the highest effective rates which would help many of our poorer citizens.

  • Anonymous

    Misses the point.

    Notice Labour’s aim is maximising the money they have to spend on themselves. It’s their aim, get the money into their pockets to spend.

    Nothing about the price or value of any of that spending.

  • Anonymous

    “Furthermore there is a group where the gross tax rate may be 90% or more. According to the DWP some 600,000 people are in a situation where a combination of taxes and benefit withdrawal means that they lose 90% or more of all their total income

    ===========

    Twaddle.

    They may lose 90% of any additional income they earn when you look at the combination of taxes and benefits.

    Set the min wage level at the upper end of poverty.

    Set the benefit cap at the low end of poverty.

    Set the tax threshold at min wage.

    Then your argument falls over.

    If you think the levels are wrong.

    1. Why should someone be better off out of work than in work?
    2. Why should people who are in poverty be taxed to pay for other people to be out of poverty?

    Remember, poor people’s biggest single cost is taxation. VAT, NI, Income tax, …

  • Anonymous

    The problem in comparing the 20s/30s with now, is that there is freedom of movement of capital, plus globalisation.

    You can’t stop that because you’ve signed it away to the EU.

    For a good example, look at all the Greek money moving to London and Frankfurt.

  • Thorsten

    Of course there is an instant gain of millions, the adverse economic effects would take time to show! That you think the Laffer Curve argument is based on an instant reaction the moment a policy takes effect shows why you shouldn’t be writing economics articles.

    If the coalition side with you and continue this experiment into 2015, the stifling economic effect will be there on a nice little chart for you, and won’t you be happy then.

  • Tim Worstall

    Umm, Alex, if you want to quote a research paper in support of your assertions it might be useful to read and understand the research paper to make sure that it does in fact support your assertions.

    Specifically this one “Other economists put the peak closer to 76 per cent.”, the Diamond and Saetz paper. Now, as one of them has a Nobel and the other is highly likely to get one I do agree that this is an interesting and useful paper that we might want to consider.

    Now, in that paper they are discussing the US taxation system. Which as you know is subtly different to ours. Most importantly, leaving the country doesn’t get you off US taxation. Leaving the UK does get you off UK taxation. So whatever the peak is for the US the one for the UK will be a little lower. How much, don’t know, but that you can flee the jurisdiction will lower the rate.

    But much more important than this is that you’ve not in fact understood what they were saying. The 76% rate is only if there are no allowances. No ability to shift income for example to capital gains. No charity credits, no pensions savings, no mortgage interest deductions.

    As they point out, that isn’t how the tax system works. So, within the constraints of the current tax system they say the peak of the curve is 54%. Do go read the paper to check, won’t you?

    They also point out that this is not in fact their estimation of the revenue maximising federal income tax rate. This is the revenue maximising “all taxes” rate on incomes. And something you’ve obviously missed, for it seems like a detail in the US tax system, is that they are including the employer paid Medicaid tax in that top rate.

    When we move over to the UK system this becomes very important though. The US has social security taxes, just like we have NI, employer and employee paid. However, in the US system, both are capped. No further contributions are made over a certain income level. The only tax that isn’t capped is that Medicaid one. And Diamond and Saetz include it in their workings. And the important of this is that NI is not capped in the UK. Employers pay 13.8% however high the wages go. Employees pay 2% I think from this year? We must therefore include the NI rates in our calculations for the UK.

    So, from the paper you yourself call into evidence we find that the top “all tax” revenue raising rate is 54%. In that we must include the two NI taxes, 13.8% and 2%. It’s what is left after that that gives us our revenue maximising income tax rate.

    That is, your very own evidence shows that 50 % income tax alone is over the revenue maximising rate.

    As I say, you might find it useful to actually read the papers you’re calling into evidence. For you might find out that if you don’t you’ll be calling into evidence something that entirely disproves rather than supports your assertions.

    Not that that is all that unusual over here in leftyland where there are infinite money trees, unicorns poop rainbows and everyone does indeed have a pony.

  • Mark Myword

    His name is Arthur Laffer.

  • Pingback: Memo to 50p tax trashers, #2: The effective tax rate is hardly ever 58p | Left Foot Forward()

  • http://pulse.yahoo.com/_7WPLXUQBQYW6WJG2II7DQ2W7II ebbi

    did the Salvation Army declines your mattress? you seem to be a desperate piece of sh%t and just love insults ! why do you ask for it? are you sick or something? why can´t you be normal ? do you have to prove the whole world what a moron you are ?
    i guess we all know by now !

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  • Anonymous

    There is an argument that shows two things, the hypocrisy and that the peak on the laffer curve is much lower.

    Look at the argument about marginal tax rates for those on benefits. If the Laffer curve peaked at 85%, then those on benefits would go and work for the 15% extra that they get for working, compared to being on benefits. They don’t. They realise that putting all that effort in isn’t worth the 15% that the government allows them to keep.

    Same applies at the other end.

  • BenM_Kent

    “Of course there is an instant gain of millions, the adverse economic effects would take time to show! ”

    You hope.

    But I suspect there won’t be any adverse effects. The initial signs are ominous for Laffer fetishists – there has been no wholesale emigration and tax receipts are depressed by macro economic problems exacerbated by coalition cuts.

    In the end a few selfish individuals might move away, but their contribution will be filled by 60-odd other million people still living here.

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  • Ed’s Talking Balls

    Wow, you sure showed him.

  • Ed’s Talking Balls

    Comprehensively bowled!

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  • Anonymous

    It is pointless to quote evidence from the twenties and thirties as economic conditions in terms of mobility of capital and labour between countries were very much different then. There was, in that era, comparatively little such movement. The world is a very different place now. The truth is that there is no general absolute correct value to the peak of the laffer curve as such a peak will vary depending on the prevalent circumstances at the time.

    For example we are in an EU of 27 countries with free movement of capital and labour with some such as the Czech Republic offering flat tax rates in the region of 20%. It would be fatuous (to put it mildly) to assert that a neighbouring, culturally and economically similar country such as Slovakia could then introduce a marginal rate of 75% without significant movement of capital and hence loss of economic activity and consequent tax revenue.

    Meanwhile it should be noted that analytical studies have shown that tax revenue in the Uk from high earners increased (both in absolute terms and as a proportion of total revenue) following the decrease in the top rate from 60% to 40% in 1988. That would indicate that the peak of the Laffer curve must, by definition, have been at a point below 60%.

  • http://twitter.com/Newsbot9 Newsbot9

    What rot. Never mind that the laughter curve is comprehensively disproved by the Nordic nations, you’re using the 50% figure as if all income was paid at that rate.

    Never mind that rich people frequently pay a LOT of tax at 28% (capital gains)…

  • http://twitter.com/Newsbot9 Newsbot9

    So starve the poor, and make a lot of people unemployable. Got it. Oh, and make all the low earners “scroungers” you can freely attack.

    Your shares must have fallen 1% this week, you’re panicking.

    1. They’re not, with the exception of a few badly disabled people. Indeed, a minimum wage job is MASSIVELY higher earning than the dole.
    2. A typical attempt to slash benefits for the poor.

    And no, their single highest cost is housing.

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  • Tim Worstall

    Please stop being an ignorant twat. The Laffer Curve is about marginal tax rates, not average.

    Fool.

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