Alex Hern defends the 50p tax rate against the economic know-nothings who would cut it to 'boost revenue' (their own)
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.
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 revenue – Alex Hern, January 9th 2012
• 50p tax: Still a Tory obsession, still not that exceptional – Alex 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 tax – Will Straw, August 1st 2011
• Fraser Nelson is wrong on the 50p tax rate – Duncan Weldon, February 24th 2011
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41 Responses to “Memo to 50p tax trashers: Laffer Curve peaks at over 75 per cent”
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.