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

Green Politics

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.

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 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”

  1. 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.

  2. 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.

  3. Oliver Kearns

    Countering the right's Laffer Curve nonsense on 50p tax rate – research shows tax revenues are maximised at over 75%! http://t.co/vWAmw6D2

  4. Bankrupt The Banks

    RT @leftfootfwd: Memo to 50p tax trashers: Laffer Curve peaks at over 75 per cent http://t.co/8Dgnn6yL

  5. H. O.

    RT @leftfootfwd: Memo to 50p tax trashers: Laffer Curve peaks at over 75 per cent http://t.co/2jL8uOiA

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