Tuesday, April 28, 2009

Impact of 50% Income Tax Rate in UK

I would love to pay the 50% income tax rate - I mean a salary of £150,000 would be a pretty good achievement for an economics teacher! But, putting aside by emotive support of high taxes on the rich - Does it make economic sense?

Firstly, the UK have had much higher income tax rates, in the past. In the 1970s, top income earners faced income tax rates of 80% plus. But, it was argued that with these kind of tax rates it encouraged many to leave the UK and find lower tax regimes.

Laffer Curve.

The Laffer curve offers a very simplistic model.
  • If tax rates are 0% the government get no tax revenue.
  • If tax rates are 100% the government get no revenue because what is the point of working if all the income is taxed?
  • Therefore, there must be a tax rate at which increase the tax rate causes a fall in tax revenue e.g. because people start to work less.
  • The difficult question is knowning where this tipping point is. Is it 50%, 60% or 70% marginal tax rates.

The Effect of Higher income Tax
  1. Substitution Effect. Higher tax encourages people to work less because work is less attractive.
  2. Encourages Tax Avoidance. Higher income tax gives a greater incentive for high earners to look for innovative ways to avoid paying tax. e.g. forming a company and paying yourself dividends rather than income.
  3. Live in countries with lower income tax rates.
  4. Disincentive for companies to invest in UK
  5. Earlier retirement
  6. Higher income tax will reduce VAT revenues as high earners have less to spend
  • Income effect. If people target a certain income - a higher tax rate may make them work harder to maintain their target income. This explains why higher income tax rates don't always cause people to work less

The crucial issue is what is the rate that causes people to go and live in Switzerland or retire early? It depends on the individual and there is much conflicting empirical evidence about the impact of higher tax rates.

The government hope the new tax rates will raise a net of £2.4 billion. The total gross could be £7 billion. However, the IFS claim the impact on tax revenues could even be negative. It is hard to predict, to some extent it may depend on the strength of the economy and whether there are less jobs in that income tax bracket. But, even the most optimistic predictions of tax receipts mean it will only make a small dint in the forecast £175bn annual deficit.

1 comment:

supernova said...

The whole argument about this issue in the news is, I believe, intellectually flawed. It is just a case of 'we're damned if we do and we're damned if we don't'.

It comes from the fact society gives too much consideration/respect to people who earn lots of money.

Very rich people live or travel across the world already anyway.

The issue is also deeply intertwined with the idea of globalization. Free trade for goods and services is there more or less but emigration is far more restricted on the grounds of national sovereignty.

If "we" are in favour of globalization, then we should accept that (more likely rich) people may want to move out of a country if they chose to.

However, even that idea is flawed to some extent, as only rich people seem allowed to migrate for economical reason.
This is just another example of double standards (from governments) where each nation state welcomes rich people and refuse poor ones.

We give too much importance (aka special treatment) to rich people at the detriment of poor ones by beleiving they have to live in our country.

If rich people want to move to Switzerland or China or Zimbabwe, let them do so!!!. In most cases, the business they support, is globalized, so the effect on jobs is minimal.

If a government from a sovereign nation wants to avoid losing taxes, then appropriate imigration laws should be applied consistently (e.g. foreign tycoons should not be allowed in) and each sovereign state should fight for the application of a common immigration law across the world.

There is progress along those lines with the G20 talking of tightening the rules for tax heavens.

So in my view, the whole debate is just an example of the government (with media support) trying to have the butter and the money from the butter....