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.
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
- Substitution Effect. Higher tax encourages people to work less because work is less attractive.
- 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.
- Live in countries with lower income tax rates.
- Disincentive for companies to invest in UK
- Earlier retirement
- 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.