Alan Johnson seems not to be keen on the 50p top tax rate. So, how should the left defend it? Here are some lines of argument.
1. There are income effects as well as substitution effects. Yes, higher taxes, ceteris paribus, make work expensive relative to leisure (or working overseas) and so, at the margin, people might choose to work less or emigrate. However, in reducing our net income, higher taxes also make us work harder as we try to achieve our target level of wealth.
If it weren’t for having to pay taxes, I’d have been able to retire years ago. So for me, taxes increase labour supply. And I’m not alone. There’s evidence that, for a group of people who can choose their working hours, labour supply can fall in response to higher incomes.
Given these competing effects, the evidence for an effect of taxes upon labour supply is quite uncertain.
2. People work and live in the UK for non-financial motives: job satisfaction, ego gratification, whatever. This is why so many of the rich carry on even when they have made millions. This suggests that the margin at which higher taxes deter work might be quite a narrow one.
3. Taxes don’t just deter productive, entrepreneurial activity. They can also deter rent-seeking. Why waste time and effort in office politics or in lobbying government for favours if the post-tax returns from doing so are low?
There’s one area where this is especially relevant - banking. Fraser Nelson points out that, after the top tax rate was cut to 40%, the share of tax paid by top earners rose. Let’s concede - massively - that there’s causality here, and that lower top taxes encouraged a boom in the financial sector. This boom, though, occurred only because of an unpriced externality; bankers got rich by getting the rest of us to pay for the risk pollution they created. Insofar as higher taxes deter such activity, they serve as a proxy Pigou tax, helping to internalize an externality.
4. It is jobs that are productive, not people. Imagine that Wayne Rooney were to take umbrage at paying 50% tax, and move to Real Madrid. Sir Alex would then buy a replacement, who would pay tax. The net loss to the Treasury wouldn’t be Rooney’s tax, but the difference in tax paid by Rooney and his successor. This would be small.
I suspect then, that the right’s view that higher taxes deter genuinely productive entrepreneurs is another example of “small truth, big error” rhetoric - it’s true, but it’s only a fraction of the story, and mybe not the biggest fraction.