Taxing the rich

A top tax rate of 50% might well bring in additional revenue after all. That’s one message of a fascinating new paper by Andrew Leigh and Anthony Atkinson.
They study the share of top incomes in five “Anglo Saxon” economies. And they show that they are quite sensitive to moves in the top tax rate. A one percentage point cut in the top marginal tax rate leads to a rise in the share in incomes of the top 1 per cent of between 0.11 and 0.18 percentage points, depending on how you control for other things.
This is consistent with the idea that the highest earners do indeed work harder when taxes are lower.
However, they don’t work so much harder as to offset the mathematical tendency for a lower tax rate to bring in lower revenue. These responses imply that the tax rate that maximizes the tax paid by the top 1% is between 55% and 90%; this is a wide margin, because it‘s hard to estimate at all precisely supply responses to tax changes.
So a 50% top rate gets us nearer to maximizing revenues.
You might object here, quite reasonably, that we should distinguish two things - the tax rate that maximizes work effort versus the rate that maximizes tax revenues. A higher tax rate can do the latter even whilst reducing the labour input of top earners.
This, though, raises a question which I think doesn’t get the attention it deserves: is it a bad thing if the very rich work less? For example, if Fred Goodwin had been lazier he mightn’t have wanted the hassle of taking over ABN Amro. If Wall Streeters hadn’t worked so hard, they’d not have invented the derivatives that brought the banking system down. A little more idleness would have benefited us all.
High tax rates don’t just deter valuable skilled work. They also deter counter-productive work or rent-seeking.
If you think all this adds up to a case for taxing the rich, there is one aspect of this paper which mightn’t be so welcome for the left. Leigh and Atkinson show that the share of top incomes across the five nations over the last 100 years has been highly correlated; the trend in the UK - for the share to fall between the 1920s and 70s but rise thereafter - is very similar to that in the US, Australia, Canada and New Zealand.
This suggests that top income shares might be driven by common, global factors. If so, there are limits to how far purely national policies can increase equality.

Comments

[Luis Enrique]

The HMRC think so:

http://news.bbc.co.uk/1/hi/business/10096723.stm

good news I think .... but to the point you raise, what's the marginal effort involved, for high earners, in honest graft versus nefarious get rich quick schemes? Could higher taxes even increase the relative prevalence of get rich quick behavior, if it requires less effort?

(I don't believe so, no).

Not necessarily bad news for lefties hoping policy can affect inequality, if national policies in US, Aus, Can etc. were also correlated?

[william]

"This suggests that top income shares might be driven by common, global factors."

Yes, something like the idea that those at the top should be rewarded massively through share options and "performance-linked" payoffs. That was internationalized fairly quickly, and equally quickly twisted to give good options regardless of share price and fairly low performance targets.

[Frank Little]

ISTR this conclusion was reached on Radio 4's "More or Less" earlier this year. Music to the ears of those of us who want to make tax more progressive.

[Tim Almond]

"This, though, raises a question which I think doesn’t get the attention it deserves: is it a bad thing if the very rich work less? For example, if Fred Goodwin had been lazier he mightn’t have wanted the hassle of taking over ABN Amro. If Wall Streeters hadn’t worked so hard, they’d not have invented the derivatives that brought the banking system down. A little more idleness would have benefited us all. "

And if Steve Jobs didn't work so hard, we wouldn't have the iPod, or the iPhone or iTunes.

The banking system's problems aren't hard work. Like so many other big businesses that go wrong, it's the detatchment of shareholders from management that's the problem.

[Tom]

I'm not sure how strongly you can draw the conclusion that "top income shares might be driven by common, global factors" when the five countries being compared are all pretty similar Anglo-Saxon economies. If the correlation was still there when you chucked in a few continental European, South American, or Asian economies, then I'd be more inclined to take it as a global phenomenon.

[chris]

@ Tim Almond - you are right. The question is: do higher taxes do more to deter the Goodwins from working than the Jobs'? AFAIK, this is an open question. One could hypothesise that good entrepreneurs are motivated more by intrinsic factors than by money, so wouldn't withdraw labour so much, but this is mere conjecture.
@ Tom - point taken. Maybe I meant something bigger than parochial national forces.

[Alex]

"This suggests that top income shares might be driven by common, global factors."

Well the first will have been the Great Depression and then WW2, leading to the Keynesian Consensus. Then Stagflation hit, and we started seeing people like Reagan and Thatcher.

[john malpas]

Does high taxing keep the rich people where they were or do they go to someplace else?

[Grumpy Optimist - Andrew Richardson]

Why not consider moral and principle. Is it right to tax anyone at 50%? For all it is, is legalised theft. Politicians are saying - vote for me and I will take money off others who by virtue of their wealth have no rights and give it to you who by virtue of your relative poverty are the repository of all rights. It is just wrong to tax anyone at 50% if the average is nearer 20%. For these people are already paying more tax in any event.

[Bootvis]

How are taxes theft? They are a fee based on income used to finance the government.

By the way, if you don't like how this is set up: 1) Vote for a new government and if that doesn't work 2) vote with your feet. If you consider the various 'walk'-options I think that you will find that a progressive tax system isn't that bad.

More on-topic: a top rate of 50% works quite well for a number of European countries.

[Tim Worstall]

"These responses imply that the tax rate that maximizes the tax paid by the top 1% is between 55% and 90%; this is a wide margin, because it‘s hard to estimate at all precisely supply responses to tax changes.
So a 50% top rate gets us nearer to maximizing revenues."

Mebbe, mebbe not. For we also have employers NI at 12% or so (plus employee at 1% and some moot that we should abolish the upper limit) taking our tax rate quite possibly well over that 55% maximum revenue point......although if it's 90% of course we're still below it.

"Maybe I meant something bigger than parochial national forces."

Globalisation. Those at the very top (and it is generally acknowledged that the rise in inequality is driven by the top 1%, even top 0.1%) are now able to make pennies from billions rather than just pounds from millions.

[John]

"This suggests that top income shares might be driven by common, global factors. If so, there are limits to how far purely national policies can increase equality."

Isn't there a lot of "inbreeding" (actually interdependence) among those 5 "Anglo-Saxon" economies?

[Fred Kapoor]

I will have to agree with @Tom, this is more like a global phenomenon. Globalisation plays, once more, a crucial role on this and it is not surprising at all.