Top taxes & growth

Some economists say the 50p tax rate “is doing lasting damage to the UK economy.” I’m not sure I agree.
As Richard and Duncan say, the economists provide no strong evidence for this. Their concerns that the rate is “making us less attractive as a destination for both foreign investment and talented workers” certainly don’t jump out of the data. Emigration actually fell last year, prime London house prices are rising and in the year after April 2010, there was £40bn of FDI into the UK - bang in line with the average for 2001-05*.
There’s another data point which seems to contradict those economists. This is that in the 22 years we had a 40p top tax rate, UK GDP growth averaged just 2%. That compares to the 2.5% growth we had in the previous 22 years - a time when the top tax rate hit 83% on earned income.
Granted, there are countless other things that affect growth. But many of these are things that supporters of low top taxes would expect to have boosted growth after 1988, such as weak trades unions and the absence of the wage and price controls we had in the 70s.
Of course, these facts don’t settle the matter. But they do draw attention to a possibility - that low top tax rates do not obviously promote growth, and might even retard it.
There are three reasons for this:
1. Low taxes have ambiguous effects on labour supply. Yes, they increase the returns to work, thus making work more attractive. But they also increase post-tax incomes, thus making leisure attractive. One effect of the cut in taxes in 1988, for example, was to allow older investment bankers to take early retirement in the 90s and 00s.
Empirically, it’s not clear which effect dominates
2. Insofar as low tax rates do encourage greater work effort, this needn’t be productive. Low tax rates encourage greater competition for senior jobs, which might divert effort away from productive labour and towards rent-seeking and office politics and might encourage a “yes-man“ mentality that leads to groupthink and poor decisions. Or they might encourage excessive risk taking and speculation, which ends in a financial crisis.
3. Even if some people do stop productive work as a result of higher taxes, the loss is often second order. Imagine a good CEO were to quit because taxes were too high; you‘ll have to imagine it because, AFAIK it hasn‘t actually happened. The firm would hire a replacement. The loss of GDP would be the difference between the CEO’s managerial ability and that of his successor, which will probably be small.
I fear that advocates of low top taxes subscribe to some Randian “great man” theory of economic growth, in which prosperity is driven by a few stars. But this is questionable. If it were true, we’d expect firms who lose CEOs to high taxes to announce their replacement by saying: “This guy’s not as good as his predecessor; you should revise down your earnings estimates.” This doesn’t happen.  
I don’t say this to asset that higher top taxes are definitely a good thing, merely to point out that both theory and evidence are more mixed than those economists who wrote to the FT say.  As IFS researchers say (pdf) there is “considerable uncertainty” about the effect of top taxes. My suspicion is that they won’t much affect growth either way, simply because so few policies do, especially those that affect only a tiny minority.
Which brings me to my biggest complaint against those economists. To worry so much about the 50p tax rate at a time when real incomes are being squeezed, unemployment is rising and some benefit claimants face real hardship is to display a rather warped set of priorities.
* Yes, FDI is sharply down from 2005-07, but that was the peak of a boom/bubble.

Comments

[Jimmy Hill]

Thank goodness both sides can just fall back on their ideology, otherwise no one would know what to think!

[Luis Enrique]

great post.

was surprised to see names like Quah (an economist who actually has some standing withing the profession)

[Charles Wheeler]

"To worry so much about the 50p tax rate at a time when real incomes are being squeezed, unemployment is rising and some benefit claimants face real hardship is to display a rather warped set of priorities."

Precisely.

They seem to want it both ways: the 50p rate should be abolished because: a) It raises little and is easily avoided, or b) It represents a significant disincentive.

Those in that earnings bracket have, to quote a phrase, never had it so good. Taking the lion's share of GDP growth since the 1980s, and benefiting from huge tax cuts, while those lower down the scale have seen wages stagnate, indirect taxes raised, and public services cut back as they try to keep up with increased debt payments back to the rentier class.

So, incomes of top earners have risen by 186% since 2002 (http://goo.gl/CIpJO), while a woman with MS is told she must sit in her own excrement overnight because the funds are not there to provide social care.

And ministers are preoccupied with lowering taxes on the top 1%.

[Tom]

For an explanation of the warped priorities, see the back history of the PR company Westbourne Communications, who have been employed by someone to 'change opinion', as they put it, on the 50p rate. They're really behind this, the economists' letter is a shot in their campaign.

Naturally they have impeccable Cameron/Policy Exchange/Notting Hill/Politics Home/Ashcroft/etc. connections and are also working on the High Speed 2 account. They appear to have been set up with the specific aim of working for or on behalf of Cameron government policies.

[Luis Enrique]

(I don't know why I'm surprised to see Quah and other hold imho thoughtless right wing views ... but usually these letters are signed by decidedly C list individuals, that's all)

[chris]

Thanks Luis. It's not just Quah. I'm amazed Bob Rowthorn is there.
I hope drink was involved

[Tim Newman]

"Imagine a good CEO were to quit because taxes were too high; you‘ll have to imagine it because, AFAIK it hasn‘t actually happened."

No, but you might find somebody not bothering to become CEO because the marginal pay relative to the increased effort, exposure, and responsibility is not worth it. You might also find CEOs cutting back on their workload. The effect of the 50% tax will be felt at the margins, not by CEOs quitting.

[Tim Newman]

"They seem to want it both ways: the 50p rate should be abolished because: a) It raises little and is easily avoided, or b) It represents a significant disincentive."

It could quite easily be both, the two are not mutually exclusive (except for the easily avoided bit: if it is easily avoided, then it hardly serves as a disincentive). But it is quite possible to hit a small number of people hard and raise little in the grand scheme of things.

[Spog]

Well, believe what you will, but I closed my company down last February due to expected higher CGT and tax, and now trade gently but satisfactorily as an LLP with half the turnover. Be afraid when lots of people do this.
Don't forget that 1% of the population pays 24% of the nation's tax, and 75% of the population takes more out of the tax system than it puts in.
It's the 25% you should be worrying about. We're not politicians; we just make practical decisions.

[Jim]

@Charles Wheeler: "incomes of top earners have risen by 186% since 2002, while a woman with MS is told she must sit in her own excrement overnight because the funds are not there to provide social care."

So if the 50% top rate raises no extra revenue (the jury is out on this of course), thus not helping those in need of extra care, would you support its removal, or would you like to keep it anyway, just to be vindictive to those that have to pay it?

[David Smith]

Could we know how many of the economists who wrote to recommend abolition of the top tax rate are themselves paying that rate? Those that are should have declared a conflict of interest.

[Strategist]

A more important disclosure would be the going rate for a signature.

It beggars belief that intelligent people would put their names to such pathetically weak stuff for free.

All this stuff about damaging incentives is such obvious garbage.

The marginal extra tax on the £150,001st pound of a 50p tax compared to a 40p tax is 10p. The additional tax taken on (say) a £200,000 salary is £5,000 or 2.5%. It's small change. Only the completely unhinged would change everything they are doing to avoid such an imposition. (Even silly old Spog above wouldn't be that mad.)

The £150,001st pound is infinitely easier to earn than the first pound. The taxman is only asking for half of it. A fair bargain for policing your streets, paving your streets, sweeping your streets - keeping your world safe for you to earn more than 99% of fellow citizens.

Any attention to the work disincentive effect of tax should be at the bottom of the payscale, not the top.

[Tom Addison]

Bob Rowthorn? I'm sure I came across some of his work at Uni when researching for my dissertation on immigration. And I'm sure that he was generally on the "Immigration Is Bad" side. Not saying that this therefore makes it obvious that he'd be against the higher tax rate, but many economists seem to have political allegiances, which affect the results of their "studies" more than anything else.

[Jim]

@Strategist: in fact the new top rate effectively kicks in at £100K, due to the withdrawal of the personal allowance. You end up paying about 60% on the margin from 100k to 125k, then 40% from 125k to 150K then 50% from 150k onwards.

And if you don't understand what Spog is getting at you obviously don't understand the attitude of many people in this country, most of who are the sort of people who drive businesses forward. If the State is going to grab half my extra work, then I'm not going to bust a gut to do extra work, or expand my business.

I'm near the 100k limit now. I'm definitely not going over it.

[Spog]

@Strategist

Whether or not I am silly or old, the point is that high taxes plus high NI make people decide to work less hard. It's much less that they leave the country, although economic migrants might not come.

When you factor in personal tax, personal + employer's NI, corporation tax, VAT, CGT [entrepreneur's relief has limited scope], and the unavoidable fixed and regulatory cost faced by a company owner, the state takes twice as much from marginal income as the owner, but the owner takes 100% of the risk.

Thus, where a company owner's personal needs are met from a lower income, it is rational to decide that the return from marginal income is not worth the effort and the state loses all its two-thirds "take". Moreover, if UK competitors make a similar decision, the work goes abroad.

[Strategist]

Jim: "I'm near the 100k limit now...I'm definitely not going over it. I'm not going to bust a gut to do extra work"

Spog: "where a company owner's personal needs are met from a lower income, it is rational to decide that the return from marginal income is not worth the effort"

Both these sound like healthy, sane satisficing behaviour, with an appreciation of the value of a decent work/life balance.

Your claim is that if you could keep 60% of your marginal income over £100k you would suddenly start busting a gut and we plebs would have you great paternal figures to thank for giving us jobs and greater tax revenue to keep our society running.

I simply don't believe you. I think you both quite like getting close to £100k/year for not busting a gut, and frankly, good luck to you.

If you were a real innovator and value creator then you'd be smashing through that £100k ceiling so hard you be getting so many marginal 50p's you'd hardly notice the 50p's you were handing over as your fair dues to the society that keeps you safe.

I don't know what business you are both in, but I wouldn't be surprised to hear it was some kind of financial speculation line of work.

[Jim]

@Strategist: you couldn't be further wrong old bean. I make a product, with my own hands (or with my machinery at least), that is in good demand, and always will be. I have calluses on my hands, and often look more like a tramp than a banker.

I have considerable opportunity to expand the business if I so wished, to take on extra workers rather than do the labour myself. But the stress involved, coupled with the 50p higher rate means I have no intention of doing so.

I refuse to give away more than half of my efforts to those who do nothing to deserve it. You may call me all the names under the sun, but you can't make me work (well I expect you'd like to send the likes of me to the gulag for re-education, but we haven't got that far, yet).

[gastro george]

"I refuse to give away more than half of my efforts to those who do nothing to deserve it."

ROFL.

[Thomas Boyle]

Don't worry, I have no intention of stopping working.

Instead, I am working in an easier job. I have less stress, more leisure, and the decline in my income isn't that big because, at a 50% rate, the government reimburses half of it.

Pity about the guy whose job I took, of course. But he's capable, and I'm sure he bumped someone else. Of course, eventually some poor guy at the bottom got stuck with no job. I don't know who he is. He can chalk it up to those leftists and their good intentions, I suppose. Not that they'll care, as long as their policies make them feel good about themselves.

[Matt]

I support low taxes 100% but whilst the lowest earners are having their gains in society cut and their life made harder through gov policy and the economic situation then I cannot support the removal of the higher rate. Remember "we're in this together" ? The UK is far too ghettoised as it is - speaking as someone myself who grew up in a working class hardland but now doing well in my 20's in the financial sector. There is really no solidarity in this country unfortunately.