50p: it's not just about revenue

Remember the economy? Looking at the debate about the 50p tax rate gives me the impression that people have forgotten it. This is because the debate is being framed solely in terms of whether the rate raises revenue or not. But this is not the same as the effect it has upon economic growth.

It’s perfectly possible in theory for the tax to raise revenue but to stifle growth. This would happen if top tax-payers reduce their productive activities in response by the tax, but not in aggregate by so much as to fully offset the higher tax rate they pay.

It’s also possible for the opposite to happen. Let’s say - for the same of argument - that the 50p rate does raise only “hundreds of millions” rather than billions. This could be consistent with the 50p rate being positive for GDP growth. This would happen if:

- the new rate triggers widespread tax avoidance or evasion by people who carry on working as before.

- some other people respond to the rate by working harder, as the income effect offsets the substitution effect.

- insofar as the higher tax rate does deter some others from working, it deters them from activities with negative externalities, such as office politicking, political lobbying, or entering careers such as banking which have large negative externalities.

There is one colossal fact which is consistent with this hypothesis. This is that in the 23 years since Nigella’s dad cut the top tax rate to 40p, real GDP grew by an average of 2.1% a year, compared to 2.4% per cent a year in the previous 23.

Now, you could object to this that lots of other things affect GDP growth too. But opponents of the 50p tax rate are in a weak position to do this. For one thing, if they are to engage in simplistic post hoc ergo propter hoc reasoning when they claim that Lawson’s tax cuts led to a rising share of income tax being paid by the richest 1%, they can hardly moan when others engage in such reasoning. And for another thing, defenders of the 50p rate like to think that other reforms of the Thatcher era boosted the economy. Which makes the slower GDP growth since then all the more troublesome for them.

I don’t say this to take sides. My point here is rather that looking only at the impact on tax revenues is to take too limited a view of the impact of the 50p rate. And the passions in the debate seem rather stronger than the evidence base.

Comments

[Matthew Sinclair]

Relative economic growth is obviously a more realistic way of assessing policy performace than absolute economic growth, given that Britain is an open economy heavily dependent on international conditions. But I agree that the 50p rate debate should be about more than revenue. How about the fact that higher top marginal rates are associated with lower total factor productivity growth?

http://www.oecd.org/dataoecd/58/3/41000592.pdf (pg. 27)

[Mil]

I get the feeling that tax cuts for the already wealthy were always the long-term end-game. The deficit is just a bogeyman to scare us all to unhappy sleep, and get away with structural changes which benefit those already wealthy I've mentioned above.

The question is not whether we remember the economy. The question is whose economy are we being encouraged to ignore.

[Keith]

There is no evidence that neoliberal economics helps the economy; not just Tax cuts for the rich but all the rest; privatisation, deregulation etc These policies do increase inequality and impoverish the mass of people.

A better explanation for economic growth might be the effects of all the spending on Science and engineering during the first and second world wars and during the Space race and nuclear arms race post war. The gains to productivity from state spending on the real economic base and the gains from spreading new organisational methods in the economy have come to and end. So productivity growth has tended to slow down in mature economies. The abandonment of any policy for full employment and obsessing with inflation and tight money eg ECB policy might have some thing to do with it as well. Locking everyone in europe into a hard money death spiral of perpectual deflation is not optimal for growth.

[Patrick]

Unlike many of the more thoughful articles to be found on your site this posting can only be viewed as dancing on a pin head.

Interestingly Ken Livingstone's defence of his personal tax planning is the tax saved allowed employment of staff that otherwise would not have occurred. This argument would seem to support the view lower taxes leads to higher economic growth.

If the rate itself raises little or no tax then all we are left with is a deep rooted and illogical view wealthier individuals should be seen to incur a higher rate.

The politics of this I understand the economics alludes me.

[Paolo Siciliani]

The Laffer's curve sort of argument seems to me to be missing the microeconomics aspects of things. Competitive pressure should mitigate the risk that economic agents work less, unless we assume that all competitors react the same way by working less, but this is an untenable position most of the time – i.e., absent some form of collusion. So it seems to me that this argument is mostly valid for two categories of economic agents: a) rent-seekers who do not have to fear from competitive rivalry; and b) Schumpeterian entrepreneur, who escape competitive rivalry through disruptive innovations. (I agree with Chris that so-called “superstar” talents are by and large part of the former) Only the second category is worth taking into consideration. Not surprisingly, lobbyists tend to frame their arguments by reference to “wealth creators”…..

[Account Deleted]

While you are right to say we shouldn't look at this just in terms of tax take, even within those narrow terms there is something illogical going on here. If, as claimed, the 50p rate is producing much less than the Tresury originally anticipated, there has to be an explanation as to why.

It could be down to widespread tax evasion. A lot of the corporate top-rate payers will have had their packages adjusted to shift income into LTIPS, and I know some companies advanced their execs >£150k pay in 2010 to beat the incoming deadline. The self-employed rich tend to disguise income as corporate profit/dividends anyway, so they're probably not even paying the 40p rate.

Alternatively, it could be down to the economy being even more parlous than we thought, with the £150k+ bracket suffering greater job losses or pay-cuts, bankers notwithstanding.

The least credible explanation is that the well-off have become so disillusioned that they're not putting in the hours.

On yesterday's Newsnight, Allegra Stratton suggested that the Lib Dem quid pro quo will not be the tycoon tax but an increase in the personal allowance. Fiscally, this is not a quid pro quo as both measures will reduce the tax take, with mid-to-high income groups benefiting the most.

This is the same sage who earlier in the week insisted we were heading for hell in a handcart due to increasing welfare spending and flat tax revenues.

[Chris Purnell]

Don't you hear axes grinding in the background? There is only an assertion that the tax take is less than was thought: What is the actual tax take? Is it too early to say? The politicisation of this arguement is remarkable for an almost total lack of fact: resorting to discussions about the Laffer Curve is symbolic of that position.

[Gareth]

"There is no evidence that neoliberal economics helps the economy"

HAHAHAHAHAHAHAHAHA. No, seriously? See also India, China, pre and post economic liberalisation. "No evidence", right.

[toryboysnevergrowup]

Of course its nothing whatsover to do about revenue. And if you look at Osborne's budget statement last year you will find the supporting evidence:

"I've said before that now wouldn't be the right time to remove it, when we're asking others in our society on much lower incomes to make sacrifices.

For we're all in this together.

But I think it's sensible to see how much revenue it actually raises."

Perhaps someone could explain how George can have a clue about how much revenue the 50p rate has raised before the end of the tax year, before tax returns have been submitted, before many banks have paid their bonuses, and before understanding how much income has been deferred into future years as a result of the FSA remuneration code requirements.

Osborne has made his "unsensible" decision well before proper evidence becomes available about the impact of the 50p rate - which being somewhat cynical is why he has made the decision now.

[chris]

@ Matthew - I'm not sure that relative economic growth is so meaningful, because Japanese growth slowed markedly after 1989 - thus improving relative UK performance - for reasons unconnected to the UK's policy changes. Also, many countries adopted "neoliberal" reforms in the 80s and 90s, so if those reforms hurt GDP there, it would look as if UK relative performance improved.
FWIW, since 1988,UK real GDP growth averaged 2.07% against the US's 2.45%, whereas in the previous 23 years the UK grew by 2.44% against the US's 3.3%. So there is evidence there of relative improvement in growth. But does this tell us the UK improved, or that Reaganomics and increasing inequality (or something else) hurt US growth.
I don't think that OECD evidence is helpful, as top marginal taxes seem to affect TFP only by interacting with firm entry. I think we can agree that improving firm entry would raise TFP, regardless of tax rates.

[Keith]

Gareth,

you wish to compare developed societies growth rates with those achieved by developing states that have entered the stage of Industrial take off? That is the comparing of apples with pears is it not? Development by export led growth based on foreign capital imports do not really provide a relevant comparison for changes to tax policy. Studies in detail of marginal tax rates such as the British treasuries 1948 study on tax and National Insurance rates show no significant effect on Labour supply or working hours of changes to tax or charges at the margin.

[BenP]

If the tax is not raising as much as expected then the rate needs to be increased untill it does.

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