Taxes & growth

Ed Balls' proposal of a 50p top tax rate has led to talk of a "disaster" or "suicide." This is silly hyperbole.

My chart shows why. It shows 30-year trend growth in GDP per capita, plus or minus a standard error. It'c clear that trend growth doesn't much change. "A bit above 1% before WWI, a bit below 2% since WWII with a lull in the interwar years" pretty much tells the story*. Growth is resilient to policy changes - perhaps because it is determined instead by technological opportunities. The idea that a tax tweak will cause disaster is historically ignorant.

To see why, let's assume  that higher taxes do reduce labour supply. Let's say that the 50p rate causes Per Mertesacker (pbuh) to leave Arsenal. What happens?

Arsene Wenger does not decide to field only 10 men. He hires a replacement. The loss of GDP is therefore the difference between the BFG's salary and his replacement's. This will be small. It might even be zero; if the 50p tax rate deters footballers from coming to the UK, Arsenal will have to pay higher pre-tax salaries in which case the incidence of the top rate falls upon profits, not wages.

So, who loses in this case? The Exchequer might not; we might well be on the good side of the Laffer curve for footballers. And there's no loss of GDP - though there might be a shift from profits to wages.

Instead, the losers are Arsenal fans, who see a weakened team. But their loss is a gain for their rivals.

If the BFG isn't the only player to leave then fans generally will suffer a loss of consumer surplus from seeing worse football. If this reduces their willingness to buy tickets, football clubs will suffer. But GDP won't, as the fans spend their money elsewhere.

As go footballers, so go other employees. If the 50p tax rate causes Tesco's boss to leave, he'll be replaced. Tesco might lose from having to hire a second-rate CEO. But Tesco's loss will be Asda'sgain. And if many CEOs leave, we'll have worse-managed companies, but this might mean lower consumer surplus rather than lower GDP.

My point here is that productivity and hence earnings are properties of jobs, not individuals. If the jobs remain, any loss of income is small.

How can GDP fall, then? One possibility is that insofar as the incidence of the 50p tax falls upon profits, firms will have less motive and opportunity to invest. But this effect will be tiny. Another possibility is that the new CEOs, being second-raters, will be less able to innovate and expand. But again, this will be a small effect. And it might be non-existent, if the inferiority of the CEOs consists instead in their being less able to exploit workers effectively.

No. The way in which top taxes would reduce GDP is by either deterring entrepreneurs or driving them overseas. The former effect requires taxes to reduce effort - which might not be the case. And the latter ignores the many things that keep businesses in the UK, such as proximity to clients, a skills base or agglomeration effects. If top tax rates were important, the media would be worrying about migration to Bulgaria, with its 10% tax rate, rather than from it..

None of this is to deny that higher top taxes might have some disincentive effect - though some good work suggests they won't. It is just to note that there's no justification for talk of "disaster."

* We might note that growth was lower in the low-tax 19th century than it was in thr high-tax post-1945 period.

Comments

[Tom Bowker]

In the case of Per Mertesacker's replacement, if Arsenal stump up the difference in order that his replacement takes home the same as PM used to, this is a transfer from profits to the exchequer. In a conversation we had on Twitter this morning you didn't seem to think this would be a net gain for the economy - though I suspect it would, as profits accruing to Arsenal's owners probably get in large part saved or spent elsewhere.

You suggest though that there could be a shift from profits to wages, which leads me to make a pedantic but perhaps still meaningful point: lots of footballers incorporate themselves in order to dodge tax. So it's actually a shift from Arsenal's profits to Per Mertesacker Inc.'s profits. Pedantic, but at the end of the income distribution that footballers inhabit it might be more useful to think of their wages as profits, as they won't spend them in the economy in the same way as normal mortals would.

[Luke]

Tom, "but at the end of the income distribution that footballers inhabit it might be more useful to think of their wages as profits, as they won't spend them in the economy in the same way as normal mortals would."

If you wanted to illustrate the tendency of high earners to save rather than spend, I reckon footballers are probably not the best example.

Going back to the post, I sometimes wonder how much Bill Gates, Steve Jobs etc knew or cared about income and capital gains tax rates when they *started* their companies. (Different once they were rich.)

[Shinsei1967]

So if all the star footballers left for the Spanish or Italian leagues you suggest this would have no impact on UK GDP as people would just spend their Saturday £50 on something else than a football ticket.

But what about the 10s if not 100s of millions spent by foreigners buying the rights to Premiership games or Man Utd jerseys.

[Tom Bowker]

Luke, fair point, but I reckon they spend a lot more in e.g. Dubai than the 1,000 supermarket workers who collectively earn the same amount do..

[Neil Wilson]

"But what about the 10s if not 100s of millions spent by foreigners buying the rights to Premiership games or Man Utd jerseys"

What currency are they spending in and where did they get that from?

Floating rate changes the rules of the game. You can't think foreigner. You have to think in terms of exchange relationships - one out, one in.

[Luke]

Shinsei
"But what about the 10s if not 100s of millions spent by foreigners buying the rights to Premiership games or Man Utd jerseys."

What about the £ms that would be paid by Spanish and Italian clubs to buy those players?

[TickyW]

The tax-rate is a red herring to any serious discussion concerning the decisions our self-annointed wealth creators may take.

Homo econimicus (is my Latin correct?) is concerned with post- tax income. Just as with investment decisions, decision makers are indifferent to the tax rate. It's post-tax income that is the relevant decision criterion (along with other criteria of which the tax rate is not one). Chris recognises this point when he says,

"If top tax rates were important, the media would be worrying about migration to Bulgaria, with its 10% tax rate, rather than from it.."

Nice one, Chris :-)

[Hoover]

We hear that "productivity and hence earnings are properties of jobs, not individuals."

And in direct contradiction, it's said that "Tesco might lose from having to hire a second-rate CEO."

It all seems highly muddled.

[joe]

I once worked for one of the World's top engineering consultants. Talented people from all over the World queued up trying to get in. Wages were well on the low side but that meant that top project bids were easier to win - job security and career development were further rewards. The company grew year by year. End of year bonuses were allocated by head count equally throughout the organisation - no one argued that their effort was any more worthwhile than a colleague's. The experience, working atmosphere and job satisfaction were all. Taxes never came into it and they reached 95% levels at the time.
If you have to pay people huge salaries and huge bonuses to turn up for work then that industry really is in trouble.
There is a huge pool of talented young people from all over the World that would rapidly replace the current overpaid bluffers that cause such business stagnation in UK. If they would only go, then UK GDP would rise to undreamed of levels. Then taxes can fall for everyone.