What did tax cuts do?

I'm disappointed to see Tim Worstall falling for an old canard. He points out that the share of income tax paid by the top 1% has risen hugely since 1979-80 and infers: "Looks like lowering rates can indeed increase tax collected."

Post hoc ergo propter hoc, dear boy.

It's quite possible that the share of tax paid by the top 1% rose since the 1980s not because of Laffer curve-type incentive effects, but because some other processes have increased the share of incomes going to the richest 1%.

One of these was that high-paid jobs expanded because the financial sector grew faster the the rest of the economy: since 1990*, business services and finance has grown by 129% in real terms whilst overall GDP has risen 61%.

Another is that "superstar (pdf) effects" have increased in importance, such that top bosses, entertainers, lawyers and sportsmen can earn more now than they did in the 80s.

These processes might have been independent of the cut in top taxes by Nigella's dad in 1988. I say this because the share of incomes going to the top 1% seems to have grown faster between the mid-90s and mid-00s than it did in the few years immediately after Lawson's cut. Sure, incentive effects might work with a long lag - but the data are also consistent with the tax cut being independent of the things generating rising top incomes.

What's more, if higher top taxes did have incentive effects, they might have incentivized not genuine wealth creation, but rather rent-seeking activities which increased the share of the top 1% at the expense of others. Such activities include corporate downsizing, offshoring, lobbying and the introduction of power-biased technologies.

There's one big piece of evidence to suggest that what's happened since the mid-80s is an increased share for the top 1% rather than genuine wealth creation. It's that aggregate economic performance hasn't improved since the Lawson tax cut. I pointed out the other day that trend growth in GDP per capita hasn't changed since then. And I'd add that labour productivity has actually fallen. Since 1988Q2, GDP per hour has rise by 1.8% per year, compared to 2.5% per year between 1971 (when ONS data began) and 1988Q2.

Of course, you might argue that economic performance would have been worse, in the absence of the cut in top taxes. But it would be unwise for rightists to do so; it would imply that other Thatcher reforms either depressed growth or failed to improve it.

I say all this not to argue against top tax cuts, but merely to point out that you need much better evidence than a rise in the share of tax paid by the top 1% to justify them.

* Chosen because that's when ONS data begins.

Comments

[Tim Worstall]

"It's quite possible that the share of tax paid by the top 1% rose since the 1980s not because of Laffer curve-type incentive effects, but because some other processes have increased the share of incomes going to the richest 1%."

Err, yes. They actually said what that other reason was at the time too. Tax rates are so high that high earners deliberately don't strive too hard. So, if we cut the top tax rates those (and potential) high earners will strive more, make more money.

So, what's happened? Top tax rates were cut and the higher earners are indeed making more money.

This isn't a side effect. It's what people were actually saying they wanted to happen, should happen, back when they cut taxes.

[TickyW]

Great stuff!

Saves me number crunching through the data to ascertain the truth (might still do that if I can find the time - it's tough at the top:-))

[Luis Enrique]

er Tim that's a "Laffer curve-type incentive" you are describing not some other process

[Metatone]

It's amusing - between his original piece and his comment here, Tim shows himself to be either incredibly ignorant about systems analysis.
(Guess what - more than one variable at work!)

Or, he's committed to saying stupid things in the hope of swaying political discussion amongst people who trust him enough not to do the analysis for themselves. (Or indeed lack the expertise…)

Still, the evenhanded, matey British blogosphere refused to ever take Tim to task when he was a small blogger for his repeated use of this tactic, so I guess here we are...

[Luke]

Tim, are you just making Chris's point? Let's say the 1% were, as you say, incentivised to strive harder. So they're working another 10 hrs a week, say.
But overall economic growth did not improve, despite all those wonderful supply side reforms.

So that extra 10 hours per week has all been spent on negotiating their salaries/devising better ways to rent seek, not inventing stuff/growing businesses?

[gastro george]

Yes, Tim rather stopped his sentence too quickly:

... high earners will strive more, make more money ... for themselves, at the expense of other people, with no effect on the economy.

[Socialism In One Bedroom]

Brilliant gastro george!

Every penny the rich spend on yachts is a penny not spent on, say, provision for healthcare. And if the rich do work harder than the rest of us, why are their skins so better tanned?

Yet another apologist for the filthy rich was on the BBC the other day, saying we should not cut bankers bonuses because you should not suppress talent.

There are 2 fundamental problems with this:

1. Capitalism does not deliver meritocracy, no rational measure of merit could ever result in 85 people being worth more than half the worlds population. To get meritocracy the 'free market' has to be rigged.

2. We do, at times, most certainly want to suppress talent. Those that have a talent for grooming children need to be suppressed. Or to take an even worse example, those accountants who use their talents to defraud the state of tax revenue in order that the filthy rich can be even richer, their talents most certainly need suppressing! I could go on. But suppressing talent could be a real economic winner!

[Keith]

I prefer Chris to Tim as an authority on the economy; and he usually makes interesting points as well.

The old socialist will say that tax cuts for the high paid must be a bad idea as they are a minority. The biggest gainers from the cuts to income tax are a very small minority of the minority. There is no realistic way you can think that all the growth in the economy is dependent on that small minority having huge pay and low taxes.

The old socialist, and Paul Krugman, will say that the slow down in growth since the adoption of Reagonomics/Thatcherism probably results from this very policy. The cuts to the income tax for the high paid are financed by higher tax on every one else and cuts to spending. If you impoverish the majority to enrich a small minority then lower economic growth is what you would expect if you believe the socialist idea that the majority are the wealth creators not the masters of high finance or private monopoly.

[Socialism In One Bedroom]

But taking the stats at the aggregate level we can see that massive inequality does affect outcomes. So, for example, 50% of the wealth in this nation is owned by just 10%. To imagine that doesn't have an affect is stretching apology for the filthy rich to the limit.

I would argue that the UK's relatively sub standard public services are partly a result of this wealth distribution.

But in one way Keith is correct, only a revolution can change the fundamentals. Tweaking taxes is a palliative measure.

[Dave Timoney]

The chart that Tim refers to shows the relationship between two ratios, one fixed (the top 1% of earners) and one varying (the share of income tax receipts they generate). In other words, the data does include any quanta, so interpretations about actual tax revenues or tax rate efficiency are impossible without additional data.

All the chart tells us is that there has been a change in the distribution. This could be the result of a variety of factors, e.g. a change in tax policy (i.e. taxing the 1% more and the 99% less), a gradual reduction in the quantum of revenue produced by the 99% relative to a static 1%, or a heroic effort by the 1% to grow the overall pie despite a static 99%.

What you read into the chart simply highlights your ideological priors. Tim wants to believe that the Laffer Curve is more than a doodle on a napkin. Quod erat demonstrandum.

[Tim Worstall]

"... high earners will strive more, make more money ... for themselves, at the expense of other people, with no effect on the economy."

That's an extremely strange idea. That if one person is making more money then it must be at the expense of other people.

For most people who do make money (there is always, alas, rent seeking) do so by producing something that others desire and are willing to pay for. And there is always, in such cases, some measure of consumer surplus. The purchasers of whatever it is being produced value it at more than they are paying for it.

Take, as an example, ARM Holdings. They make £100 million a year (or is it a quarter?). They also supply the chip designs for the billion smartphones sold each year. Has that 10p per £500 device been "taken" from those buyers? Or do they think it's a massive bargain that they're lucky to be allowed to buy?

One that's actually worth much more to them than the pittance they're being asked to pay?

Given that smartphones are the technology with hte fastest global adoption ever it's more likely to be the latter.
That is, we all believe that we're made richer by handing over money to the plutocrats at ARM.

Or, we're not being made poorer by the riches they amass, they're being made richer as a sign of how much richer we think they are making us.

[pablopatito]

"For most people who do make money (there is always, alas, rent seeking) do so by producing something that others desire"

Most? I could do with some stats on how much of the wealth generated in the last 20 years was rent-seeking and how much was "producing something". I'm not sure ARM is a typical example of the UK economy. I'd also be interested to know how many people at ARM earn over £150k.

[Socialism In One Bedroom]

ARM Holdings, interesting. Let us take another example, a local council. They provide essential services to the entire community, ranging from emptying bins, maintaining the roads to life saving provision for the elderly, disabled and vulnerable. Work that by any common sense thinking is of an even greater value than the very useful smartphone technology.

That doesn’t stop the Tory boys constantly attacking these services, the people who provide them and the people who receive them!

[Luis Enrique]

there is a distinction to be made between a firm that makes lots of money selling things people want, and the distribution of money within that firm

suppose ARM only had two employees. It could pay one £1 and the other £99 or both £50. In the former case, it's not clear that the one being paid £99 has made their money by creating consumer surplus, not at the expense of others.

[gastro george]

@Tim

Except nobody was arguing that people making more money *must* be at the expense of other people.

Merely that high earners *have been* extracting higher returns at the expense of other people with no effect on the economy - which is what Chris' stats show.

[Sardo Numpsa]

Glad to see pictures of busty females make a return to the blog.

Keep up the good work Chris.

[Andrew]

Interesting how an ever expanding economy, describable in terms of trend growth, can also be described as not increasing in performance.

If we had increase in growth, would we then lament the lack of increase in increase in growth?

What derivative of economic activity and value should be stop at?

Perhaps human productivity is inevitably declining, relative to the increasingly productive alternative, and the UK is as ever, leading the way?