Top taxes & growth

Rich people don’t like paying taxes. This is pretty much the only thing we’ve learned from some of the hysterical reaction in the papers to Labour’s plan to raise taxes on the rich.

Let’s remember the historical facts here. Low tax rates aren’t associated with faster growth – if anything the opposite. For example, in 1988 Nigella’s dad cut the top income tax rate from 60% to 40%. Since then, GDP per head has grown by an average of 1.4 per cent per year. That compares to growth in the 29 years before the cut of 2.6% - and that was a time which included top tax rates on earned income of over 70%. Much the same is true in the US; the economy there was stronger in the 50s and 60s when the top tax rate was 91% than it has been recently with lower taxes.

You can read this fact in three ways.

One possibility is that growth has slowed in the 00s for other reasons, and the slowdown would have been even worse, had taxes not been cut. For me, this runs into two problems: one is that some of the likely causes of slow growth, such as the banking crisis, might not be independent of top tax rates. Another is that supporters of lower taxes believe that other reforms in the 80s should have raised trend growth too – such as privatization, deregulation and the weakening of trades unions. If they did so, their effect was swamped by other things.

A second possibility is that lower top taxes actually cause lower growth. For example, they might incentivize financialization and hence greater financial fragility, or encourage rent-seeking such as jockeying for top jobs or CEOs extracting higher pay for themselves. Of course, higher taxes might cause some top-earners to retire or emigrate. But this doesn’t necessarily cause a big loss of output. If, say, Eden Hazard were to move to Spain in response to higher taxes here, Chelsea won’t field only ten players.

A third possibility is simply that – within reason - trend growth isn’t much affected one way of the other by changes in national economic policies.

To argue that higher top taxes are the “economics of the madhouse” requires a strong case for my third possibility and good arguments against the second and third. This, I think, would be very difficult.

All this is a story about economic growth. You could argue, however, that higher top taxes would reduce tax revenues even if they don't much affect GDP: as Alan Manning has said, tax-dodging is more sensitive to tax rates than labour supply.

Even here, though, the argument is moot. For one thing, as the IFS has pointed out, these are subject to huge uncertainty. And for another, in this context the fact that Labour’s so-called “tax grab” would impinge upon the “middle classes” such as doctors and headteachers isn’t a bug but a feature. Insofar as it does so, it’s a revenue raiser. Teachers and doctors are probably less internationally mobile than the mega-rich, and less able to use tax-dodging ruses. For the purposes of raising revenue, they are a large slow-moving target.

For me, the non-hysterical arguments against Labour’s tax plans lie elsewhere. You could argue that – with tax morale low partly as a result of the rise of individualism – they’ll decrease social solidarity. People will regard them not as the price for living in a civilized society but as a burden which subsidizes “scroungers”. Or you could argue that the revenue raised by taxes will fuel wasteful public spending. Or you might argue that redistributive taxation isn’t enough: we need to reduce inequalities of power as well as income. Or you might argue that the tax base should be shifted from incomes to land and inheritances*. And personally, I’m not wholly unsympathetic to the view that very high taxes diminish freedom – though  few people can consistently argue for this, given the general lack of support for liberty.

What you shouldn’t do, though, is argue that higher top taxes will wreck the economy. Other things might do that, but it’s unlikely that top taxes will.

Comments

[Matthew Moore]

I thought you were a small state Marxist?

[Mark]

It's true that most rich people don't like paying heavy taxes. Of course, some react by putting in place avoidance measures, transferring more of the fiscal burden to the merely affluent. But it's also the case that most poor people don't enjoy being beholden to the state through transfers, whether these take the place of work or subsidise it.

My greatest objection to heavy taxes is that they're a poor substitute for supply-side reforms that render unnecessary the large-scale redistribution that is widely resented, is open to being gamed and creates an army of functionaries to implement.

[Aaron Headly]

inheritances* <-?

[nicholas]

I know a number of people who have become very wealthy while using Gordon Brown's Helpful Tax Dodge For Very Rich People - that is, allowing business owners to sell their business and pay a very low rate of tax on the proceeds. As a consequence they leave profits in the business, sell it and pay 15% tax instead of 40% tax. It is surely this sort of nonsense that should be targetted, rather than doctors and teachers.

[Rich]

Or the most likely explanation: some rich people run newspapers, don't much like paying any tax at all, and will make up any old thing to try to influence an electorate with little economic literacy.

[aragon]

Pesky economists...

https://www.theguardian.com/commentisfree/2014/apr/12/capitalism-isnt-working-thomas-piketty

"The solutions – a top income tax rate of up to 80%, effective inheritance tax, proper property taxes and, because the issue is global, a global wealth tax – are currently inconceivable.
But as Piketty says, the task of economists is to make them more conceivable. Capital certainly does that."

No cause to worry then...

"The lesson of the past is that societies try to protect themselves: they close their borders or have revolutions – or end up going to war. Piketty fears a repeat."

Oops...

[aragon]

More from the article... (book is 700 pages)

"As a result, the burden of paying for public goods such as education, health and housing is increasingly shouldered by average taxpayers, who don't have the wherewithal to sustain them.

Wealth inequality thus becomes a recipe for slowing, innovation-averse, rentier economies, tougher working conditions and degraded public services. Meanwhile, the rich get ever richer and more detached from the societies of which they are part: not by merit or hard work, but simply because they are lucky enough to be in command of capital receiving higher returns than wages over time. Our collective sense of justice is outraged."

Read the whole article.

[chris]

@ Matthew - I am. I'd rather inequality was restrained by (eg) worker control over management and by well-functioning markets. Redistributive tax is a social democratic policy, not a Marxist one. But this doesn't mean we should hyper-ventilate about modest tax rises.
@ Nicholas - agreed.
@ Aaron - the * referred to a missing footnote, wherein I pointed out that a footnote in the Labour manifesto was sympathetic to a land value tax. I wanted to say that it should hav made more of that point.

[derrida derider]

Ah, optimal tax theory is an area of my professional expertise.

There is an enormous international literature on the effects of top taxes rates on both tax revenue and on GDP. The broad gravamen of it is:

1) You don't get much boost to revenue from raising the top tax rates - as you say, this is more because the buggers stop reporting income rather than stop making that income. From the viewpoint of GDP, or of the material wellbeing of the rich (should you care about that), this is a GOOD thing - that income is still being made and spent.

2) From the viewpoint of inequality and equity more tax avoidance by the rich is, of course, pretty disastrous. It means that high marginal income tax rates on the rich are not a very effective way to pursue these goals, except insofar as the modestly higher revenue allows more spending on things that are effective. The truth is if you want to raise lots of money you need to tax people like you and I more - there are many, many more of us and we also find it much harder to ship our money through the Cayman Islands or have it tied up in elaborately structured stock options.

2) If the one-off reduction of the LEVEL of GDP is small, it is even smaller if we are worried about the GROWTH of GDP. There is neither theoretic nor empiric backing for harmful (or helpful) effects on longer-run growth, even for large variations in the top marginal rate.

[Jim]

@derrida derider:"you don't get much boost to revenue from raising the top tax rates":

This is what the Left either don't understand, or don't want to understand. Its no good just saying 'soak the rich', there's not very many of them, and they are mobile. You can put top rates up to 60,70,80% if you like, it'll raise no extra revenue, in fact probably lose it. The only way to raise extra revenue to do all the lovely things the Left want to do with it is to tax Joe Public more, because there's millions of him, and he can't bugger off somewhere else very easily. And Joe Public considers himself over taxed already. The UK government has struggled to get more than 40% of the economy in revenue, it didn't even manage that during WW2. In fact Mrs T was one of the few to manage it, during the 1980s, ironically. Even when the Beatles were paying 98% in the pound in tax the revenue only was about 35% of GDP.

Its appears we are at or near the upper bound of what the UK economy/population will take in tax, historically speaking. The only way to get more tax revenue to spend on more goodies is to grow the economy and the tax base first, then spend the resulting extra revenue.

Ironically Tony Blair got this, and was very successful in implementing it, but the Left appear to have decided he's Satan so are ignoring his achievements.

[Simon]

Margaret Thatcher to Tony Blair benefitted hugely from an unsustainable build-up in UK private debt. Hardly great supply-side reforms to massively artificially boost demand with excess bank-created money.

[C Adams]

@derrida derider:

On point 2 are you talking top 10% or 1%? How do you explain falling income share of 1% and high growth between '45 and '75?

[C Adams]

@Jim

Income share of the 1% rose dramatically during the Blair era. This is an instability that is not sustainable. The end game is either an economic or political crisis, and we saw both.

Economists like to talk about equilibrium but without redistribution there is no stable equilibrium.

[derrida derider]

Kinda missing the point, C Adams.

Firstly, "the top 10%" are precisely people like Chris and I (dunno about you). Secondly, the point I was making was about the ineffectiveness of soaking the rich by income tax, not about soaking them by other means.

I want steeply progressive wealth taxes - especially land and natural resource taxes. I'm Australian, so the second is a bigger deal for me than for a Briton. But you lot should definitely be taxing the s**t out of London land).