Something close to a concensus is emerging: the 50p top rate of income tax doesn’t work. As The Guardian reports today, “A review into the rate is expected to confirm suspicions it does not bring in much revenue but serves to deter international business from locating in the UK at a time when the chancellor is seeking to encourage inward investment and spur growth.”
This is one of those issues where what ought to be a simple factual dispute descends into right and left interpretation. Is the 50p top rate – which was raised from 40p for those earning above £150,000 a year in 2009 – bringing in significant extra tax revenue, or isn’t it?
On the surface of it, the answer should be an obvious ‘yes’. You tax more, you get more revenue. But of course, it’s not that simple. The idea of the ‘Laffer curve,’ popularised in the 1970s, posits that increasing taxes raises revenue up to a point – but above a certain level, further tax increases actually reduce revenue by encouraging tax avoidance and discouraging entrepreneurship that leads to economic growth.
In the case of the 50p rate, it’s believed that it brings in little revenue largely because the rich are so adept at avoiding it. As economist Howard Reed explained earlier this year on the TUC’s Touchstone blog, there are multiple ways to do this: reclassifying income as capital gains, setting up a company, or leaving the country for lower-tax climes.
The problem is that it’s extremely hard to assess how much of this is taking place. And as Reed points out, some of the ‘analyses’ of the effect of the 50p tax rate make absurd assumptions about the way the rich respond to tax rises. A report by the Adam Smith Institute, published in March, estimated that the 50p rate could lead to £35bn lost tax revenue each year by spurring the rich to leave the country. But its figures, drawn from a survey of accountants, are ridiculous: the report assumes that between 12% and 23% of higher-rate taxpayers – those earning over £50,000 and paying 40% or 50% – will leave the country over the next ten years. Paul Daniels was bluffing, and clearly so are many of those surveyed.
Evidence from since the 50p rate was introduced suggests it’s actually bringing in substantial revenue. As economist and blogger Duncan Weldon explained in the Guardian in February,
The latest public sector borrowing figures have revealed an unexpectedly large surplus for January 2011. The Treasury repaid £3.7bn last month, surpassing expectations and representing the strongest month since July 2008 for the public finances.
The data shows that income tax receipts in January came in at £2.38bn – up by 17.8% on the year before. However receipts from national insurance contributions (NICs), which one would expect to move with income tax, rose by only 4.2% over the same period.
Last week’s labour market statistics showed that there had been no improvement in the overall labour market with the percentage of people aged 16 to 64 in work being static at 70.5% between December 2009 and December 2010. The same report said that average weekly earnings had grown by only 1.1% over the past year.
So we have a mystery – the number of people in work is fairly constant, earnings have only increased by 1.1% and NICs are only up by 4.4% and yet income tax revenues are up by nearly 18%.
The most likely explanation is that higher income tax receipts partially represent the new 50p rate kicking in and rasing [sic] revenue.
Of course, this is a rather rough-and-ready analysis. It’s perfectly possible that the Treasury’s investigation will reveal that the 50p top rate has, in fact, brought in very little revenue. But how much is ‘very little’? Would £1 billion a year extra revenue be sufficient? £2 billion?
It’s likely that the decision to cut the top rate has already been made, and the multiple leaks suggesting it isn’t working are merely an attempt to prepare the public for a cut. Hopefully the Government, which likes to trumpet its (admittedly seemingly genuine) commitment to openness, will release the relevant data in detail for experts to pore over.
If the evidence really does show that the 50p top rate hasn’t worked, it will delight Conservative voters and be extraordinarily hard for Labour supporters to swallow. New Labour’s failure to raise the top rate of tax provoked almost as much annoyance amongst the party rank and file as Iraq or tuition fees.
But the real question, of course, is how the Liberal Democrats will respond. Danny Alexander, after all, said just two weeks ago that those urging a cut in the top rate were in “cloud cuckoo land.”
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