On Sunday, Labour pledged to tax as income the performance fees (known as the “carried interest”) paid to certain investment managers. This rather than the much lower capital gains tax rate enjoyed hitherto. The pledge followed Labour’s promise, earlier in the week, to remove the centuries old non-dom tax break and, last month, to restrict pension tax relief for high earners.
Taken individually, there is a compelling case for each of these measures. And they cohere as individual parts of a bigger programme to bring more earnings above £150,000 into the top rate of tax. Looked at as a matter of good design, we should applaud them. The removal of piecemeal tax reliefs and complexity is the intellectually unassailable argument of flat taxers. They should love this programme too.
They don’t though.
In 2012, Allister Heath, the Telegraph’s Deputy Editor, chaired a report calling for a flat tax of 30%. But on Thursday he led the charge against the non-dom changes in a heroic leader piece entitled “Labour’s Socialist Headbangers Will Clobber Us All.” It was a “near certainty”, he said “that a significant minority of non-doms, including the richest… would up-sticks.”
He did, though, concede that the eligibility conditions for non-dom status were “bizarre.” When I asked him why he had not called for their reform earlier he claimed he had. But he dropped the point when I pointed out his report had explicitly recommended no change. I had an almost identical conversation with another avowed flat-taxer, Stephen Herring, Director of Tax at the IOD.
The problem they face is this. If you won’t advocate sensible reform against your own interests you can’t expect to be listened to when you advocate sensible reform for them.
Now, none of this would much matter but for the fact that the right is already losing this argument. And not – entirely at least – in a good way.
There is a rate of tax that is too high. Although we sustained marginal rates of income tax as high as 99.5% in the post-war years through to the late 1970s the world, our place in it, and the tax rates of our competitors, were all very different then. Today we are – like it or (more likely) not – highly dependent on the highest earning 1% who pay around 27% of all our income tax receipts. And the evidence clearly shows there to be a point where increasing the rate of tax brings about only small increases in receipts – and beyond which increasing it further can lead to reductions. It is this relationship that the Laffer curve describes. Even around the 50% mark policy makers begin to “stroll,” as Robert Chote, Chairman of the Office for Budget Responsibility, memorably described it “across the summit of the Laffer curve.”
What is true for individuals is also true for business. Despite the Coalition’s promise to rebalance the economy, we remain heavily reliant on financial services. Yet, for understandable political reasons, banks have been hit time and again. And there are serious murmurings of discontent, even amongst the most socially responsible of bankers.
It is this debate that ought to be centre stage; it is this debate that matters. There is meaningful difference between the parties: Labour is promising to restore the top or “additional” rate of tax to 50%. The Conservatives have refused to confirm they will not cut it to 40%. What the extra yield might be today – because things have moved on from when Treasury last did the exercise – from a higher rate of tax is a point I mean to cover in a later blog post. But what I do know is that, if the right persists in inconsistent and alarmist ‘Chicken Licken’ry, it will further remove itself from a position of influence.
That would be a bad thing. We need an intellectual compelling counter-argument to the view, slowly taking hold and fostered by ongoing increases in the personal allowance, that taxes are things other people can be relied upon to pay.
There are those on the right who see taxes as a confiscation of personal wealth under compulsion of law by a spendthrift state. The left’s equivalent would soak high earners until the pips squeak for the sin of financial success. They deserve each other, these ideologues.
But for the rest of us, the only question we should be asking is, how much tax is too much?
Jolyon Maugham QC advised the Labour Party on its reform to the non-dom rules.
Waiting for Godot 
For what it’s worth, in 1967-68, the “special charge” was imposed. For investment income over £8,000, the rate was 45% which – with income tax at 41.25% and surtax at 50% – meant a total rate of 136.25%.
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If the Tory pension tax relief comes in (and the additional rate stays at 45%) we will have a 98.95% marginal tax rate for a share option gain where the employee bears the employer’s NIC cost and doesn’t reimburse the PAYE promptly. Good job that a student loan repayment of 9% is not a tax [snigger] as otherwise the marginal rate would be 107.95%.
I pressed the wrong buttons on my calculator: that should be 95.135%.
Perhaps I need to repeat again that the remittance basis was first introduced over 200 years ago (although there was then no income tax in 1802-3, or between 1816 and 1842) but it originally applied to all taxpayers and was only limited to “non-doms” just over 100 years ago. Yes, the regime is still old and peculiar and we would not introduce it now, but it I’m sure it attracts people to the UK who would not otherwise come here or stay here. Constant tinkering with the tax regime does not make the UK more attractive, even if the result is intellectually more satisfying.
Labelling carried interest as a “performance fee” is pre-judging the issue to some extent. As I am sure you know, it is usually the managers’ share of the capital gains realised by the fund from successful investments (some investments are not successful) after the other investors have received their (usually quite generous) preferred return. There is a definition of sorts in the Finance Act 2015, in the disguised investment management fees rules. So, a (capital) return from performance, yes, but not an (income) fee as such. As I understand it, the Labour proposals will not reclassify carried interest as income, but just change the basis on which capital gains tax is charged. Also, unlike income tax, NICs and VAT, Labour has not pledged to keep the rates of capital gains tax or inheritance tax the same.
Tax rates of over 50% just feel wrong to me, although there are areas where withdrawal of benefits or reliefs will give effective rates substantially higher than 50% already. I have heard Gabriel Zucman saying at the LSE that he thinks the peak of the Laffer curve might be around 80%!
If I have got my sums right, an employee on the additional rate, who spends some of his post-tax income on goods or services that bear 20% VAT, has had something like 54% taken in tax (allowing for employer and employee NICs, and CT relief for the employer, but ignoring the duties on petrol, tobacco and alcohol).
Jolyon
Personally, I am a “flatter tax” supporter rather than a flat tax believer ie I consider it is about the direction of travel and (eg) the 60%+ kinks are damaging to incentives. As for who is winning the tax debate, let’s return to that one post GE2015 as we will not agree beforehand!
“Labour’s promise…last month, to restrict pension tax relief for high earners.”
On this point, it is apparently ‘unfair’ that the ‘taxpayer is subsidising’ high earners pensions.
The logic apparently is that if a high earner puts £1,000 into a pension then the high earner pays £500 less tax whereas a basic rate payer pays £200 less tax.
OK, suppose said high earner is a plumber who spends £1,000 respraying his van. He now pays £500 less tax. Is this ‘unfair’ because a basic rate taxpaying plumber spending £1,000 respraying his van would only save £200 tax?
Of course not.
The argument to restrict the tax relief to pensions for high earners because it is ‘unfair’ is nonsense. Call it what it is. You just want more tax out of high earners.
Point of fact. It’s not “me”; it’s both mainstream parties.
How much of your time, Andrew, would you say you spend writing furious pieces about how stupid and misinformed I am? I don’t much mind, knock yourself out I say. But don’t you think you might find something more constructive to do with your life?
I wasn’t in the least bit furious when I wrote that. Just rasing the point that if it is ‘unfair’ that pension contributions result in a greater reduction in the tax due from higher rate taxpayers than from basic rate taxpayers it would be logically correct to say it is ‘unfair’ that painting a van results in the same tax consequences.
I didn’t say you were stupid, either, or misinformed. It’s just that I didn’t see that your logic held together. (I asked you because you said there was a “compelling case” for the pension measure).
I’m interested what you think the difference is. Both are payments from otherwise taxable income which benefit the individual and result in less tax to the exchequer. Why is the outcome of one ‘unfair’ and considered an egregious state subsidy and the other acceptable?
Suppose a higher rate taxpayer employs someone and contributes to that person’s pension. Is it unfair that that higher rate taxpaying employer reduces his own tax bill by more than a basic rate taxpaying employer would who made the same payment?
You’ve written 60 comments on here. Have you made one that is complimentary? It’s possible that I’m always wrong, of course. But then again, there are other possible explanations too.
“You’ve written 60 comments on here. Have you made one that is complimentary?”
Do you mean ‘complimentary’ or ‘in agreement’? I’m not sure it would be an interesting blog if all you had were sycophantic messages lauding you and you views. Surely that’s not what you want?
“It’s possible that I’m always wrong, of course. But then again, there are other possible explanations too.”
I’ve asked you about one particular point and said I don’t follow your logic. There are an awful lot of your blogs I’ve not commented on and and awful lot of points you’ve raised where I’ve been in agreement but not seen the point in posting a “yes I agree with what you’ve said” post as I can’t see that adds to your blog. If you’d like me to to do this to redress what I seem to sense from you is annoyance I’m happy to do so.
You should do what seems right to you Andrew.
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In an election it’s tempting to polarise along Manifesto lines but it can tempt us into agreeing on party lines with things that I think range from bonkers to absolutely bonkers (be it assuming dormant companies materially impact on the tax gap, setting specific targets to reduce the Tax Gap year on year, or raising IHT threshold to £1mn.)
I think an a la carte approach might be far more productive.
But equally productive is to have some more intellectual compelling argument and counter-argument. Take pensions and tax relief (which you and Andrew Carter mention). Government policy is that for its own employees the more you earn the higher your contribution rate. The rationale (sic) is that higher paid people generally live longer so it costs more to fund the pension until their 80s and 90s. State pensions are funded on a different basis.
There are serious differences of view on tax relief for pension contributions. We already have annual and lifetime caps and now there are suggestions on reducing the relief. Lib Dems want “a single rate of tax relief for pensions, which would be designed to be simpler and fairer and which would be set more generously than the current 20% basic rate relief.” So, presumably to get a credit of above 20%, the 40% would fall?
Labour will “restrict tax relief on pension contributions for the highest earners” (but I could not see any numbers or rates here).
As far as I can see some Manifestos implicitly hold it to be unfair that higher taxed people end up getting more tax relief on the same contribution as a lower taxed person. In what way is that ‘unfair’? For the same extra £ of income the higher paid pay more tax than the lower paid. But we accept the higher tax is what progressivity is all about. So why are pensions different? As the IFS said, why not have tax relief on the way in and taxability on the payment?
There are clearly some public policy gains from encouraging personal pensions (reduction of poverty, reduced state funding, etc.) and maybe there is a need for state support. But I’ve seen nothing in any Manifesto that looks at the issue of “fairness” as a justification for ending the relief at the highest marginal rate. Assertions are common but would it not be more value to have that intellectual compelling argument and counter-argument?
If you want to be even more ambitious in future posts maybe the pensions example can be expanded into a wider discussion on tax relief due on other claimed deductions/reliefs (obvious examples being gifts to charities, donations in lieu of IHT). So the (extra) question would then be not how much tax is too much, but is there a ceiling on reliefs?
Asking for a view on what is the right level of taxation is only half of the argument; the second and equally important part is how much should the State provide for its citizens as this will determine the level of taxation required.
IMO the State is currently providing too much in terms of the NHS and welfare (and that includes pensions). The generation that went through WWII are now much reduced and therefore the massive debt for their struggle is coming to an end. Therefore we are able and should review what is the sensible amount of State provision of services (and this does not mean that I agree with using private companies to provide – that is State spending – and should not be distinguished). I would welcome a debate on this rather than on the amount of tax levied by the Govt.
In terms of taxing carried interest as income this only seems correct to me. PE partners repeatedly raise funds to earn a return – an older case involving a driving instructor who repeatedly set up and then sold on the business were taxed as income. How do PE partners differ in this respect?