Earlier this week, George Osborne came close to suggesting that by cutting the top rate of tax from 50% to 45% he had increased tax revenues by £8bn. The relationship between that suggestion and the truth is a distant one as I explained here.
Its evident falsity does not, however, make it any less convenient to those whose constituencies, or pocket-books, would benefit from further cuts. And so, predictably, it has precipitated a number of calls for those further cuts – perhaps in the coming Budget.
It is, unfortunately, recondite in these times to want to make policy by reference to the evidence rather than the heroic assertion of that which is convenient. Be that as it may, here’s some evidence: about who it is who pays the top rate of income tax; how much they benefit from cutting it; and how much it costs the public finances to make that cut.
In this tax year, about 332,000 people will pay the 45% “Additional Rate” of income tax. That’s about half a percent of the population. About 83.5% of them are male. More than 332,000 people earn more than £150,000 per annum – the earnings level at which you begin to pay the top rate – but the tax system offers reliefs to reduce your taxable income, and these reliefs are overwhelmingly accessed by higher earners, as I showed here.
The mean average earnings of someone in the Additional Rate category of earner is a bit over £400,000 pa. That means that more than half of the income of that mean earner is taxed at the Additional Rate. If you are one of the 16,000 people earning over £1,000,000 pa, your mean average earnings of £2.43m pa means that virtually all of your income is taxed at the Additional Rate. If you earn £2.43m, a cut of 5% in the top rate of tax will give you an extra £120,000 in your pocket every year.
In total, Additional Rate payers will pay a bit over £30bn in income tax this year. So if you cut the Additional Rate from 45% to 40% you will give them, collectively, a tax break of more than £3.3bn.
This won’t, however, cut what Government receives by £3.3bn.
Most people aren’t keen to pay tax and when we raise income tax rates we increase the incentive to find ways to avoid that increased burden – either by engaging in tax avoidance, or by retiring early, or working less or leaving the country. When people give up work or work less or emigrate they don’t just avoid the increase in the rate of tax, we also lose the rest of the tax that they pay.
So there are reasons to be cautious about raising rates of tax. But, of course, people who are highly motivated by tax rates tend to live in low tax jurisdictions – they are not in the UK in the first place. As the FT put it earlier this week:
These considerations also act in reverse. When you cut tax rates you can decrease people’s desire to avoid tax, you can increase their inclination to work or work on, and to move to the UK.
We typically call this relationship between the tax take and changes in rates the Laffer Curve. But, as I’ve written here, calling it ‘the’ Laffer Curve is a misnomer because there isn’t only one Laffer Curve – there are different curves for different taxes, at different times and in different economies. And the shape of the curve is affected by a huge number of variables including, in particular, how easy it is to avoid tax.
Back in March 2012, George Osborne announced that he would reverse Labour’s decision to increase the top rate of tax to 50% with effect from 6 April 2013. At the same time as making that announcement HMRC released a paper called ‘The Exchequer Effect of the 50 per cent additional rate of income tax.’ That paper is the only public study of which I am aware into the effects of increasing or decreasing the top rate of income tax in the UK. It concluded that cutting the rate from 50% to 45% would cost around £100m per annum.
However, there is no room for doubt but that cutting the top rate from 45% to 40% would be considerable more expensive.
First, our inclination to alter our behaviour as tax rates change is dynamic. The lower the top rate, the weaker the incentive to change behaviour to avoid it. You can tell this is so because otherwise, by cutting rates to zero, we would raise more than the £163bn we presently receive in income tax. Plainly this is not so. So a cut to a lower top rate (45% to 40%) will cost more money than a cut to a higher one (50% to 45%) – even where exactly the same people are affected.
Second, the Coalition had marked success in tackling personal tax avoidance. One of the arguments as to why cutting rates will not lead to a reduction in tax receipts is that the incentive to avoid tax will weaken. But if it is already extremely difficult for high earners to avoid tax, it cannot sensibly be argued that diminished incentive will have a marked effect.
Third, pay growth in the top percentile of earners – roughly equivalent to those who pay income tax – is strong as this HMRC chart shows:
The number of those earning above £150,000 is projected to grow by 6.5% from 2014-15 to 2015-16 alone. And the aggregate taxable earnings of that group will grow by over 6% (both calculations from data here). As more income becomes subject to that top rate of tax the cost of cutting it increases.
Writing in the Telegraph last week Fraser Nelson said this:
The top rate of tax is, today, 45p but it was 40p throughout the Labour years. And for good reason: it was the optimal rate, taking the most from the highest-paid. If Osborne were to restore the 40p rate, he’d squeeze far more tax from rich and again demonstrate Conservatism in action.
Now, this is heroic asserting by Fraser. But, if you have regard to the actual evidence, there isn’t room for serious doubt about the effects.
Cutting the top rate of tax will deliver to the top 0.5% of earners a tax cut worth £3.3bn. And it will cost the Exchequer very considerable sums of money. My opinion is that these sums are more likely to be counted in the billions rather than hundreds of millions per annum.Follow @jolyonmaugham
Reblogged this on sdbast.
Some studies on the 50p question that may be relevant.
Click to access Thompson-Taxing-top-incomes-final-17-04-15.pdf
A Laffer curve exists with directors’ pay. As top tax rates have been slashed since the 1980s so has the pay of directors risen massively. So if board pay has risen by a factor of 5 it is easy to see that the income tax take will have risen following top tax rate cuts (5 x 40% > 83%).
City Boy Kan – You seem to be confusing correlation and causation. Do you have any evidence that the increase in board level pay has been caused by lower tax rates? From my limited research in the subject it appears that the skyrocketing in boardroom pay occurred between the mid-90s and late 2000s when the top rate of tax was flat.
Congratulations on bringing some reason and attempt at objectivity to this debate. We can all better swallow something we like, but as you rightly advocate, this does all a disservice, where policy-making is concerned. I hope your words attract a wide audience. Thankyou.
Our reading of your analysis would benefit from you laying your own cards on the table. What is the outcome you would regard as preferable here, and increase or a decrease in the tax take from the top .5%? At what point would you wish to stop taking more tax from that group? Previous blog posts have suggested you are concerned the 100th percentile or even 10th decile is paying too much tax for the good of society. Your repeated references today though to ‘How much will it cost “US”‘ suggests a conversion to Corbynista class war.
I don’t think my personal views are especially relevant to an analysis of the data; I don’t think those views are helpful if I’m talking about heroic asserting; and I don’t think that referring to the general body of taxpayers – as “us” – suggests anything of the nature that you suggest.
All of that having been said, I’m happy to direct your attention to what I said in a tweet earlier this afternoon https://twitter.com/JolyonMaugham/status/706812589792239616
Well, I can’t do other than accept a direct answer to a direct question Jolyon. Thank you.
“there is no room for doubt but that cutting the top rate from 45% to 40% would be considerable more expensive”
Of course the incentive to avoid tax increases as the rate increases, so we know that (where Nx is the ‘amount’ of tax avoidance at tax rate x) N50 > N45 > N40. But I can’t see any basis for asserting that (N50-N45) > (N45-N40).
Take that up with HMRC: it’s the whole predicate of their “Exchequer Effect” paper. FWIW, if you sense a gentle discomfort in my blog with the notion that the effects of raising and lowering are symmetrical, well then, you’ve obviously read it very carefully.
I’m not sure it can really be described as the ‘whole predicate’ of that paper: it took me a while (admittedly without reading the whole thing) to find anything on the subject, buried in Annex A (p.51)!
What I take from that analysis is that whether a cut from 45 to 40 would take more or less than the cut from 50 to 45 depends on what assumption you make about elasticity. It certainly doesn’t flow automatically from the fact that ‘the lower the top rates, the weaker the incentive to change behaviour to avoid it’ as you suggest.
Apologies – coming back from a drinks party I think I misread your original question. The predicate of the paper is that what happens when things go up must happen when things go down.
The relationship between yield and rate changes is generally thought not to be static – you can see this from the fact that we talk of a Laffer *Curve*. The small cost of cutting from 50% to 45% suggests we were – as Robert Chote put the matter – strolling across the summit of the Curve. Once you’re off the summit (assuming you’re on the left hand side of the curve, which is a different point) you would expect the yield (or cost) of raising (or lowering) rates to be higher than on the summit. I don’t *know* – I don’t suppose anyone does – whether it’s *always* true that the lower the rate the weaker the incentive to change behaviour to avoid it – try to balance when I write the need to be accurate and the need to be comprehensible – but the truth of the statement to this situation is (given where we are positioned on this curve) beyond doubt.
My original point was querying what I saw (and still see) as a logical flaw in your argument, since it relied on unstated assumptions about the shape of the Laffer curve.
I would still say that “beyond doubt” is too strong, since the shape of the curve is very uncertain. The statement “(N50-N45) > (N45-N40)” is true at the government’s central assumption for TIE of 0.45, but it is not true at higher or lower elasticities, as the graph on p.51 shows.
Furthermore since you are (implicitly) relying on the government’s view of the shape of the Laffer curve, it seems odd that you choose to ignore their estimate of the cost of reducing the top rate to 40%, which is £0.7bn.
The fact that the assumption was unstated doesn’t mean the argument has a logical flaw. It just means that, as I explained in my earlier comment, I try to strike a balance between accessibility and technical accuracy. I don’t make any apologies for doing that: I’m not writing academic papers.
As to whether it is “beyond doubt” I would make two points. First, on the best evidence that we have it is beyond doubt that the statement “(N50-N45) s and your <s mixed up) is true. I would also point to the explanation I gave in my blog post – my "Second" – as to why I think the Coalition's success in tackling tax avoidance has moved the revenue maximising point of a Laffer Curve to the right of where it was in 2012. I think it is beyond serious doubt that I am right about that.
As to your final point, I am unaware of Government's estimate of 0.7bn. Can you direct me to it please? If it is buried somewhere in the "Exchequer effect" paper I remain very comfortable with my assertion "billions rather than hundreds of millions" given the point I have made about the shift to the right of the curve.
Incidentally I am not querying your statement that ‘the lower the rate the weaker the incentive to change behaviour to avoid it’. It think that’s obviously true. What I am querying is the logical leap from that to ‘a cut to a lower top rate (45% to 40%) will cost more money than a cut to a higher one (50% to 45%)’.
Call it what you will, the point is just that your argument doesn’t stack up without the assumption about the shape of the Laffer curve, so it’s odd that you don’t state it.
Your point about success in tackling avoidance may or may not be valid, but without evidence it looks like ‘heroic assertion’ of the kind that you are criticising. It also looks like cherry picking: other things have changed since 2012 which may have moved the curve one way or the other.
The £0.7bn figure is in the paragraph at the bottom of p.51, under the graphs showing the Laffer curve under different elasticity assumptions.
I’m afraid you’re now just being argumentative. And you’re on especially thin ice accusing me of inconsistency: the £0.7bn figure is absolutely consistent with everything I said in my original blog post – and in particular (given the change in the position of the curve that I wrote about in that post) my point about billions not hundreds of millions. Anyway thanks for your thoughts.
I have heard it seriously argued that the peak of the Laffer curve at tax rates of around 80%.
I wonder if there is scope for hysteresis here – that the effect on the way down will be different to the effect on the way up (not just the same number with the opposite sign). And of course economic circumstances are different now to those in 2010, so the curve will be different anyway.
My personal view is that the peak was (and is) to the right of 50p – but that’s just assertion so I haven’t been making that point.
I don’t think I accused you of inconsistency. I noticed and queried a logical flaw in your argument.
More broadly I think that when you say things like “there isn’t room for serious doubt about the effects”, you’re overstating the case in a field that is fraught with uncertainty. If you think this is just ‘being argumentative’, then so be it I suppose.
And do you support or oppose a 50 percent rate? Personally, I think it sends the wrong message when tax exceeds half (as it will, including NICs).
I think the 60 percent effective rate for withdrawal of the personal allowance is wrong too, but not as iniquitous as the income traps that I understand can still apply on withdrawal of benefits lower down the income distribution. (The IFS used to have some good graphics of the effective tax rates, for incomes from zero up to the top rates, taking benefits, allowances, tax credits etc. into account.)
on the ‘exchequer effect of the . . . ‘ paper John Thompson did a detailed investigation of the HMRC study and concluded that, among many other things:
“it is first shown that tax yield estimates rely on an unacknowledged assumption, and that the uncertainties in these estimates are large and are not reduced by comparisons with other studies based on other tax changes at other times. The second section shows that the conclusions about the impact of tax rates on economic growth are due to a misreading of some of the evidence, and a failure to acknowledge the full range of arguments and evidence in the literature”
One of the pieces of evidence they cited was from Thomas Piketty. He was contacted and asked if he approved of the way in which his research had been used, and he replied:
‘it is indeed quite surprising to learn that our paper with Saez and Stantcheva was used in this manner, given that we basically find the opposite’.
Click to access Thompson-Taxing-top-incomes-final-17-04-15.pdf
It’s clear just from reading the HMRC study that they have no real idea what the impact of these changes was. It is riddled with statements like “the true TIE for the model is likely to lie anywhere in the range of 0.14 to 0.81” or “estimates from the US tend to be in the range 0.4 to 0.7”.
I have never found the pseudo-science of the Laffer Curve very convincing, at least if one is not dealing with extremely high tax rates. But that aside, a cut in the additional rate from 45% to 40% is unlikely to trigger a greater willingness to pay UK tax among affected groups. In my experience, many non-doms regard normal UK tax rates as too high full stop ……as compared to say Hong Kong or Singapore. Such people are often not even willing to pay the annual remittance basis charge and will use shortish periods of non-UK residence to sidestep it if they can.
As for UK domiciliaries, their appetite for schemes promoting the creation of tax losses (e.g. Film schemes) was very significant even when the top rate was 40%.
Yet, given how relatively overtaxed work is, a cut in income tax rates may be no bad thing……matched by steps to tax huge unearned and untaxed capital gains from housing which are concentrated in ever fewer hands. I am not holding my breath given how many senior Labour and Conservative politicians, and their financial backers, are heavily invested in prime London property.
“My personal view is that the peak was (and is) to the right of 50p”
That is actually quite revealing, since this view is directly contradicted by the “best evidence we have”, which elsewhere you are happy to cite in support of a view that is “beyond doubt”.
I’m afraid that really is inconsistent.
No James. When I express a view based on the evidence I say so. When I express a personal opinion I say so. It’s called transparency not inconsistency.
“I have never found the pseudo-science of the Laffer Curve very convincing”
I completely agree with this. The modelling in the HMRC paper is of a kind that I would dismiss out of hand as a basis for any kind of decision-making in a professional context. ‘Garbage in, garbage out’.
My experience of individual taxpayers also tallies with yours, up to a point. My European colleagues have an iron conviction that tax rates in the UK are far too high, and they point to the cost of living in London compared to other European cities (with a particular focus on schooling) in support of their argument that these punitive tax rates are simply unbearable. However I’ve been hearing this for years and without exception they all still live here.
“tax rates in the UK are far too high” – just income tax, or other taxes too?
For some comparison to the rest of the EU, see this – http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_structures/2014/report.pdf
So, the UK’s top income tax rate of 45% is about the EU average, and plenty of EU member states have top rates over 50% (eight in 2014, according to that paper).
Most EU states have standard rates of VAT greater than the UK’s 20% rate (18 in 2014, according to that report, and most EU states raise a greater proportion of their revenues from indirect taxes than the UK).
The UK sits well below the average for total tax take (including social security contributions) as a percentage of GDP – around 35% compared to an EU average of nearer 40%.
Social security contributions are well below average, and our corporation tax rate is below the average and getting lower.
OK, so property taxes make a comparatively contribution, but then our land is comparatively expensive. And our tax system is extraordinarily centralised, with only 5% of taxes raised below national level.
I can’t fault you on transparency, but the dividing line between a personal opinion and a view based on the evidence is never quite as clear as you imply. And in this case I’m afraid I think you allow your personal inclinations to influence your interpretation of very questionable evidence.
I don’t even particularly disagree with the overall thrust of your argument. Your view is certainly better supported than the one expressed by Fraser Nelson, or those who ignore forestalling altogether to declare that cutting the top rate to 45% saved billions. But in this field the evidence is poor and very little is beyond doubt.
“just income tax, or other taxes too?”
“Everything. And property prices are outrageous, and you have to pay a fortune to send your kids to a decent school, which is all free back home. And you need private insurance because the health service is so rubbish, the trains are completely hopeless, and look at the traffic: it’s impossible to drive around this city. At home I would be able to walk to the office.”
“So when are you moving back then?”
I take with a large pinch of salt the complaints of many Europeans about UK tax rates. What many do not acknowledge is that they insist on living in hugely expensive London postcodes largely because they think there is tax-free money to be made by buying houses there……which there probably is, not least because of capital flight from the Eurozone, China and Russia. They also often send their children to hugely expensive schools. This is their choice but not obligatory. A Gucci lifestyle comes with a Gucci price tag.
However, I have some sympathy to the extent that Europeans probably get a better deal in terms of value for high Taxes than is the case in the UK, especially in the South East. Public transport, healthcare and state education are better and cheaper for the average German or French person than they are for the average British person. The social safety net is more secure and day-to-day living less costly. It is far from perfect but these countries have not allowed vast sums to be diverted into driving up land prices and the position of middle income people is probably less precarious than here.
This is all somewhat removed from Jolyon’s original question….
Well indeed, but the real point I’m trying to make is that these people don’t move. They didn’t move when they started having to pay for their non-dom status, they didn’t move when the upper rate was increased to 50% (or 52% including NI) and so far they haven’t moved now that the taxation of carried interest (very relevant to my line of work) has been made much less attractive. When compared to other tax jurisdictions the UK still isn’t that bad, and London still has other big advantages.
This is relevant to the subject of the blog in so far as my personal observation makes me very sceptical about claims of large Laffer curve effects in the 40-50% tax range. My hunch is that reducing the rate from 45% to 40% would cost about the same as reducing the rate from 50% to 45%, but that the cost of the latter has been much higher than the numbers arrived at with entirely spurious accuracy in the HMRC report. But this is just a hunch based on anecdotal evidence, and the reality is that we don’t really know.