The claim
“If a small portion of these highly mobile workers move elsewhere because of the 50p rate then it is clearly a self-defeating way for the Treasury to try to raise money”.
Letter to the Financial Times from Dr DeAnne Julius, chairman of Chatham House, and others, 7 September 2011
The background
Twenty leading economists have called on the government to scrap its 50p tax rate for high earners, warning that it will do “lasting damage” to the economy.
The 50p rate for those earning more than £150,000 is one of the highest in the world, making the UK “less attractive as a destination for both foreign investment and talented workers”, they said.
It was introduced as a temporary tax by the Labour government in the 2010 budget to tackle the deficit. Hitting the richest 1 per cent of taxpayers, it is expected to raise an average of £2.4bn a year.
But this is a drop in the ocean compared to the £496bn the government expects to raise overall this year. So is it really worth it?
The analysis
HM Revenue & Customs said it won’t know how much money the tax will bring in until the self-assessment tax returns for 2010-11 are finalised in January.
In the interim, both the Institute for Fiscal Studies and the right-wing think tank Adam Smith Institute point out there are lessons to be learned from the 1980s.
During the 1980s governments on both sides of the Atlantic raked in more money by lowering taxes.
In 1988, UK Chancellor Nigel Lawson slashed the top rate of tax from to 40 per cent, pulling in a quarter of all tax from the highest 1 per cent of earners.
His move more than doubled the taxman’s haul, which ten years earlier had reaped just 11 per cent from the same 1 per cent.
How? Put simply, the super rich will do anything they can to avoid paying more tax.
So by putting up taxes, the highest 1 per cent will look for tax loopholes or even leave the country. But if they feel they’re being treated fairly, they won’t go to such lengths.
Chancellor Denis Healey promised to “squeeze the rich until the pips squeak” by putting taxes up to 83 per cent – and the move saw the actors Sean Connery and Michael Caine quit the country, among others. The latter wrote in his biography that he didn’t want to leave Britain, but he couldn’t bear to pay so much. He has since returned.
Across the pond in the US, in 1981 Ronald Reagan prompted the largest tax cut in US history, pulling down the top rate from 70 per cent to 50 per cent. According to the Inland Revenue Service (IRS), this saw the super rich 1 per cent shouldering 27.5 per cent of the tax burden – an increase of 10 per cent.
President J F Kennedy said in 1963 that high taxes coupled with low revenues were a “paradoxical truth”. He concluded that the “soundest way to raise the revenues in the long run is to cut the taxes”.
And before him, President Calvin Coolidge’s Treasury Secretary Andrew Mellon said: “It seems difficult for people to understand that high rates of taxation do not necessarily mean large revenues to the government and that more revenue may often be obtained by lower tax rates”.
He cut taxes from 73 per cent to 25 per cent after World War 1 and nearly doubled revenues.
A study by the IFS found that the rich are “very responsive” to income taxes – but other taxes such as National Insurance and VAT are important too, since what really matters to people is what they can buy with their net earnings (after tax).
A high income tax will push the super rich to look for tax loopholes, and it could lead to a reduction in their spending, which would affect the amount raised by consumption taxes such as VAT, said IFS analyst James Browne.
If the rich reduce their spending by as much as their income is reduced, Mr Browne estimates that the government will collect £1.5bn less per year, slashing its income from the 50p tax rate to £0.9bn.
And that’s if they stay put. If the rich flee from the UK, the taxman will have even less to claim. These are the “behavioural consequences of the new higher rate of taxation” that Lord Myners warned of last year.
The verdict
The 50p tax rate will raise a relatively small amount for the taxman, and history has shown us that lowering taxes can boost or even double revenues – because the rich won’t go to such extremes to dodge them.
We have no way of knowing how many people have left, or will leave, the UK purely because of the 50p tax.
But we do know that the money coming in has dropped. The number of foreign investment projects pumping money into Britain dropped by 11 per cent during 2010/11. And this cut the number of jobs created by a fifth, according to UK Trade and Investment.
As the economists’ letter to the FT pointed out, Britain has slipped from second to fourth place as a destination for inward investment.
Mr Osborne said last month he didn’t see the tax lasting because it’s “very uncompetitive internationally, and people, frankly, can move”.
He’s right; in which case stalling the decision must be because of the politics.
For as Shadow Chancellor Ed Balls said today: “Millions of struggling families and pensioners on middle and low incomes will wonder why the only tax rise or spending cut George Osborne is willing to reconsider is the top rate of tax for the very richest.”
By Emma Thelwell
