Tax at 50% is a Good Way to Kill the Golden Goose

Though it was given a bit of excitement by the coup that never was (and maybe never will be) against Gordon Brown, this election campaign already has a depressing feel to it. We feared the debate would be reduced to the lowest common denominator and that is what we are getting.

Alistair Darling should have known better than to wheel out a dossier he described as “the Conservatives’ £34 billion credibility gap”, detailing what he claimed were the opposition’s uncosted tax and spending commitments.

I am always inclined to think kindly of the chancellor, perhaps naively, so I suspect he knew better but that his hand was forced by a higher authority. Heaven knows what tricks he will be required to perform as polling day approaches. Just say no, Alistair.

What you will also know is that David Cameron got himself into a bit of a tangle over whether a Tory government will definitely introduce some kind of tax break for married couples.

He will, though I suspect he was trying to give himself a bit of extra room for manoeuvre. We can also assume, barring a political earthquake, that the Tories will stick to their pledge to raise the inheritance tax threshold to £1m per individual. This pledge is a good example of how policies that were right for their time can end up being huge millstones around a party’s neck. When the inheritance-tax pledge was unveiled in October 2007 it gave George Osborne his greatest political triumph and did more than anything to persuade Brown to delay an early election that he probably would have won.

Now it looks badly out of place. It should have been buried when it became clear that the state of the public finances did for the Cameron-Osborne strategy of “sharing the proceeds of growth” between public spending and tax cuts.

If not then, it should have gone when the government announced tax hikes for all, most notably the planned rise in National Insurance in 2011. The Tories regard the inheritance-tax pledge as a matter of trust but it is something they will live to regret.

I regret it because it means that nobody is standing up against what will be a very damaging change to our tax system, due to take effect in less than three months.

In April Britain’s top rate of tax will rise to 50%, reversing the cut to 40% 22 years ago. Britain will have one of the highest rates of income tax among the advanced economies, as part of a very messy system.

As many will know but others are yet to discover, the effective marginal income-tax rate on incomes between £100,000 and £112,950 will be 60%, because of the progessive withdrawal of the personal tax allowance. Then there is a lull, before the new top marginal rate comes in at £150,000.

Some who read this will be directly affected by this change. Others will wonder what the fuss is all about. After all, what is wrong with rich people paying more? And did we not have a 60% top tax rate for nine years under Margaret Thatcher?

It matters for three reasons. It sends out the wrong signal to people wanting to set up and succeed in Britain — risking killing the golden goose. It will also mean that even more effort is spent on trying to keep income out of the taxman’s grasp. And, most importantly, it is likely to result in less revenue for the exchequer over time.

If there was such a thing as a political consensus in Britain in the 1990s and most of the 2000s, it was over the top rate of tax. Tony Blair persuaded a reluctant Brown that a sure way to extend the party’s appeal to aspirational Britain was to commit to not raising the top rate of tax above 40%.

He could not prevent him finding ever more inventive and stealthy ways of raising tax in other areas but the 40% top rate was sacrosanct. It was a Labour manifesto commitment in 1997, 2001 and 2005, which means that in April it will be broken.

True, the Liberal Democrats always favoured increasing the higher rate to 50%. But as far as the Tories and Labour were concerned, this was not a matter of debate. However much Labour ministers would have liked to squeeze the rich much harder, they were persuaded by the evidence that this would be counterproductive.

What we know from that evidence from HM Revenue & Customs (HMRC) is that even as the top rate of income tax came down the proportion of tax contributed by the highest paid went up. Whether this was the Laffer curve — above a certain level higher tax rates act as a powerful disincentive and reduce revenues — or simply the fact that lower tax rates reduce the need for complex avoidance activity, something important has happened.

In 1978-79, when the top rate of income tax was 83% (98% on earned and unearned income combined) the highest-earning 1% of the population paid 11% of income tax revenues. By 1986-87, after the top rate was cut to 60%, the highest-earning 1% accounted for 14% of revenues. By 1990-91, following the top rate reduction to 40%, the top 1% contributed 15% of revenues, since which time their share has increased considerably, to an estimated 24.1% this year.

Nor is this confined to the very top tier. In the late 1970s, the top 5% paid 24% of all income tax; this year it is 43.1%. The top 10% accounted for 35% of the tax take when Denis Healey was chancellor in 1978 but now the figure is 53.3%.

It is the case that over the past three decades the richest have become, relatively speaking, much richer. Their share of the tax take has, however, grown much more rapidly than their share of income. There is another change, which is that until 1990-91 married couples were treated as a single tax unit but the effect of this is small.

Now we are going back to new higher rates of income tax, and nobody is speaking out against it.

My hopes were raised by a speech last week by Lord Mandelson, perhaps the last true standard bearer for New Labour now that Blair has put it behind him. But, while saying “there is never a case for punitive taxation” and that the government would guard against imposing tax rates that would act as a disincentive, the new top rate was “justified in the quite exceptional circumstances we face”.

So not much of a fight from the business secretary and none from the Tories, who think opposing the new top rate would mean a plunge into the elephant trap dug by Labour. They may be right, though I would have thought that a principled and philosophical opposition to Labour’s top rate tax hike was politically more astute than the pledge on inheritance tax.

So the battle has been lost without a fight. I always thought having a low top rate of tax was very important for Britain, not least because it compensated for some of our shortcomings in the eyes of footloose international businesses. Now that advantage is going, possibly for ever.

Originally published at David Smith’s EconomicsUK and reproduced here with the author’s permission.

One Response to "Tax at 50% is a Good Way to Kill the Golden Goose"

  1. Matthew G. Saroff   January 15, 2010 at 2:33 pm

    I disagree.What you have in the UK in “The City” is not a vital industry doing essential work to aid in the distribution of capital, but a group of parasites who siphon their fees from making this process complex and opaque.I will note the NEF study showing that bankers destroyed £7 of value for every £1 they are paid privately.If you chase them out, not only will you get better results for the real economy, but you will also see relief to the middle class in areas popular to the hyper-wealthy, because when artifacts of wealth like Penthouse apartments are abandoned, and replaced with multiple affordable flats, it reduces pressure on basic commodities like housing.