Today’s papers report that the Chancellor is seriously considering announcing a cut to the 50p income tax rate in next week’s budget. If it happens the cut will surely dominate any other aspect of the statement, despite its being largely peripheral to most of the issues the UK faces.
Doubtless, over the coming days, the anti- and pro-50p brigades will trot out the usual lines. The former make an efficiency argument, that 50p damages the economy by discouraging effort and entrepreneurialism. For the latter the main argument is about fairness: that when low-income groups are taking a big financial hit, this is no time for those on over £150,000 to get a give-away. But both of these arguments seem pretty ropey – both the fairness advantage and efficiency disadvantages of the tax are questionable.
The efficiency argument rests on the assumption that higher taxes make people less likely to want to earn more, all else equal. But all else is not equal. When people make a judgement about whether or not to put their skills to work, all they really care about (in the barren world of ‘economic man’) is what financial reward they can take home for each extra hour or day of toil.
Evidence shows that top pay has raced ahead over the past decade. Indeed, the IFS calculated that in 2009-10, income among the top 1% rose by 13%. So unless top-paid people are working harder than they were ten years ago, their pre-tax return on effort has also doubled. Raising the marginal tax rate on those higher rewards by a quarter (from 40% to 50%), doesn’t change the picture that effort among the highest-paid is more handsomely rewarded today than it was a decade ago.
To take a simplified example, if a FTSE CEO was paid £1m in 2002 and faced a 40% average tax rate, she’d be taking home £600,000. Even if that CEO’s gross pay had merely doubled since then, an average tax rate of 50% would leave her with £1m net of tax for doing the same job. So with the higher tax rate, it’s still much more worthwhile working hard to get to be the boss. None of this is to say that we shouldn’t worry about other consequences of the 50p rate, but idea that it makes earning bucket-loads of cash ‘not worth it’ is absurd.
On the other side of the argument, the pro-50p camp also have a dodgy argument. Under the last administration, the Treasury estimated that the 50p rate would bring in £2.8bn in 2012-13. HM Revenue and Customs is due to report next week on its assessment of how much the new rate has raised. The mood music is that it’ll be below £1bn. And clearly any number they come up with is going to be subject to all manner of caveats and uncertainties. But the IFS has pointed out that avoidance behaviour could mean that the top rate would cost the exchequer revenue as avoidance activity picks up.
So it’s not tenable to support the 50p rate on the grounds that it’s unambiguously progressive. Whether it raises or reduces revenue from highly-paid people is an empirical question – and one that we’re unfortunately ill-equipped to answer. The pro-50p camp must accept that there’s a chance that the measure is regressive. Some argue that it’s an important piece of symbolism even if it doesn’t raise money. But, if the IFS is right and the 50p does cost more than it raises, then that tax shortfall will have to be made up from somewhere. Is it really fair to tax lower-paid people more just for the sake of a symbol?
All in all, it seems like the economic efficiency arguments for abolishing the 50p rate are rather overcooked. Axing the rate is unlikely to do anything significant to get the UK out of its current growth problem. On the other hand, those who want more progressive taxation may have their guns pointing in the wrong direction as they rail against the unfairness of a cut next week.