There has been an interesting response to the Compass tax report. One has been to challenge why my co-authors and I did say that:
Of course the right will argue that higher taxes will just lead to higher rates of avoidance or the flight of talent. Research by the Work Foundation busts the latter myth. Our view on avoidance is that if the top rate is increased while at the same time reforms are made to the tax system, minimising avoidance and evasion, the taxable income elasticity is likely to be small, if not zero.
Tax is a life issue, not just an economic one. As an accountant I know that. Of course it is. But, as is so often the case, those who claim that the well off will reduce their effort in the face of tax rises entirely miss the point. Those who think this adopt the assumptions of conventional micro-economics, with all its flaws. These assumptions are wrong: for a start this assumes people can respond to changes in tax. This may not always be true. And this model assumes that people conform to the model of homo economicus: that people are wholly rational but only with regard to matters relating to cash reward and that nothing else matters.
First, our target is people in the top decile of income earners. These people earn on average £94,000 a year — but many earn much more. A significant majority of these people (also representing the majority of tax paid) earn less than £150,000. I could, no doubt, work out what proportion of them is in employment: the reality is it is a significant number. Most of these people will not be rewarded by the hour; most of them with variable earnings will receive that variable pay in accordance with criteria quite unrelated to labour effort expended. A great many will work hours way above contract demand and do so for reasons quite unrelated to money. In other words, they have no reason to change their work effort depending on tax rate. And some will have no measurable opportunity to do so.
More important though, most in this large group will, based on my experience, spend a great deal of their income. Savings where they exist will be in institutionally run pensions in this income grouping. Remaining cash will be committed to excess consumption, over-sized housing, school fees, ponies and more. This is the reality for those who earn (as opposed to those who live on unearned income, who byu definition will not be changing their effort) in this group: they are committed beyond their means despite those means being amongst the highest in society.
As such for many their option to withdraw effort and reduce earnings in response to a tax increase does not exist. Rather, many, if not most in this group behave in exactly the same way as economists assume the low paid do in response to a tax increase: they are price takers and respond against their fixed budget commitments by seeking to increase effort, putting in more work to maximise reward to maintain what is by far the most important social goal of this group (and others), which is keeping up relative reward and appearing to out-perform others, usually indicated by conspicuous consumption. For this socio-economic reason the impact you suggest might exist is highly unlikely to do so.
And as I note, those with investment income will not be sweating harder. So their behaviour does not affect this issue.
And there is another factor to take into account. By eliminating tax avoidance for this group by setting minimum tax rates we do two things. First, we make net return have a direct relationship with gross earnings — so the incentive to work harder in the face of increased tax is enhanced because the incentive to avoid tax has been removed. And second, this removes the harmful and wholly destructive game of comparative tax deduction competition that many will play to seek to outperform the perceived tax avoidance of others in their peer group.
Finally, there are some other realities: the first is there is little demand for Brits abroad. The second is few can work abroad in places where it is easy to go because they can’t speak the required language. The third is a lot of self employed are not in this earnings bracket, and those that are will not tax evade any more to get out of tax at this level than they do now. Fourth, really successful self employed people are not driven by money — or if they are it is as a gross and net a net measure.
I could go on, but the point is clear: the model on which claims that people with high earnings will reduce their effort in the face of tax increases ignore the realities of life.
Which means they really are not a safe basis for predicting outcomes. Which is why I ignore them — especially when, as is the case proposed, the change is hard to avoid and reasonable.
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So, what you’re saying, in formal terms, is that moving the average tax rate up by 60% (from 34% to 55% as you describe it at one point) will have no effect upon the following equation:
C = w (T – l)
Which is an extremely brave assumption to make and one that would require, before it being accepted as true, a certain amount of empirical research. You are, in effect, stating that no one would subsitute leisure for market income with such a tax change and that everyone has a fixed desired income which they will work to fulfil.
Yet you do seem to miss the logical implication of that latter part. If it is true that we all have some fixed income that we work to fulfil (or that this top decile do) then your tax changes will increase tax revenue over and above static changes. For as post tax incomes will be lower people will work more to get to their desired post tax income.
And as you’ve not included such a tax rise as a result of your impression of the income effect we have to conclude that you don’t actually believe this point either.
But as to the major point. Don’t you think it might be a good idea to base our estimates of the revenue to be had from tax changes on the empirical research of the past couple of centuries rather than the societal impressions of a retired accountant?
@Tim Worstall
Tim
Richard engages in various aspects of classical media manipulation. I would encourage all readers of this blog to review this article (http://en.wikipedia.org/wiki/Media_manipulation) and tick off how many aspects Richard employs. I say this not necessarily to criticise, because Richard evidently believes in his cause. However, on the basis that the ‘ends justify the means’, his approach verges on the cynical.
One of the sad aspects of this, and picking up on your final comment, is that Richard is to the world of tax professionals what Katie Price (Jordan) is to professional acting.
Contemplatively, the Girrl
This better-off group, by your own admission, already pay the majority of tax in the UK. If your argument is right, in that they’ll have no choice but to pay-up whatever tax rate you come up with, how can you morally justify making such a tiny proportion (and by definition the most talented and productive) of the population pay for everyone else? It is inequitable. Your changes would lead to people giving up and/or leaving, I don’t care what you argue above – bloody-mindedness at the very least would make this portion of the population rebel in some way. They will either leave, stop working for their own good (and our good) or they will find ways to avoid paying. These people also employ a lot of less well-off people in the UK, if they give up or leave then those jobs (and the tax revenue) will go with them. And what about ambition? Why would anyone strive to build a successful business and employ people if the state will just expropriate the reward for all that effort?
I have built my own company from scratch and expanded into the US, I am one of the people you are talking about. I don’t have to stay in the UK but it is my home, I pay my taxes (in the US and UK) without a quibble. I have to say though that I am not going to let the Government take the rewards from me that I worked bloody hard to gain – it’s me that worked 15 hour days for 12 years without a holiday, not the state. I’ve paid my share and then some already.
These proposals are totalitarian, they force the best in our society to abandon their stake in our society through self-preservation. Your proposals would make our society poorer, and not just financially.
Tim
a) We may have understated the additional revenues we might raise – which is not a crime. a little caution always pays
b) Economists have got it all wrong – as even the Queen noted, rather well
c) So economists who have got it wrong time and again because they have asked the wrong questions, used the wrong assumptions and often deliberately mis-stated results, or me? It’s really not a choice, is it Tim, when you put it that way? 🙂
Richard
“So economists who have got it wrong time and again because they have asked the wrong questions, used the wrong assumptions and often deliberately mis-stated results, or me? It’s really not a choice, is it Tim, when you put it that way?”
I note the smiley: but to think that you and you alone know more about the effects of taxation upon incentives than tens of thousands who have studied the point in detail is, well, what should we call it? Hubris? Arrogance? Perhaps not a sound basis for public policy?
Tim
I find that really quite amusing from you! Arrogance – something I know you are quite unfamiliar with
So why not stop the arrogant posturing and answer my points – show why I am wrong? Try arguing, in other words.
Relevant current data please – and not just blackboard stuff – we all know that’s nonsense
Richard
OK:
“http://www.nber.org/papers/w15343”
Estimations of the peak of the Laffer Curve for the US and the EU 14.
“For benchmark parameters, we find that the US can increase tax revenues by 30% by raising labor taxes and 6% by raising capital income taxes. For the EU-14 we obtain 8% and 1%. Denmark and Sweden are on the wrong side of the Laffer curve for capital income taxation. ”
Before you start saying that this proves you correct…..the result is swayed by the way that it is possible to tax the middle higher than it is, not by raising marginal rates to 75% as you plan.
Tim
a) I have to believe the Laffer curve is right to but this – and I don’t – not least because much of the effect (if it exists ) is from avoidance and our plans destroy that option and
b)I note the report says the capacity to increase tax exists
Odd argument on your part Tim; very odd
Richard
Here is a good place to quote Paul Krugman:
“Maybe so–but surely my arrogance is a puny thing compared with that of men who believe themselves able to invent a new and improved economics from a standing start”
Richard,
Finally, there are some other realities: the first is there is little demand for Brits abroad. The second is few can work abroad in places where it is easy to go because they can’t speak the required language.
Ahh, the parochial notions of the Little England mindset. Do you really think the language of international business in Bahrain (or anywhere else) is Arabic (or any other language)? The “required” language of business throughout the world is English (fyi).
Georges
Tim, I think this paper’s assumptions are so strong that – at least in terms of the argument that you use it to make – the approach may in effect assume the answer that you are looking for.
Here is the abstract in full:
“We characterize the Laffer curves for labor taxation and capital income taxation quantitatively for the US, the EU-14 and individual European countries by comparing the balanced growth paths of a neoclassical growth model featuring ”constant Frisch elasticity” (CFE) preferences. We derive properties of CFE preferences. We provide new tax rate data. For benchmark parameters, we find that the US can increase tax revenues by 30% by raising labor taxes and 6% by raising capital income taxes. For the EU-14 we obtain 8% and 1%. Denmark and Sweden are on the wrong side of the Laffer curve for capital income taxation.”
Although the paper can’t be accessed freely via the NBER, you can find the University of Chicago version here:
http://mfi.uchicago.edu/wp/pdf/trabandt_uhlig_laffer_vers21_WP.pdf
The model has three key (sets of) assumptions on which any results must therefore rely:
i. the assumptions underpinning the neoclassical growth model; and
ii. the assumptions underlying constant Frisch elasticity preferences.
iii. a closed-economy
Let’s take these in turn…
(i)
The neoclassical growth model has been largely superceded by endogenous growth models, although it is still taught in e.g. undergraduate development economics courses as a simple way of begining to think about the growth process. Steve Keen’s debunking of the assumptions (e.g. showing the internal contradictions, never mind the lack of empirical support) is a little over the top but very clear; see his book but also e.g.
http://www.debunkingeconomics.com/Talks/KeenGrowthTheory.PPT
A longer perspective, encompassing the theory’s marginalisation of income distribution issues and highlighting some key flaws (e.g. the critical lack of evidence for fundamental underpinnings like the production function) is in e.g. Pasinetti:
http://www.unicatt.it/docenti/pasinetti/pdf_files/Treccani.pdf
Since the assumptions of the neoclassical model cannot be stood up, and have a direct bearing on the returns to capital and labour, we should be rather wary of putting much weight on the predictions of tax elasticity (of e.g. labour supply!) that the paper generates.
(ii)
The assumption of constant Frisch elasticity is, if anything, a more serious concern. The Frisch elasticity of labor supply is defined as the percentage change in labor supply resulting from a one percent increase in the expected wage rate, holding the marginal utility of wealth constant. Constant marginal utility of wealth means, for example, that an extra £1 is worth the same to someone with nothing or someone with £10m. You can think for yourself what that assumption might do to an assessment of responses to taxation.
In their ‘Proposition 3’, the authors demonstrate mathematically how the Laffer curve emerges from the CFE (and broader neoclassical) assumptions – the existence of the curve is thus entirely based on the mathematical extension of these assumptions.
(iii)
The closed-economy assumption is an obvious concern for anyone who thinks that there may be anything to phenomena like international tax competition or tax-induced capital flows — e.g. profit-shifting , which is estimated to reduce Germany’s tax take by more than 10% – see Huizinga and Laeven:
http://www.luclaeven.com/papers_files/huizinga_laeven2007.pdf
When this model is used to calibrate real economies, in which we would expect to see both real capital flows and also artificial shifting of profit and income declaration locations, it seems inevitable that the calibration will give rise to upward bias in the estimates of capital tax elasticity. This would make the authors much more likely to find (erroneously) that any given real country is near the peak or even on the wrong side of the capital tax Laffer curve whose existence they have effectively assumed.
This is exactly what transpires: “we find that the US can increase tax revenues by 30% by raising labor taxes but only 6% by raising capital income taxes, while the same numbers for EU-14 are 8% and 1% respectively.”
[Open-economy assessment might favour, for example, better regulation of such international manipulations, rather than capital tax cuts.]
**
A final thought, Tim: even after all the assumptions are made, and the results thereby determined, the authors still find that tax cuts would not pay for themselves in either the US or the EU as a whole – indeed, tax increases would increase revenues. And all of this is without mentioning the likely inequality impact (ignored in the paper), or the fact that the authors focus on taxes being used to pay for transfers rather than e.g. public goods (which the authors, in fairness, point out as distorting the findings)… Imagine what the results of an assessment based on more realistic assumptions might look like.
[…] blogger who likes to think he can answer all objections with reference to neo-liberal economics, challenged some of the assumptions in the Compass tax report, with reference to the Laffer […]
“A final thought, Tim: even after all the assumptions are made, and the results thereby determined, the authors still find that tax cuts would not pay for themselves in either the US or the EU as a whole – indeed, tax increases would increase revenues.”
Alex, please note that I am not claiming that tax cuts (from current levels of taxation) pay for themselves. Nor am I even claiming that Richard’s suggested tax rises might not increase revenue raised, I’m open to being convinced by evidence on that point.
My claim is the much more minor and very much more restrictive one that tax rises of such magnitude cannot be assumed to raise revenue in a straight line manner. To claim, as Richard does, that raising average tax levels from 34% to 55% on one group of people means that we’ll end up getting 55% of that same income is an extraordinary claim. One that needs to be backed up by a great deal more information than so far given. Richard’s claim really is that, do you see? That there will be no behavioural changes from a tax rise of this size.
I may have missed valid comment from Richard on this but I do get the impression that he is for maximising tax take as a worthy end in itself. I am with Jask above who amply pays his/her taxes in UK and US. Do we not have a right to expect restraint in public spending as a counterweight to tax justice. “Justice” here seems to mean soak the talented and entrepreneurial to spend on any passing fancy with no regard to the dubious net gains to society. The existence of hundreds of costly, pointless, interfering quangos just as one example attests to this. Governments, particularly of the left, always think they know how to spend OUR money better that we do. They are usually wrong.
@Jask
Jask
I too have built companies
But you want to claim you did it all yourself
Sorry, you didn’t
You relied oin the law to give you a company as a legal entity
And the law to uphold your property right
And the state educated and medicated and insured your employees if you went wrong
And a lot of your custom, direct or indirect came from government spending
So you worked hard – I don’t deny it. Good. Well done. So have I. But the reward is not yours alone. You owe for the fact that you built on the shoulders of many, many others. That owing is settled in tax
So please don’t be so ego-centric. Open your eyes and say thanks to those who pout you in your very comfortable position, socially and fiancially
Just as I do
Richard
[…] blogger who likes to think he can answer all objections with reference to neo-liberal economics, challenged some of the assumptions in the Compass tax report, with reference to the Laffer […]
Surely the crux of it all is that people will in general pay tax rates that they think are fair. There will always be people at all points on the income scale who seek to fiddle the system: from the very wealthy with complex and possibly illegal schemes to those who accept payment in cash, those who buy ciggies from friends and those who systematically do benefit fraud. But I believe most people try to do the right thing most of the time.
The question is simply: will raising tax on the wealthy 10% cause many of them to leave the UK. And having visited the UK recently, and spent 5 hours on the M5 while repairs took place to a “worn-out” road, I wouldn’t be sure that the allure of the UK is that great. From what I can see, the taxes you pay in the UK simply do not provide the levels of healthcare, education or infrastructure that you would get in France or Germany.
And when people think about what is a fair amount of tax to pay, that is what they look at. How much do I pay and what do I get. And it is the failure of successive governments to deliver on the “what do I get” side of the equation that makes people wonder whether what they pay is fair.
@Richard Murphy
Really, that doesn’t rate as an answer does it. I already said that I have paid my taxes, and without a quibble. The state has had more than enough of my money, and it proceeds to prodigiously waste that money at every opportunity – but I was clearly making a different point above, not the one you seem to have answered. In fact my custom almost wholly originates outside of the UK, mostly in the USA – so in fact I am earning a lot of money for the UK but the UK hasn’t done much for it.
The point I was making, that has passed you by, is that if you tax people like me to the n’th degree then we are likely to do something about it. Your seeming authoritarian view is that you can close every loophole and make life as difficult as possible for people like me and everything will carry on as before – in my view it won’t. Buy hey! I don’t know most of the people you are proposing to harshly tax so maybe they aren’t like me at all – but then, I suspect you don’t know most of them either. That was my point.
My secondary point is that talented and hard-working British people won’t even try to build a business that will eventually employ lots of people and make money for this country – what would be the point? People don’t work for the state, they work for themselves and their families. Perhaps your ideology blinds you to the real reasons people work so hard to succeed. I don’t know you so I can’t say what your motivations are but if you had built companies as you say you have then you wouldn’t in my view write the things that you write.
Is it ego-centric to believe that my knowledge and labour are my own, and don’t belong to the state? I haven’t said that people like my shouldn’t pay tax, or that we should pay less tax – but clearly you believe that the sweat of my brow should be wholly rendered to Caesar. If 40% + NI + business taxes and everything else aren’t my fair share then all I can say is that you are wrong and your proposals if ever enacted would finish this country as an economic power. I’m sure you have a different view so lets leave it there and agree to disagree.
Richard #14
“So have I. But the reward is not yours alone. You owe for the fact that you built on the shoulders of many, many others. That owing is settled in tax.”
The building is usualy with staff and backers who are rewarded via salary and benefits (maybe even equity) or interest on capital support. “The country” per se is marginal to that building of an enterprise, and so taxation by the state is, and always has been, something that any democrat should be keen to study and debate: both absolutely and in terms of rates etc.
The Girrl
I wonder what a world full of these hard working self-made entrepreneurial types (a separate factor of production according to some economists) would be like?
I deleted a great many comments on this blog this evening
They were either a) rude b) incoherent c) did not add to debate or were d) rants
Others felt like paid for commentary
And I’m really not interested in any of them
@mad foetus
Mad – a few – the weak, the deluded, the unwise (you) – will leave, of course
The wise won’t
No loss
Those who go self-select themselves as dispensable
Like you – doing a worthless job
Richard
Richard,
I didn’t leave the UK – I went to university and law school there then came back to Jersey.
But you are correct in implying that anybody who leaves Britain solely because of tax is, to say the least, misguided. My point is that these days people choose where to live on a variety of factors of which economic well being is just one. Climate, infrastructure, closeness to friends and family. an unspoiled environment, social cohesion – in fact many of the things that you believe that tax justice could better achieve should all play an important role in that decision. And my point is simply that on those measures many other countries are doing better.
And of course those who are higher earners are well travelled – the idea of living somewhere else doesn’t frighten people anymore.
But I don’t think you would disagree with my basic point, which is that the majority of people will not object to paying higher taxes if they feel the taxes are fairly imposed and sensibly spent. While it seems self-evident to you and Polly that all public spending is good, I think you’ll find the public itself isn’t convinced.
But of course you are correct that people like the Barclay brothers – holed up in a castle on a remote Island because they wont pay taxes – are really below contempt.
@Carol Wilcox
#18
Carol
Presumably just like Britain before the industrial revolution?
The Girrl
@Jersey Girrl
How can that be? Who will work for these superior beings – trained monkeys?
Personally I closed my company in the UK in March of this year. I had an epiphany while travelling on business and realised how much harder it was becoming to compete. Since moving out of Britain in March and reconstructing my business in Macedonia I have effectively doubled my client base as I am able to compete much more effectively with my traditional competition who are still based in the US and UK. Personally I had no desire to leave my home in the UK but it became increasingly obvious how much of my efforts were actually funding other people in a way I consider disproportionate. Personally I refused to be penalised for working harder, longer and with the passion required to run a successful small business. Running a successful small business in the UK these days is extremely difficult ( and I was one of the fortunate ones not beholden to my bank). Why discourage entrepenurial spirit even further.?
Simon
Good luck
But it does not stop me thinking you have just about every priority in your life wrong
But that’s your choice
Few will share it
Richard
Many thanks for the kind thought Richard.
I strongly disagree with your comment about many others not sharing my point of view though. The department of industry seems to think that Brits are one of the most likely people to leave their country of origin in all of Europe. In my own small way I am benefitting from that. In December I had another 20 guests over from the UK looking to take money out of the UK and (potentially) invest here.
My former friends and colleagues all had senior positions in IT only 12 months ago. Most were in the countries top 5% in terms of earnings. However, the job market in the IT industry in the UK has shrunk by 37% consistently for the last 2 years. We have all been involved in outsourcing great chunks of our former Corporate overlords businesses to other countries (predominantly India). My reasons for leaving were not business related alone. My wife became pregnant and we wanted to bring up our child somewhere with a more family oriented culture so this was also a key factor. Divorce here is tiny and young people have a very different attitude in general which I believe is part of this. A friend that is currently staying with me from the UK has only been here twice for 2 weeks and he is so impressed with the quality of life Brits can achieve here that he has already started looking for land. The administrative burden on his construction business imposed by the inland revenue bought him close to a nervous breakdown until he won his court case at the end of last year and he wants to go somewhere where small businesses recieve focus and support. For a wide variety of reasons including those above, I must heartily disagree with you as much as I appreciate your kind sentinment. All the best for the New Year.
Simon
That sounds like a nostalgic description of Guernsey from older folk I am in regular conversation with as part of my day-to-day.
As a by product of your success will be business structure imitation, it becomes a socially responsible must that you attempt to maintain the abstract attributes of your home jurisdiction which attracted you in the first instance.
I don’t see much co-operative humility from the business folk in Guernsey.