John Redwood was on Question Time last night - saying he wanted to tax the rich more and the only way to do so was to cut tax rates to below 40%.
He was, of course, quoting from Laffer curve theory that is much beloved on the far-right as it was designed to support their greed. It does not, as Left Foot Forward noted yesterday, have evidential support at current UK tax rates. I'll quote LFF, in the interests of getting things done today, but just wish Rachel Reeves would have pointed out this nonsense last night:
500 “business leaders” have written a letter to the Telegraph today, encouraging George Osborne to drop the 50p tax rate. The letter is short — dwarfed by the list of names — and doesn't really attempt to make much of an argument.
Their main claim is that:
The 50p tax is set to reduce government income, and damages the economy, the public services and charitable giving.
This claim is hard to back up with empirical evidence. As we reported last month, the HMRC'sbest estimate is that :
The first year of [the tax rate's] introduction led to a “surge” in revenues of hundreds of millions of pounds.
Without data to support it, the signatories have had to resort to trotting out discredited economic theories when they have defended their letter on TV and radio. The phrase of the day is “Laffer Curve”.
The Laffer Curve is a concept coined by the economist Andrew Laffer which adds one and one and one and makes three million. It begins with three ‘common sense' claims:
- At an income tax rate of 0 per cent, the income tax revenue will be £0, because no tax will be taken in.
- At an income tax rate of 100 per cent, the income tax revenue will be £0, because no one would do any work if they didn't get paid.
- Somewhere between 0 per cent and 100 per cent is a tax rate which maximises income tax revenue.
From this, Andrew Arthur Laffer and the signatories of todays letter draw the conclusion that cutting income tax will encourage people to work harder, and increase revenue.
Unfortunately for them, we now know where on the curve revenue is maximised — and it's pretty far away from 50 per cent.
As Matt Yglesias writes:
Christina Romer and David Romer have a new paper looking at evidence from the 1920s and 1930s and find that the revenue-maximizing rate on the highest earners is extremely high–over eighty percent.
Among the top 0.05 percent of the income distribution they find an elasticity of taxable income of 0.19 percent which implies “that tax revenues would be maximized with a tax rate of 84 percent; that is, you could raise taxes up to 84 percent before people's reduced incentives to make money would compensate for the higher tax rates.”
Other economists put the peak closer to 76 per cent.
Either way, if you want to maximise revenue, the 50p tax rate is about 25p too low. The Institute of Directors may want to think twice before bringing up the Laffer Curve in support of tax cuts any time soon.
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i found it a very strange QT last night to be honest, the quality of the panel was highly questionable (which seemed also to be the view of the vast majority on the QT twitter feed).
I am sure HMRC know how much tax has been generated as a result of the 50% rate coming in and it would be nice if they told us so that all this speculation can end (the link you provide to LFF is again nothing more than speculation).
I agree with the Laffer curve in principle ie at its extremes of 0% and 100% but its not clear to me where the optimal position is. Linking to a study based on tax take during the 1920’s and 1930’s is clearly ridiculous given the ease of international travel and remote working options that are now available compared to then.
Has anyone updated this study for todays (or at least a vaguely modern) working environment do you know?
Current studies also say about 70% – most recent in US last year
QT was dire
So the Laffer Curve does exist then? You have suggested about 70%. But you acknowledge its existence.
Look – it’s obviously true at 0% there is no tax
And at 100% there’s something different from tax
But to assume that in practice Laffer has any use whatsoever is another matter altogether
That’s your mistake
And a massive one at that
Unlike SteveT I don’t even agree with the Laffer curve in principle, ie at its extremes of 0% and 100%.
A 0% tax rate will certainly not produce any revenue, but it is simply not true that a 100% rate would do likewise. Vast numbers of people work for charities (and for their families) with no expectations of financial reward.
It may seem an academic point, but the Laffer curve is usually drawn as an upright semicircle, and it just looks “natural” that the maximum tax take is at 50%. A recognition that some people would choose to work at a 100% tax take would mean that the Laffer curve would be skewed to the right in the way Richard Murphy has drawn it above, with a peak between 70% and 80%.
As a technical question, when in a liquidity trap you don’t alter the tax take until you have used enough fiscal stimulus to get traction back on interest rate setting. But as we have a government that doesn’t do stimulus, it seems another round of ‘old’ liberal versus ‘new’ liberal tug of war over the higher tax rate is inevitable. I note also that Laurence Ball has just published a paper on why Bernanke knew how to deal with the zero lower bound in the early 2000s and seemingly now has forgotten, ‘BEN BERNANKE AND THE ZERO BOUND’.
I kind of agree with you, however, in the real scheme of things, with NIC running at just over 20% and VAT at 20%, the myriad of other taxes on petrol, fags, booze, heating oil/ gas (all plus VAT), airport useage, council rates, water rates, “green” taxes, etc. etc. etc. the uk public is already being taxed beyond the 76% peak.
Respectfully: stop being either ignorant or silly.
UK tax take is about 45%
I imagine he is talking about 50% tax payers plus all the indirect taxes that can be taken into consideration as you well know.
Stop your usual “So what” and answer the question!
I have – let’s be clear 50% only really applies at incomes of £1 million as an overall rate
So shall we get real?
45%? In most people’s dreams. You are having a Laff!
If the uk overall tax rate was that low you would have Switzerland and Monaco on their knees.
Shall we deal in facts?
If you can’t – don’t call again
Zaphod: It’s amazing the number of people who debate this without understanding how the tax system actually works.
You have to understand the difference between effective and marginal tax rates. Going into a new tax band doesn’t mean that you immediately pay that rate on your whole salary. Only the amount paid over the lower limit for that band is charged at that band’s rate.
Worked examples: someone paid £50,000, with standard allowances (no credits or taxable benefits) pays:
Nothing on their first £7,475 of earnings;
20% of the next £35,000 = £7,000;
40% of the remaining £7,525 = £3,010
Total paid £10,010, effective rate 20.02%
Someone paid over £100,000 loses their personal allowance. At £100,000 the tax paid is £30,010 (30.01%) while at £100,001 it is £33,000.40 or a little over 33%. At £200k it’s then £7K for the first £35K, £46K for the next £115K, and 50% of £50K = £25K, for a total of £78K, 39% rate. Plugging the numbers into a spreadsheet, you can see that an effective tax rate of 40% is only reached at £220,000. As salaries go up and up, the effective rate nears 50% but can never actually reach it.
National Insurance contributions by an employee are similar to income tax but with weird marginal rates: 0% below £139 per week (£7,228 per year), 12% between £139 and £817 per week (£42,484), then 2% on earnings over £817 per week. The effective rate reaches a peak of 10.2% at that upper limit, then trends *down* towards 2% as the amount above the Upper Earnings Threshold starts to outweigh the amount below it. At £1M the effective rate is 2.35%.
Other taxes are dependent on your consumption of those items. It’s a general principle that those earning more tend to put more of their income towards saving (in whatever form, such as acquiring shares) than towards direct expenditure (particularly purchasing of consumables). Those on the poverty line spend all their income and save nothing, making – again – their effective rate far higher than those who mostly save.
It might be instructive to go through the baskets used to calculate the national Living Wage at http://www.minimumincomestandard.org/ and figure out what proportion of taxes apply to each line in the calculation, but I don’t have time to do a proper analysis right now. Estimating food at 5% (because only premium items have VAT at 20%), alcohol and tobacco at 25% , and allocating others at the appropriate rate of VAT or specific taxes (water rates are zero-rated, rent is not taxed, insurance premiums at 6%, fuel VAT rate is 5%, council tax is all tax at 100%) gives about 16.2%, for a single person.
I saw the beginning but had to turn over very quickly so I’d like to ask you a question: did Rachel Reeves not pick up on this Laffer curve nonsense? It would be so very disappointing if she did not.
No, she didn’t. Stuck to repeating again and again the Labour script and did not address the issues
Rachel Reeves was frankly awful on the panel – but actually so were the rest of the panel. Starkey is a complete nutcase and im frankly surprised the BBC give him airtime.
This is why I have stopped watching Question Time – only the celebs might say something that is off the script, but they usually have nothing more to say than the ordinary man in the street.
Carol
You attended the Fabian Conference and Rachel Reeves was on one of the panels and frankly I thought she was rather hopeless, Yes she could criticise but she did not seem to have any ideas of her own. Did she not work for the Treasury, if so then she is probably steeped in neoliberalism. Labour needs a new economic narrative and on present form this will be impossible to construct.
Yes, Teresa. I had seen her a couple of times on TV and thought she was a sharp cookie. But since then I’ve revised my opinion.
Interesting assumptions.
Particularly
“At an income tax rate of 100 per cent, the income tax revenue will be £0, because no one would do any work if they didn’t get paid.”
It would be a poor outlook for charities and a myriad of non profit organisations worldwide of no one ever volunteered their labour because they weren’t being paid.
And Human nature being what it is (and neo-liberals never take this into account), a lot of people would do stuff anyway simply for the challenge, out of curiosity or to alleviate boredom.
So, once you challenge assumptions like this, you can see the whole Laffer theory is built on intellectual sand.
Not to mention workfare. But that is in another part of the forest, presumably
So Mr Redwood will be voting against his government’s reduction in tax credits which increase the marginal tax rates for many of the less well off with families to 73% – somehow I doubt it – but then tax credits only affect the poor which are a different species in his party’s eyes.
Talking of the original and not so original ways the well off argue for a reduction in tax rates has anyone noticed the now annual recurrence of the rise in petrol pump prices so as to encourage a reduction in duties which will not be matched by a reduction in pump prices but will fatten the oil company profits further. All of those who say it is all driven by the markets – perhaps should remember that energy markets far from being proper markets driven by supply and demand, actaully only handle a very small proportion of physical trades and are rather easily manipulated by the oil companies and hedge funds – hence their volatility and ease of manipulation by big players. I’m afraid oil company executives are just bankers who haven’t yet been rumbled.
Perhaps those who actually believe in what Redwood says might like to explain why Sweden which historically has some of the highest average and marginal tax rates also has one of the best records for long term economic growth, even though it has little in the way of natural resources.
Actually – it’s just about the only place also where some evidence of Laffer at work may have been found
But only just!
This might be seen as evidence that you should go to Laffer limit in order to promote economic growth (ceteris paribus). Perhaps the high marginal tax rates have the effect of discouraging economic undesirables such as casino bankers – Sweden certainly avoided the worst of the banking crisis.
I really have to endorse the consensus on Rachel Reeves last night. Rabbit in headlights seemed to sum her up. My heart sank when I saw the line up. Redwood and Starkey were batting for the right. The LibDem is well a LibDem who can’t be too critical of anything Tory these days.
Clark Carlisle is a sensible fellow but a bit lightweight on the politics/economics. His comment regards ‘listening to business leaders’ and not the ‘wrong ones’ threw me a bit. He seemed to be agreeing that the 50% rate should go. I presumed he was referring to the Telegraph letter of the 500. Which just left Reeves so it looked like a walkover for the right on paper and so it proved. Listening to Starkey on GP’s was bad enough but he enthusiatically endorsed the Laffer nonsense by referring to the ‘Lawson boom’ in the eighties [tax cuts followed by increased tax take]. Never mind that the economy was already growing strongly from the the depths of a savage recession well before Lawson’s 1986 tax cuts, and that it was growing was due in large part to big falls in interest rates and a resulting housing boom. It ultimately ended in a bust in the late eighties/90’s and 15% mortgage rates. Hoorah for Starkey who must be suffering from amnesia [unfortunate for an historian]
But where was Reeves who obviously knows nothing of economic history or the Thatcher years? Surely if she’s at the Treasury that should be no problem for her? I guess that one good reason why she didn’t want to get into the 50% rate too much was that even Labour regard it as an expedient measure for emergency purposes only, so there wasn’t a single powerful proponent for the 50% rate as a result.
Woeful casting by the Beeb.
The rate of tax is a partial red herring. Tax is cultural not just arithmetical. If tax legislation and enforcement is poor and/or the tax paying population is not compliant, increasing rates of tax are like whistling in the wind. The Laffer curves applies not just as a function of whether one works harder or not, but on one’s attitudes to being taxed.
I suspect that is much more important
indeed – greece is an excellent example of a common culture towards taxation……the wrong sort obviously
Very good point about effective and marginal rates, I would add a robust general anti avoidance rule and a merging of NI and PAYE would help to make the simpler and more transparent.
Perhaps we need a publicly available spreadsheet showing that for NI/PAYE in a simple way.
Wage £, Paye £, NI ee £ Effective tax rate, Marginal rate with a nice graph or similar.
One thing you might find interesting. During the Eisenhower administration in the US in the 1950s. The top tax rate for wealthy Americans was 91%. By the early 70s under Nixon it was 70%. It has since fallen to 35% after being cut by Reagan and Bush.
Now remind me of how awful life was in depression hit 1950s and 60s America again!
http://politics.gather.com/viewArticle.action?articleId=281474977623449
The so-called “Laffer Curve”, which reckons that tax cuts put more money into people’s pockets and hence stimulates the economy, has no empirical evidence to back it up.
If the government were to cut corporation tax as suggested here, that is lost revenue to the government….as is all tax cuts!
How do people presume the government recoups these lost funds? Be it a sell-off of national assets, cutbacks of public services, tax rises elsewhere in the economy or added to the deficit, one way or another, you are paying for that tax cut!