Why the 50p Tax Rate is a bad idea.

And then the Labour party looked like losing the election. And in casting about for land-mines to leave behind (something Tory administrations don’t do, incidentally…) Labour, in their last budget raised the top rate to 50p on income over £150,000 and, in a nasty, spiteful little measure, cut the tax-free allowance progressively on people earning over £100,000. The top marginal rate of tax therefore, on incomes between £100,000 and £116,000 was 60%. And simply so that Labour could have an attack line on “Tory tax-cuts for the rich while they cut services”.  They did the same trick with 90-day detention. The sheer, naked, abusive, corrupt and transparent timing of this measure takes my breath away and how they’re not excoriated in the media for it is beyond me.

Labour, however were overjoyed. They finally got their wish that a Labour government would soak the rich “until the pips squeaked”.

The trouble is, it didn’t work. The rich, you see aren’t very often on Pay As You Earn, so changing tax rates isn’t a simple matter of altering a number in a spreadsheet. The highly paid are very often in control of the exact mechanism of payment. Either as contractors, self-employed in some way, or business owners. They often have multiple income streams. There are many ways to choose the tax-year in which you declare your earnings or whether to take it as capital gain or income, or as many people I know, simply take less pay “so the buggers don’t get it”. They can increase pension contributions or invest in another business. 

All people paying the higher rate have to submit a tax-return and therefore probably have an accountant who will advise them on their options. None of this is illegal, or even contrary to the spirit of legislation, and certainly not “tax avoidance”. All you have done is taken a situation where it didn’t really pay to make a great deal of effort about the tax affairs, to one in which it did because one form of tax is so far out of whack with the rest. And so the 50p tax raised a great deal less than the £3bn expected.

I’m making no great claims about the money raised or not by this measure. The 50p rate probably raised a bit more money than had it not been introduced, at least in the short run, but not much (less than the £3bn promised). And Dropping the rate to 45% almost certainly reduced the amount raised compared to the status quo ante, but again, in the short-run, and by negligible amounts. 

In the longer run though the evidence appears clear. The revenue maximising rate is somewhere between 40% and 50%. A 50p rate is probably nudging into the downward-sloping end of the curve and this is mainly due to investment and incentive effects. It simply becomes less worthwhile, at the margin, to make the effort to get beyond £150k when the Government takes over half. And so fewer people do, many that do will shift earnings over time to less punitive jurisdictions. UK subsidiaries will be shut, or not started in the first place and the economy suffers. Business might still get done, it just won’t be done by people taxed here. It suffers not because an extra 10% of earnings over £150k is a lot of money, but because you’re attacking the people who make the decisions.

Ultimately the mechanism by which the right-hand side of the Laffer curve works is by shrinking the pie, not just for the rich who pay the taxes, but for everyone.

It boils down to this simple statement: a higher rate of 40% is accepted by those who pay it. One of 50% is not. And the people who pay it have options. But it is economically damaging beyond the simple effect on the Exchequer’s bottom line, because those who are going to be forced to pay it feel it’s vindictive. They are really, really angry about it. And for this reason, the economic and social rationale needs to be a bit better than the “Because crisis. Bankers. FUCK YOU, That’s why” that seems to underpin the Labour thinking. 

Not having any sympathy for someone on £250k a year means not having any sympathy for someone who writes a cheque for £92,627 (39%) to pay for nurses teachers and doctors. You think they should pay £102,367 (41%) instead. And if a number of them walk, to Monaco, Geneva, New York, Spain or wherever, instead of “driving them to the airport“, consider where the £92,627 they’d have paid willingly will now come from. That’s before you consider the VAT, CGT, NICs and so forth that “wanker” you’re wishing would just “fuck off” would have contributed.

This is a transparently chippy little bit of class war bullshit that will risk more damage than is worth the paltry sums it might optimistically raise. In supporting it, you’re revealing yourself to be a spiteful, economically ignorant Jack Spart, who is motivated by envy, not a desire to get the deficit down. 

Ultimately the chorus of business leaders making this point will damage Labour’s economic credibility even further, even as a grumpy electorate tells the pollsters they like the policy. The economic recovery is happening. People will not want to risk this over the next 15 months. This is set to become Labour’s new clause IV. It will not form part of the manifesto of the next Labour government.