Shifting justifications for the 50p tax rate

It’s often said that modern day politicians lack conviction – that is, they are afraid of expressing their firmly held beliefs. This is not universally true, of course. But one of the consequences of the so-called ‘end of ideology’, the Third Way politics of Blair and Cameron’s ‘modernisation’ agenda has been the reluctance of politicians to state any of their opinions in a non-technocratic way. They are all, of course, just seeking to do ‘what works’ or enacting ‘evidence based policy’. Heaven forbid that anyone has a dreaded ‘ideology’ informing their choices.

In reality, of course, often without realising it or being willing to acknowledge it, politicians seek to impose their moral outlook and belief system on us. This is seen in what they consider ‘problems’ and the role of government they assume in ‘dealing with them’. Harvard professor Greg Mankiw, for example, recently explained that ‘Economists who discuss policy responses to increasing inequality are often playing the role of amateur philosopher’. Classical liberals, for example, might only be concerned with inequality to the extent that it is reflective of rent-seeking activities and crony capitalism amongst a sub-section of the population, and will advocate less government as a means of dealing with it. Socialists on the other hand might consider inequality per se to be unjust, and advocate highly progressive taxation and redistribution to try to counter it.

In my experience, in mainstream politics those with a classical liberal outlook tend to be more honest about their priors than those with socialistic instincts. This is seen most obviously in the inequality debate where the unjustness of inequality is often taken as given, without justification. But a similar phenomenon can be observed in the discussion surrounding the 50p tax rate, not least in Ed Balls’ torturous interview with Jeremy Paxman on Newsnight.

See, the Shadow Chancellor wants us to believe that his call for the reinstatement of the 50p marginal tax rate is a purely pragmatic move to raise additional revenues to reduce the deficit. Hence why the Shadow Business Secretary Chuka Umunna insists this would be a temporary measure until the fiscal deficit had been eliminated. Leaving aside that there’s no iron law that revenue from those with the highest incomes has to always be maximised (a judgement call in itself), the problem for Balls and Labour is that there is considerable evidence in theory and practice that the 50p rate won’t raise much money. In fact, it may even reduce the overall yield.

The most recent research by HMRC, and signed off by the Office for Budget Responsibility, suggested that – as a central estimate – the revenue maximising rate for the additional rate of income tax was 48 per cent. Cutting the 50p rate to 45p, as implemented by George Osborne, therefore was only estimated to reduce the exchequer revenues by around £100 million after behavioural effects, including steps to avoid the tax, had been considered. Early indications after the tax was implemented suggested that the behavioural effects might be more significant still. In pure revenue terms, HMRC figures show that in 2011/12 and 2012/13 the amount collected from top income taxpayers was £41.3 billion and £41.6 billion respectively under the 50p rate before jumping to £49.4 billion in 2013/14, when the top rate was cut to 45p.

Of course, much of this may have been due to forestalling of income and other activities based on knowledge of the planned rate changes – but at the very least the ease with which those top rate taxpayers were able to rearrange their tax affairs should put significant doubt in the minds of those who believe that a permanent rate would lead to significant extra revenues.

From an economic perspective, the key assumption in assessing the revenue effects is something called the ‘taxable income elasticity’ – that is how much taxable income changes as the tax rate changes. The economic literature in this area suggests a figure of between 0.4 and 0.7. HMRC’s central estimate uses a figure of 0.45. As the IFS reminds us, there is considerable uncertainty around the true figure here, but with an increasingly mobile high-income class, globalisation and the extent of tax planning, it is well within the realms of possibility that the true responsiveness is higher than the estimate used in the HMRC work, meaning that reinstating the 50p rate could even reduce the tax yield.

At best then, Ed Balls has no idea how much re-establishing a 50p tax rate would raise – and the central view currently held by economists is ‘little to nothing’. Balls’ claim that revenues were higher than expected when the 50p rate was adopted has been refuted strongly by the Institute for Fiscal Studies.

Yet when this is put to the Shadow Chancellor, he changes tack away from his central ‘this is about deficit reduction’ argument and speaks instead of the ‘unfairness’ of the ‘millionaire’s tax cut’ from 50p to 45p. In other words, the mask slips. Whereas he wants us to believe this is about deficit reduction, a current universally accepted aim, faced with inconvenient analysis he shifts to talking about the morality of a higher tax rate for the high paid. The socialistic instincts come out.

The inevitable question, put to Balls by Paxman, is therefore: if fairness is defined by the rate the rich pay, wouldn’t 60p be even fairer? Here Balls tortures himself. On the one hand his New Labour instincts means has to explain that a 60p rate would be self-defeating in revenue terms and against our economic interests. But on the other hand his socialistic instincts are causing him to simply wave away evidence that 50p might be self-defeating and instead claim the 50p rate would be ‘fair’.

Many social democrats admire Rawls’ view that policy should be arranged to maximise the incomes of the least advantaged. This would suggest a tax rate on the rich that is lower than the revenue-maximising rate given that the process of raising tax rates and choking off economic activity will damage the poor. The benefit to the poor of a lower tax rate on the rich is determined both by the extent to which the increase in economic activity benefits the poor and the fiscal cost of lowering the tax rate. If the fiscal cost is close to zero then a reduction in tax rate will benefit the poor and an increase will harm them. In waving away the argument regarding revenue raising and appealing to fairness, the nature of Balls’ understanding of fairness becomes clear. To Balls, the tax system is fairer if it penalises the poor less than it penalises the rich. Making the poor poorer can, indeed, be justified by the Shadow Chancellor as long as the rich are made proportionately poorer still. Envy has become part of the utility function once again.

Ryan, On a point of order, the data on the 50p rate was never conclusive for the reasons you suggest. It was in place for two tax years, meaning that people could bring income forward in year 1 to pay 40% or push it back in year 2 to pay 45%. If Labour introduce it, then it will be interesting to see how much it raises. Toby
Why all this kerfuffle about the 50p rate? The "rich" don;t pay PAYE anyway and it's not even close to teh highest marginal rate anyway which I believe is the ludicrous 62% from 100k to 118k ( which widens out every time the nil rate band is increased. All this is is an attack on th eupper middle class and not the "rich" as the likes of The Guardian would like you to believe.
Mark Littlewood, on Question Time this week also raised the question that Paxman asked Balls: if a 50% top rate of income tax is 'fairer' than a 45% top rate, wouldn't 60% or 70% or more be even 'fairer'? In other words, what are your criteria for fairness? It rather looks as if the Labour leadership would argue that a higher top rate is always, necessarily, 'fairer' -- almost by definition. It seems perfectly possible that a 50% top rate would actually reduce total tax revenues (compared with a 45% rate) -- indeed, a 45% top rate might reduce total tax revenues compared with the 40% rate that was in force for practically all of Labour's 13 years. In that case, some of the tax revenue raised from British taxpayers would be going to finance the Labour Party's notion of 'fairness' -- a price I doubt if many people would willingly agree to pay.

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