Wednesday, 21 September 2011

Should we squeeze the rich or leave them alone?

Before we address the heated question of tax policy and the super rich, let is start with a question......

In fiscal year 2010-11 how many people in Britain earned more than £1 million a year? Before you answer, here are three background facts. First, there are 31.5 million income tax payers in the UK. Second, their total tax liability was £159 billion. Third, the average nnual payment for all tax payers was £5,220.

So what is your answer? Well, according to the Office of National Statistics, the number is just 13,000. Their tax liability, on the other hand, was a little more impressive. Again, in 2011, it amounted to little over £12 billion. A tidy little sum, but still only a fraction of the total economy-wide income tax liability.

What does this tell us about tax policy? Should the Chancellor squeeze these big earners with a higher income tax rate? Or should we leave them alone?

It is this group that the leftists have in mind when they proffer a “soak the rich” alternative to austerity. The argument is by taxing this miniscule minority of super rich, we can pay for a first-class health service, a generous benefit system and ample subsidies for climate friendly start ups. The Right, on the other hand, counter that these are the wealth creators. If the rich are overtaxed, incentives are blunted, and ultimately economic growth is diminished. If the tax rate is really punitive, the super rich will pack up and go, leaving Chelsea and Kensington to be reclaimed by Chavs.

Neither of these arguments are terribly convincing. Even if the rich were taxed at the rate of 100 percent, the UK would still have an unpleasantly large fiscal deficit. While the rich earn telephone number salaries, there aren't enough of them to cover the difference between government expenditure and tax revenues.

As for the incentives argument, the vast majority of these super earners are working in the financial sector. The staggering growth of the banks and other financial institutions certainly contributed generously to UK GDP prior to 2007. Once the crash was underway, the costs of the bail out and the repression have meant that the UK economy gave back everything it gained from finance during the heady days before Northern Rock and Lehman. Moreover, the household and corporate sectors are now deleveraging massively. As the financial sector shrinks, consumption and investment will be constrained. The financial sector will impose a terrible burden that could weigh upon GDP growth prospects for at least a decade.

So, taxing the rich will not solve our problems, but neither will it make them any worse. The UK's fiscal difficulties are much more intractable. Rather than start with unhelpful rhetoric about the rich, it is more useful to think about the size of government. Currently, government expenditure is almost half of GDP. Taxation also claims a fearful amount of national output, but it's more in the region of 40 percent of GDP. In other words, public expenditure is massive, the tax burden is oppressive, and we still can't balance the books.

Prior to the crisis, the headline numbers didn't look quite so bad. However, dig into the details and we quickly find some deeply disturbing trends.

On the expenditure side, health and education spending were growing alarmingly. On the tax side, revenues became heavily dependent on financial services, asset price growth, and housing transactions. This vulnerability became painfully evident as soon as the financial crisis began. From the autumn of 2007 onwards, tax revenues fell down a dark hole. That tax revenue model isn't coming back any time soon.

Does the UK public want a government that spends half of national output? Overall, it appears that they do, especially when one considers that it was health care, pensions, and education that drove the public expenditure to GDP ratio upwards to 50 percent. Is the public prepared to allocate 50 percent of national income to taxation? Unfortunately, the answer seems to be no. We want the services but we don't want to pay for them.

This is why discussions about tax policy have homed in on the 50 percent tax rate for the rich. If the rate goes up or down or stays where it is, it won't seriously affect fiscal outcomes. It is a phony war; a largely irrelevant discussion that neatly avoids addressing the deeper and more painful issues. What should be the optimal size of government? And are we really serious about paying for public services in a sustainable way?


Found A Voice said...

Interesting post, but why did you start at 1m GBP?

I believe that the 50% rate debated would apply to a much lower 'super rich' income - probably 250k p.a.. This might change the basis of your argument somewhat.

Also, I was a *just* 40% taxpayer (plus the 12% NI, and 20% VAT on spending) and I left the UK this year for a more liberal tax regime. My example is not uncommon and the brain drain / wealth drain starts much lower than 1m GBP.


Jim said...

It occurs to me that if there are only 13000 people who earn over £1m (incidentally does that include the self employed?) we are quite dependent on football for tax revenue. There are 20 Premier league clubs, and each club has at least 25 players per squad. £1m/year is less than £20k/week, and I should think 99% of Premiership players earn more than that. So thats 500 £1m+ earners right there. Add in some clubs in the Championship will also have some star players who earn £20K/week, and you're looking at perhaps 5% of all the super rich coming from the football industry alone.

Perhaps the Government should stop harassing football fans and treating them like animals, and start encouraging them to go to games, in order to maintain this vital revenue stream!

Anonymous said...

You say that we want the services but don't want to pay for them. There are many "services" that I neither want nor want to pay for. The EU springs immediately to mind, with an annual cost circa £20billion to £65billion, depending upon how you like to calculate. Then there are other minor political "must haves" like useless, irrelevant and unnecessary wars, quangos (which are reputed to make nice bonfires), lots and lots of lovely shiny new rules and regulations.

If we could insist that our governments spent no more than their tax income (except at times of national emergency), perhaps life would be better. Failure to do so to result in a general election.

A David

Electro-Kevin said...

To label all £150k plus earners as 'wealth creators' is a generalisation. Some are. Many are leeches like those in charge of pension funds or the bankers who have just wrecked us.

Some are not remotely wealth creators at all - like senior police officers.

On the other hand many in the 40% tax band are genuine wealth creators whose innovative ideas are essential to entrepreneurs. "What beats me is that I employ these people and not the other way around" Felix Dennis - to that effect.

My guess is this (and I'm all for people being rich and successful to the mutual benefit of Britain):

Our country could run reasonably well with just the working and middle classes left in place.

It couldn't run at all with the super rich and underclass left alone. In fact I'd love to try it.

The real trouble starts when we begin to lose key 40% tax paying workers whose skills are the most essential to the running of society.

Their pips are squeaking right now. This will be a disaster when the lights start to go out and there's no-one left to fix them.

Mark Wadsworth said...

We should do neither.

Income tax, bad tax.

Land Value Tax is far better, it's like a poll tax on housing, if you want to live somewhere nice, then cough up. The fact is, if you want to move somewhere nice, you've got to pay more anyway, so why does it make a difference if we cut income tax and increase taxes on land values? Does it matter whether you pay rent to a landlord or pay it to the government?

Electro-Kevin said...
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