September 7, 2011 9:43 pm

Q&A: The 50p tax debate

What is the evidence to suggest that the 50p tax rate should be scrapped?

The 20 high profile economists who voiced their fears about the “lasting damage” that the 50p tax rate would inflict on the UK economy were unable to point to an exodus of entrepreneurs and talented workers when they made their case.

Bridget Rosewell, chairman of Volterra Consulting, who organised the letter, said that there was very little evidence yet to demonstrate a harmful effect from the 50p top rate of tax. But she said her opposition stemmed from a calculation of risks. “There is a serious risk we’re putting off the people we need to get in there, take some risks and make some money,” she said.

DeAnne Julius, a former member of the Bank of England’s monetary policy committee and one of the signatories of the FT letter, pointed to the shift of many hedge funds to Geneva in support of her arguments but added that other moves might not yet be apparent. “People don’t just pull up roots and leave immediately. They think about it“, she told the BBC.

In spite of the political clamour over the 50p rate, there has been little new evidence about its impact since its introduction in April 2010. Paul Johnson, director of the Institute for Fiscal Studies, the independent think tank, highlighted a survey that indicated that individuals, particularly the self employed, were bringing forward incomes to the year before the 50p rate started. Other than that, he said “I am not aware we’ve got any more evidence now than when the thing [50p rate] was first mooted”.

More will be known after tax returns are filed next January. Officials are likely to assess the impact of the tax changes by comparing changes in the income share of the wealthiest 1 per cent – those affected by the 50p rate – with those of slightly less wealthy groups.

How do the very rich tend to respond to tax changes?

Until the new evidence emerges, officials have been forced to rely on historical data to calculate the likely impact of the 50p rate. They have gone back to tax cuts unveiled by the Thatcher administration which took the highest marginal income tax rate on earned income from 83 per cent in 1978 to just 40 per cent a decade later . They have also examined research based on the big falls in top marginal rates under presidents Ronald Reagan in 1981 and 1986 and George W. Bush in 2001 and 2003.

After these cuts the taxpayers who enjoyed the biggest cut in their rates often reported the biggest increases in income in the following years. The findings have been widely seen as evidence that lowering tax rates for the rich boosts the economy, perhaps by attracting more individuals to the country, creating an incentive for them to work harder or put less effort into tax planning.

Yet other factors such as globalisation and the liberalisation of the financial services industry also played a part. Critics argue that tax cuts for high income taxpayers created windfalls for those whose incomes were already rising sharply because of broader market forces. In Britain, the income share of the richest 1 per cent kept on increasing since 1988 even though the tax rate remained constant, according to the IFS.

What other options might there be for extracting more revenue from the rich?

For many economists, including influential commentators at the Paris-based Organisation for Economic Co-operation and Development, higher property taxes are less distortive – and so inflict less economic damage – than higher income taxes. So the higher property taxes for the wealthy being mulled by the government as an alternative to the 50p rate would be likely to be endorsed by some high-profile experts.

In principle, the mansion tax – a 1 per cent annual levy on the amount by which a property’s value exceeds £2m – would be almost enough to replace the 50p rate. This idea, included in the Liberal Democrat manifesto last year, was billed to raise £1.7bn a year - a figure that the IFS said was plausible.

But the idea appalled many Conservatives, who have also made it clear there is no chance of a revaluation of properties for Council Tax.

If high-end property taxes are rejected the coalition would struggle to find a way to replace the income from the 50p rate – if, that is, it turns out to be a sizable money raiser after all.

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