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Leading economists today argue that the 50p rate of tax for the top earners is failing to raise money and stunting wealth generation, amid a fierce coalition row over whether to scrap it. In a new series fact checking the biggest stories of the day, Polly Curtis investigates the revenue raising powers of the highest taxes. Email polly.curtis@guardian.co.uk or contact her on Twitter @pollycurtis
11.02am: Twenty leading economists today urge George Osborne to drop the 50p tax rate for people earning above £150,000 arguing that it is making the UK less competitive and failing to raise significant sums. Reality check asks: how much does the 50p rate raise? Please do get in touch below the line, email polly.curtis@guardian.co.uk or via Twitter @pollycurtis and let me know what evidence you've found.
The claim
The economists write in their letter to the FT:
If a small portion of these highly mobile workers move elsewhere because of the 50p rate then it is clearly a self-defeating way for the Treasury to try to raise money, and a reduction in tax avoidance would be more effective. It is often portrayed as a justified tax on the rich but the economic damage it causes means that it is against the interests even of ordinary workers who don't pay it.
The evidenceTreasury projections in the pre-budget report in 2008 and budget in 2009 suggested that increasing the top rate from 40 to 50p in the pound would raise £2.4bn a year but that only 30% - £750m - of that revenue would be generated by raising it from 45p to 50p. It's worth considering £750m - by anyone's standards a huge sum - in the context of the overall tax revenues of £153.5bn last year.
But this figure is contested because it depends on speculation of what top earners will do: pay up or pack up and leave the country. The respected Institute for Fiscal Studies has attempted to answer this question and revisits the subject in its newsletter Mirrlees Review next week, draft versions of which are available here (section 4.3.2).
It concludes that there are so many ways for people to avoid tax that it could end up reducing income from the highest earners. It says that people could minimise the amount they pay by:
• Changing the form of their remuneration.
• Contributing more to a pension (maximum of £40bn) or to charity.
•*Converting income into capital gains.
• Setting themselves up as a company.
• Investing in tax avoidance.
• Leaving the country or not coming here in the first place
It concludes:
In fact, it is not clear whether the 50% rate will raise any revenue at all. There are numerous ways in which people might reduce their taxable incomes in response to higher tax rates; at some point, increasing tax rates starts to cost money instead of raising it. The question is, where is that point? Brewer, Saez, and Shephard (2010) addressed precisely this question for the highest-income 1%. Their central estimate is that the taxable income elasticity for this group is 0.46, which implies a revenue-maximizing tax rate on earned income of 56%. This in turn (accounting for NICs and indirect taxes) corresponds to an income tax rate of 40%. So, according to these estimates, the introduction of the 50% rate would actually reduce revenue.
However the paper also cautions that that data was based on behaviour of higher tax rate payers when rates changed in the 1980s and there are a multitude of reasons why this might be different now, not least more sophisticated tax avoidance. Tom Clark, a leader writer at the Guardian who has a keen interest in this area, says that any prediction is fraught with difficulties. He says:
All anyone can do so far is guess. Most people who are rich and pay this rate fill in a tax return and the tax is paid by self-assessment. The deadline will be January coming up for the financial year 2010-11. Only a few months after that will we have real data on how many people have paid how much tax. If it looks like there are as many people on the top earnings as ever, then you can say there is no change. It's too soon to be talking about abolishing when you don't have the evidence.
Duncan Weldon, an economist writing for Comment is free, argued in February that there are early signs that there is some revenue coming in. Public borrowing figures at the beginning of the year showed a surprising surplus. He wrote: We have a mystery – the number of people in work is fairly constant, earnings have only increased by 1.1% and NICs are only up by 4.4% and yet income tax revenues are up by nearly 18%. The most likely explanation is that higher income tax receipts partially represent the new 50p rate kicking in and raising revenue.
Richard Murphy of Tax Research UK, who campaigns for better measures to prevent tax avoidance, says there's no reason to question the Treasury's original estimates of £2.4bn from the cumulative raise from 40 to 50p arguing that most people on the highest earnings earn much larger amounts than £150,000, meaning the lengths they would have to go to to hide their additional earnings would be extraordinary. He says:The only way you can avoid it is by making sure it doesn't go over £150,000. 24% of all income tax is from 328,000 people - 1% of all taxpayers. To prevent paying 50% they have to take drastic steps - it's just not plausible. They've got to reduce taxable incomes below 150k and when you think of Bob Diamond's millions it's just not feasible.
ConclusionThe Treasury estimated that the increase in the tax rate for people earning in excess of £150,000 from 40p in 2008 to 45p in 2009 and 50p in 2010 would bring in £2.4bn, £750m of which was from the 45-50p change. There is historical evidence that people will try to avoid paying tax at this level and an argument, based on historical trends, that it could in fact cost the country in income tax revenues as people rush to avoid it. However public borrowing figures currently don't bear this out and suggest that income tax receipts have, inexplicably at a time when wages and employment is stagnating, soared suggesting that the highest earners are not going far.
But it's too early to prove or disprove the Treasury's original estimates.
George Osborne has ordered an HMRC investigation to establish how much it has raised amid the furious coalition row over whether to drop it or not. The Treasury confirmed to me that this will report in the spring, most probably just ahead of the budget coming just in time for a decision about whether to scrap it. That will be the first hard evidence of how much it raises as the analysis will follow the January 2012 deadline for 50p taxpayers, who pay via self-assessment, and will include the full sums.
Is there evidence I haven't looked at and should have? Do you work in the tax field and know another way to better estimate the impact of the 50p tax rate? Email polly.curtis@guardian.co.uk or contact me on Twitter <a href="mailto:Twitter </p><p>I'll post later today with any evidence we've found to reach a firmer conclusion.</p><div class="related" style="float: left; margin-right: 10px; margin-bottom: 10px;">
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