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Boris and the 50p rate

    A Lib Dem peer yesterday accused Boris Johnson of "rattling the begging bowl for the starving rich,” following his call for the Chancellor to scrap the 50p rate of income tax in the upcoming budget.

    The exchange between the two pretty much sums up the politics of this controversial tax structure. On the one hand many people see the rate as a fair means whereby the rich can pay their share in the tax hikes and spending cuts agenda. Opponents, meanwhile, claim the rate is being tolerated for political purposes, with little evidence that it is contributing positively in revenue to the Exchequer whilst actively harming growth prospects.

    There is no doubt that the tax competitiveness of an economy has long-term growth impacts. And Boris appears to be correct in being concerned on this front. Although the coalition government has committed itself to a path of staggered reductions in corporation tax rates, international evidence is suggesting that the UK’s tax competitiveness has actually WORSENED since this time last year.

    The UK is now ranked 95th out of 139 countries on the “extent and effect of taxation” by World Economic Forum, compared with a position of 84th of 133 last year.  Likewise, the World Bank estimate of total tax rates for 183 countries around the world show the UK currently ranking 76th, compared to 67th in the previous report.  And although corporation tax cuts have been welcome, OECD data shows that 17 of the 28 richest nations in the world have corporate tax rates lower than the 27% rate of the UK for 2011.

    This evidence suggests that the UK is currently becoming a less competitive place to do business. The 50p tax rate, in turn, makes the UK a less attractive place for richer individuals and businessmen to reside. Given that we all want strong economic growth and the UK to be attractive for business, the argument for the maintenance of the 50p tax rate should therefore rest solely on its revenue-raising power in contributing to the elimination of the budget deficit.

    It is here where the evidence is mixed and/or lacking.Government estimates in the 2009 Budget suggested that the change would raise £2.4 billion per year, whilst the TaxPayer’s Alliance estimate that the rate is actively COSTING the exchequer £4.5 billion per year in lost revenue because of its behavioural effects.

    The real discrepancy in the reporting of the story online has been in the use of the Institute for Fiscal Studies’ analysis. Looking solely at the effect of the change from 40% to 50% based on revenue from income tax, they said:

    “The new 50% income tax rate could increase income tax revenues by about £1 billion compared to…the current 40% rate.”

    This suggested that whilst the government’s projections appeared optimistic at £2.4 billion, the change would be revenue positive.

    BUT, when they factored in that this fall in income would also reduce expenditure – affecting the amount raised by VAT, they said:

    “If the richest 1%...reduce their expenditure by as much as taxable income, the current 40% rate is already generating the maximum government revenue.”

    Concluding:

     “taxing the rich as a source of raising additional revenue does not seem to be a very promising avenue….there is little scope for more revenue to be raised by increasing this rate.”

    As Fraser Nelson pointed out in November, they assume in the work that the responsiveness to tax rate changes is the same now as in the 1980s. In reality, mobility is likely to be far more significant today – worsening the revenue potential of the rate change further.

    The Treasury, by now, should have been able to assess the effect that the introduction of the 50p rate has had on revenues. If they have reached the same conclusion as both the IFS and the TPA, then they should scrap the rate immediately.

    Removal of the rate was described as “toxic” by one cabinet source this week  - but if its imposition is actually costing the exchequer money whilst at the same time acting as a disincentive for the wealthy to live in the UK, then there does not appear to be a case for it.

    Politically, it will be a tough sell – and will be framed as a favour to the rich. But can we really afford to persist with a punitive tax rate if it worsens - rather than improves - the government finances?

    Ryan joined the Centre for Policy Studies in January 2011, having previously worked for a year at the economic consultancy firm Frontier Economics.

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