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Why we should cut the 45p rate

    In a recent article in the Times, David Cameron announced that he would not touch the 45p tax rate, instead reaffirming his emphasis on raising the personal allowance and the thresholds for lower tax bands. While reductions in tax at these lower levels is commendable, it is vital that the 45p rate is reduced back to 40p sooner rather than later, bringing it back to level which had existed since 1988 until Alistair Darling introduced the 50p rate in his 2009 budget. 

    This is not about going back to the status quo which had existed for this fortunate 1% of the population before the financial crisis. Indeed, this is no doubt what George Osborne fears will be the general public perception (with good reason given the backlash he faced when he reduced the top rate from 50p to 45p to the pound in the 2012 ‘omnishambles’ budget). It is instead about having a meritocratic society where the successful are not ideologically attacked by a tax bringing little benefit in the short run, as reports have shown, and, most probably, causing damage for the economy in the long run.

    A study by HMRC in 2012 showed that a reduction in the top rate of tax from 50p to 45p, which would cost the treasury an estimated £3.5 billion in 2015-16 if there were no behavioural changes, would actually only cost an estimated £100 million. This was calculated by estimating a TIE, a ‘’taxable income elasticity’’, which takes into account all the behavioural effects of changing a tax, such as the decreased incentive to avoid or evade. Their TIE was 0.45, a relatively cautious estimate based on IFS research taken during the last major tax changes the UK faced at the top end in the 1980s, and if we raise that elasticity to 0.55 – which is certainly not impossible given the increased labour mobility which has emerged since the time of the IFS research, it is found that the Exchequer would have actually raised about £600 million.

    These results led the OBR chairman to state that the 50p tax, was ‘strolling on the summit of the Laffer Curve’. Indeed, I would say that the 50p tax, and perhaps even today’s 45p tax, is falling down the far side of the theoretical mountain – a theory which has been given yet more evidence by this HMRC report. For the long term effects on economic growth of the tax are yet to be felt and, as it becomes clearer to people that the tax rate is a permanent feature, the amount of taxable income will be reduced, as these people may retire – about 30% of people earning above £150,000 are over the age of 55 (the minimum age at which pensions can be withdrawn), they may operate in another country given that jobs at this wage are in an internationally competitive labour market, and, as has been mentioned, more people will tax evade.

    Reducing the 45p tax rate to 40p is therefore needed for the country as a whole, not just the 1% of the population that is directly affected by it, especially given that these people pay between 25-30 per cent of all income tax. As part of his plans to reduce the deficit, the Chancellor of the Exchequer looks to reduce tax evasion and avoidance by about £5 billion, and by lowering taxes, he reduces the incentive to do so. We do not need total taxable incomes for people earning above £150,000 to fall by £29 billion, as they had done after the introduction of the 50p tax, when we have a deficit to cut. Instead we want the 1 per cent raise in GDP per capita estimated by the OECD that a 5 percentage point reduction in the marginal income tax would create3. Osborne could only do half the job in the last Parliament, largely because of the Liberal Democrats, but now it is time that an inefficient, potentially damaging and anti-meritocratic policy is finally ended.

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