Many people are dubious of the behavioural changes attributed to tax cuts, particularly cuts to taxes which primarily benefit wealthier individuals. This reaction is perhaps at its most pronounced when it is claimed that higher taxes on investment bankers will result in a mass exodus from the City of London to Frankfurt, New York or Geneva.
How much do high earners really respond to increases in tax rates by moving abroad? A new paper by Henrik Kleven and Camille Landais of the LSE and Emmanuel Saez of UC Berkeley attempt to answer this question by looking at perhaps the only class of individuals who can claim to be both richer and more widely despised than investment bankers: professional footballers.
They look at two tax reforms in Denmark and Spain. Both introduced preferential tax treatment for foreign workers with the intention of attracting high-skilled immigration (ironically the Danish tax cut was intended to attract top quality scientists). A knock-on effect was that foreign footballers would pay a substantially lower rate of tax compared to their domestic counterparts.
Focussing on the higher profile case of Spain, the effect was that, in 2004, the rate of income tax paid by foreign footballers fell from 43% to 24%. The authors find dramatic effects. The proportion of foreign footballers in the Spanish first division grew much faster than in other, similar countries whose tax systems were unchanged.
Interestingly, the authors find that there was also an affect on the quality of foreign players in the Spanish league. Because football club’s demand for players is limited (only eleven can be on the pitch at any one time!) the effect of the tax reform was that Spanish clubs could afford to replace lower quality Spanish and foreign players with high quality foreigners: the quality of players in the league, as measured by the proportion who had played international football, also increased dramatically in comparison to other countries.
The authors also find suggestive evidence that tax reforms can affect clubs’ performance in European competition. Prior to the 1995 Bosman ruling by the European Court of Justice which removed numerous regulations on football clubs (in particular one that limited the number of non-domestic players to three per team) there was no correlation between a country’s top rate of tax and its clubs’ performance in European competition. After the ruling there is a strong negative correlation: clubs from low tax economies perform better in the UEFA Cup and Champions League.
So, the claim that high-earners move abroad in large numbers in response to tax increases, seems to have some truth behind it. While footballers are obviously a special case (they are highly geographically mobile and work for firms that have very rigid demand for employees) so that the effects in the paper probably represent an upper bound on the size of the effect in other industries, there are still natural implications for how the government should tax industries, like private equity and hedge funds, which pay huge salaries to a multinational work force that can move between countries relatively easily.
The paper also has some implications for how upcoming tax reforms in France might have unintended consequences for the football industry. President Hollande intends to introduce a new 75% rate of tax on earnings above 1m Euros. Initially there were rumours that footballers and other athletes would be exempt, but this no longer appears to be the case. However, there are now suggestions that the tax will be watered down by allowing married couples to pool their income so that they will pay the new rate only once their joint incomes exceed 2m Euros.
If this is true we can expect two responses: