This piece was originally published by the Telegraph online.
We now know that the Labour Party manifesto will set out plans to hike income taxes for those earning above £80,000. This would, argues John McDonnell, introduce a “fair taxation system to pay for our public services”.
Are high earners paying their fair share of income tax? The answer, of course, depends on who you ask. But it is indisputable that, since 2010, they are paying a much greater proportion of income tax, while the contribution of basic rate taxpayers has been dramatically reduced.
Let's look at the recently published breakdown of income tax receipts from 2014/15. During the Coalition years, the income tax revenue received from basic rate taxpayers collapsed from nearly half of all receipts to just over a third. Benefiting from the huge increase in the personal allowance, basic rate taxpayers now contribute £12.2bn less in income tax every year. On the other hand, taxpayers caught by the 40p rate of income tax now pay considerably more. Over those five years, 1.3 million more people were dragged into this tax band, leading to an increase in receipts of around £14bn per annum.
Yet even more surprising is the trend in payments from additional rate taxpayers – the so-called “top 1 per cent”. Against a great deal of opposition, George Osborne cut this additional rate of tax for those earning above £150,000 from 50p to 45p in 2013-14. Receipts from additional rate taxpayers then jumped by £8bn in that financial year.
Of course, much of this was due to the deferral of income. Yet the increase in receipts was sustained in the following financial year, suggesting significant benefits for the Exchequer from competitive tax rates. Despite the cut in rate, additional rate taxpayers have gone from paying under 23 per cent of total income tax receipts to a whopping 28 per cent.
The increase is welcome in many respects. But it does also, of course, pose risks. It means that public finances are increasingly reliant on a small group of taxpayers. Adding to that concern is that this group of taxpayers is the most mobile of them all, with countries around the world competing to attract them.
Labour mobility in general has increased over the past two decades, and it is widely accepted that individuals with higher incomes are more responsive to changes in tax rates. Evidence suggests that those with the very highest earnings are even more mobile. In 2014, it was reported that the top 0.1 per cent of earners (around 30,000 people) pay 11 per cent of total income tax receipts, equating to well over £20bn. The decision of a few thousand of these people to move overseas would cause significant problems for the UK’s tax base.
But how responsive are these high earning individuals to tax changes really? Is this all just hot air aimed at reducing taxation of the rich? There is significant uncertainty around this question, partly because, until 2010-11, the top rate of tax had not changed for over two decades. But there is no doubt that there are significant behavioural responses.
For example, when the 50p rate came in, HMRC estimated that around £16bn to £18bn of income was “forestalled” to avoid it – a much bigger response than was expected. And HMRC is clear that tax increases on the richest which become a permanent feature of the UK tax system will damage the UK’s attractiveness to start and grow a business.
Of course, increasing these taxes for the highest earners is popular with the public. A YouGov poll commissioned in 2014 suggests that over 60 per cent of Britons back increasing the top rate to 50p. But there are huge risks to doing so.
The cut to 45p has meant that the richest 1 per cent of individuals are now paying more in income tax receipts, both in cash terms and proportionally, than at almost any point since 1980. The consequences of driving them away would be severe – a reduction in the income tax receipts received by the Treasury, not to mention the damage to the UK economy’s competitiveness.
Meanwhile, permanent increases in taxes for high earning individuals could raise additional revenue – nut in the scheme of things, the amounts are miniscule. According to the 2013 Budget, reversing the 45p cut might only raise just over £100m a year.
So significant increases to income tax for higher earners can only really have two outcomes. One is miniscule benefits for the Exchequer; the other is disastrous consequences for the whole country. Why risk it?