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John Simkin

Income Tax: The Laffer Curve

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It is estimated that a 50% tax band for incomes over £100,000 would raise £5bn. However, Tony Blair argues that it would not raise as much as this as the wealthy would avoid paying this extra tax by exploiting loopholes in the tax system. This seems an amazing thing for any prime minister to say. If that is the case, why don’t the government close those loopholes?

In an interview yesterday Tony Blair said: Every single piece of analysis that has ever been done indicates that… large numbers of those taxpayers… would hire a whole lot of new accountants to do this and that. And actually your tax take would be a lot less.” This is of course the argument that was used by that other conservative prime minister, Margaret Thatcher. However, as Richard Adams points out in an excellent article in today’s Guardian, this is not true. What Blair is referring to is the Laffer Curve This was a theory proposed by the American economist, Arthur Laffer, in 1974. The idea is that growth in tax revenue falls away after a certain point, as higher rates of tax give people less incentive to work and a stronger incentive to evade paying. This argument is very appealing to those right wing politicians who seek to protect the wealth of the rich. However, Laffer never actually stated when this point was reached. What we do know is that he was referring to those tax rates of over 90% that was fairly common in some European countries in the 1970s. He definitely was not talking about a 50% tax band.

As Richard Adams points out, the very rich, already officially live in tax havens. Those earning £100,000 do not have that option. Even someone earning £250,000 a year would only pay an extra £20,000 a year if the top tax band was increased from 40% to 50%. This is not enough to get them to flee the country.

In the last election Tony Blair argued that he was against raising the top rate of income tax because he did not want to force people like David Beckham to leave the country. Britain’s upper rate remains at 40% but Beckham still decided to move to Spain. He does not seem particularly concerned that the top rate of income tax in Spain is 50%.

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John you have touched on a difficult topic within what is widely known as macroeconomics. Research suggests that the marginal rate of income tax paid by those who are considered 'rich' seldom reaches the levels Dennis Healey called for when he wanted to squeeze money from the wealthier residents of UK. In reality those who would fall into the top brackets will engage someone to navigate through loopholes. Put simply their fee must be less, one imagines considerably less than the potential tax liability. Each move to tighten tax legislation seems to breed even more devious tax lawyers and advisers. As you rightly say the really rich do not even live here for more than 180 days a year as that makes them a UK resident and liable for earned income to be taxed at our rates. I imagine Beckham is owned by a leasing company, as an asset and leased to Real Madrid. Such a company will doubtless not be registered in Spain and will pay their costly image builder via an account in Zurich - indeed, I wonder where his earnings for all other activities than football are registered?. One thing I have learnt from working in various developing economies is that those who acquire riches seldom fancy sharing them.

I also feel that Blair is accepting the mantle of post Thatcher with an air of resignation (not yet literally) in that he inherited a country that will not accept extra taxes. The Liberal Democrats always talk about them but know that their representation at Westminster will never force a coalition partner to accept this proposal as one that will ensure some form of power sharing. Howard is just waiting for Kelly and tuition fees to die down and the 'stealth tax' war will burst into action - just in time for the local and European elections. It's a dirty game politics and its exponents seldom intend to score an own goal over tax proposals.

Best wishes,

John

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One thing I have learnt from working in various developing economies is that those who acquire riches seldom fancy sharing them.

I also feel that Blair is accepting the mantle of post Thatcher with an air of resignation (not yet literally) in that he inherited a country that will not accept extra taxes.

Newspaper proprietors such as Rupert Murdoch and Conrad Black are constantly telling us that the British public is not willing to pay higher income taxes. It is true no one likes paying taxes. However, it is necessary to consider what types of taxes. The rich are particularly opposed to high rates of taxes on high income earners. They do not mind the regressive taxes that have been imposed on the British people over the last 20 years (in fact, that is what they have been campaigning for). I am pretty certain that any public opinion poll on the proposed increases in tax on people earning over £100,000 would have the support of the overwhelming majority of the population.

There is a myth that no political party can win an election if it proposes an increase in taxation. It is pointed out that Franklin D. Roosevelt won four presidential elections promising the American people that he intended reducing taxation. After every election taxes went up. Yet still people continued to vote for him. The reason was that people knew they were better off paying higher taxes under Roosevelt than lower taxes under a Republican president. After all, under Hoover, so many of them had little opportunity to pay taxes.

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John, do you know that the Spanish government has passed a law about reducing taxes to high specialist foreign workers? David Bekham is included. Probably he will pay proportionally less taxes that most of us. I am aware he didn't know that by the time he moved to Madrid, or did he?

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I am pretty certain that any public opinion poll on the proposed increases in tax on people earning over £100,000 would have the support of the overwhelming majority of the population.

You bet on it! Why it is so? Because the majority pretty well know that it´s not them who will pay these taxes.

It’s always easy to spend others money.

"Don’t tax me tax the guy behind the tree" is probably a most common opinion among ordinary people.

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