Peter Young is a fiscal policy adviser to the Adam Smith Institute.
In justifying his decision to cut the top rate of income tax to 45% George Osborne relied upon the report from HM Revenue and Customs (HMRC) on the revenue effect of the 50% additional rate. This report deserves to be much more widely read, especially given some of the ill-informed if not plainly silly commentary on the Chancellor’s decision. Indeed it is surprising, given the strength of the arguments in the HMRC report, that Osborne did not make the full cut to 40%, rather than the 45% compromise.
HMRC was asked to report on the revenue or exchequer effect of the 50% rate, and concluded that the last Government’s estimates of the amounts that it would raise were vastly exaggerated. “The underlying yield ….is much lower than originally forecast….and it is quite possible that it could be negative,” said HMRC, who condemn the 50% rate as “a highly distortionary form of taxation.”
HMRC’s report makes many of the same points as the Adam Smith Institute report on the revenue effects of the 50% rate which Miles Saltiel and I produced over a year ago. They highlight its damaging migration effects, which are today much more pronounced given increased international labour mobility, “which means that the adverse effect of high rates of personal taxation on both inward and outward migration to the UK and tax revenues can be significant.”
The report highlights the key role in creating economic growth of both highly skilled workers and FDI: “High marginal rates of income tax risk weighing on the growth potential of the economy by deterring the most highly productive individuals from living and working in the UK, and through deterring the foreign direct investment that can be an important element in the diffusion of new technologies and techniques”.
HMRC stress that the longer the higher rates remain in place the greater the economic damage that will be caused. The reports highlights data showing that our tax rates have become globally very uncompetitive, with the top rate being “over ten per cent higher than the average of other top central Government rates in the G7 and EU-27 and over fifteen per cent higher than the average in the rest of the G20”. The conclusion one draws from the data is that our top rate needs to be no more than 35% -not 45/47%.
HMRC were asked to look at the exchequer effect of the 50% rate, but in their conclusion point to the far more important economic effect: “The impacts of increasing the highest rates of tax may extend well beyond the direct Exchequer impacts. In particular, other things equal, high tax rates in the UK make its tax system less competitive and make it a less attractive place to start, finance and grow a business. The longer the additional rate remains in place the more people are likely to consider it a permanent feature of the UK tax system and the more damaging it would be for competitiveness. This suggests the negative impact on GDP may increase over time, and therefore the direct yield (and revenues from other tax bases) might fall over time toward or beyond zero”.
The essential point is that the broader impact of uncompetitive rates on the economy is much more important than the narrower revenue impact. Revenues will fall in the short term, as they have done, but they will do so much more over the longer term, as economic growth weakens and Britain becomes a poorer country. It is just a shame that the Chancellor did not use the opportunity presented by the HMRC report to scrap the additional rate altogether. The remaining 47% rate will still encourage tax avoidance and result in lower revenues. As HMRC make clear, the longer such uncompetitive rates remain in place the greater the economic damage that is caused.
The political objective must now be to secure properly competitive tax rates, and that means not just the abolition of the 45% top rate (actually 47% including NI) but also substantial reductions in the 40% rate, which will soon be paid by an amazing 5 million people. All the international evidence shows that cutting high tax rates boosts both revenue and growth. We should thank HM Customs and Excise for their excellent report which provides further evidence that this is indeed the case.