In a sign of the times, the government in the United Kingdom is talking about increasing the top tax rate from 40% to 50% to fund part of their burgeoning budget deficit. A few points about this they may have forgotten:
- High income earners are likely to be more responsive to an increase in tax rates (at the margin) – as a result, by increasing tax rates at the top, we are pushing our most talented workers out of the labour force,
- The deadweight loss of taxation increases at a faster than linear rate – implying that for each 1% of tax we add we get a greater level of lost surplus than for the previous 1%.
- Highly skilled labour is more mobile – as a result, a lift in tax rates for the highly skilled will lead to them moving overseas. When the UK does this it is a good thing for countries like Aussie and NZ – but not for the UK.
- Highly skilled labour is able to “move income about” more easily. For example, if the corporate tax rate remains well below 50%, highly skilled individuals may find ways to set up companies and shift part of their income into the corporate tax bracket (Note this relies on being able to include a lot of spending as a business expense methinks). When this occurs corporate tax take will rise, but the increase in income tax revenue will be much weaker than expected.
- An income tax is also a “tax on business” – the relative split depends on the “incidence of tax”. As a result, a lift in the top tax bracket implies that there will be more pressure on firms that hire skilled labour – not really the best move when these industries are already credit constrained …
- By increasing the tax on income we will drive down the incentive to invest.
- Skilled and unskilled workers are complements – by reducing the incentive to hire skilled workers, you also reduce the incentive to hire unskilled workers. As a result this will drive down demand for unskilled workers, lowering wages and increasing unemployment.
Thank goodness economic policy in New Zealand makes more sense 😉